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EX-21 - SUBSIDIARIES OF CRC HEALTH CORPORATION - CRC Health CORPdex21.htm
EX-12 - STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - CRC Health CORPdex12.htm
EX-31.2 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - CRC Health CORPdex312.htm
EX-4.1K - TENTH SUPPLEMENTAL INDENTURE - CRC Health CORPdex41k.htm
EX-32.1 - SECTION 1350 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - CRC Health CORPdex321.htm
EX-32.2 - SECTION 1350 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - CRC Health CORPdex322.htm
EX-10.2K - FORM OF SUPPLEMENT NO. 11 - CRC Health CORPdex102k.htm
EX-10.3K - SUPPLEMENT NO. 11 - CRC Health CORPdex103k.htm
EX-31.1 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - CRC Health CORPdex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

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

For the fiscal year ended: December 31, 2009

or

 

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

For the transition period from              to             

Commission file number 333-135172

 

 

CRC HEALTH CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   73-1650429

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer
Identification No.)
20400 Stevens Creek Boulevard, Suite 600, Cupertino, California   95014
(Address of principal executive offices)   (Zip code)

(877) 272-8668

(Registrant’s telephone number, including area code)

 

 

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

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

 

 

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  x    No  ¨

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

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

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

The total number of shares of the registrant’s common stock, par value of $0.001 per share, outstanding as of March 24, 2010 was 1,000.

Documents incorporated by reference: exhibits as indicated herein

 

 

 


Table of Contents

CRC HEALTH CORPORATION

INDEX

 

          Page
   PART I   

Item 1.

   Business    3

Item 1A.

   Risk Factors    14

Item 1B.

   Unresolved Staff Comments    24

Item 2.

   Properties    25

Item 3.

   Legal Proceedings    27

Item 4.

   Reserved    27
   PART II   

Item 5.

  

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

   28

Item 6.

   Selected Financial Data    28

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    30

Item 7A.

   Quantitative and Qualitative Disclosure about Market Risk    43

Item 8.

   Financial Statements and Supplementary Data    44

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

   95

Item 9A.

   Controls and Procedures    95

Item 9B.

   Other Information    96
   PART III   

Item 10.

   Directors, Executive Officers and Corporate Governance    97

Item 11.

   Executive Compensation    100

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   109

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    112

Item 14.

   Principal Accountant Fees and Services    113
   PART IV   

Item 15.

   Exhibits, Financial Statements Schedules    115

Signatures

   121

 

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Forward-Looking Statements

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

PART I

 

ITEM 1. Business

Overview

We are a leading provider of substance abuse treatment services and youth treatment services in the United States. We also provide treatment services for other addiction diseases and behavioral disorders such as eating disorders. We deliver our services through our two divisions, our recovery division and our 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 healthy living division provides therapeutic educational programs for underachieving young people through residential schools and wilderness programs. Our healthy living division also provides treatment services through its adolescent and adult weight management programs and its eating disorder facilities. As of December 31, 2009, our recovery division operated 100 treatment facilities in 21 states and treated approximately 27,500 patients per day, which we believe makes us the largest and most geographically diversified for-profit provider of substance abuse treatment. As of December 31, 2009, our healthy living division operated 42 programs in 15 states and two foreign countries. During the 2009 calendar year, the healthy living division enrolled approximately 4,500 students from families from all 50 states of the United States and from 120 foreign countries. Since our inception in 1995, we believe that we have developed a reputation for providing outstanding services and care and as a result have become a provider of choice throughout the communities we serve.

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

 

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Industry Overview

Addiction Disorders

Addiction is a chronic disease that adversely affects the lives of millions of Americans. One of the most common and serious addictions is substance abuse, which encompasses the abuse of alcohol and drugs. Without treatment, substance abuse can lead to depression, problems at home or work, and in some cases, physical injury or death. In 2003, expenditures for treatment of substance abuse in the United States totaled $21.0 billion and is projected to increase to $35.0 billion in 2014 (U.S. Department of Health and Human Services). In 2008, 23.1 million persons aged 12 or older needed treatment for an illicit drug or alcohol abuse problem (9.2% of persons aged 12 or older in the U.S.). Of these, 2.3 million (9.9% of those who needed treatment) received treatment at a specialty facility. Thus, 20.8 million persons (8.3% of the population aged 12 or older) needed treatment for an illicit drug or alcohol use problem but did not receive treatment at a specialty substance abuse facility in 2008 (2008 National Survey on Drug and Health sponsored by the Substance Abuse and Mental Health Services Administration). Furthermore, there is increasing recognition by private and public payors that failure to deliver early treatment for substance abuse and other behavioral issues generally results in higher acute-care hospital costs and can compound the negative effects of these issues over time. Treatment providers for the large and growing behavioral healthcare market, at both the adult and adolescent levels, are highly fragmented, with services to the adult population provided by almost 14,000 facilities of which only 25% are operated by for-profit organizations (2007 National Survey on Substance Abuse Treatment Services sponsored by the Substance Abuse and Mental Health Services Administration), and with services to the adolescent population provided primarily by single-site competitors and a handful of competitors of significantly lesser size. Due in part to the regulatory and land use hurdles of opening new substance abuse treatment facilities, we believe that supply of residential substance abuse treatment and therapeutic education services is constrained in the United States as evidenced by high industry-wide utilization rates.

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

Adolescent Behavioral Disorders

According to the 2008 National Survey on Drug Use and Health (NSDUH), in 2005 and 2006, an estimated 8.7 million (34.5%) youths aged 12 to 17 reported that they engaged in at least one delinquent behavior in the past year, and from 2008 report NSDUH, “Major Depressive Episode among Youths Aged 12 to 17 in the U.S.: 2004 to 2006”, approximately 2.1 million adolescents, or 8.5% of the population had at least one major depressive episode. While the majority of adolescents successfully cope with these issues on their own, there are a growing number of adolescents who need help and support to successfully transition to a productive adulthood. Other developmental challenges faced by adolescents include learning disabilities, such as attention deficit hyperactivity disorder and obesity. According to the National Resource Center on Attention Deficit Hyperactivity Disorder, this condition affects 3% to 7% of school-age children, who in relation to their peers have higher rates of psychiatric and behavioral disorders. The National Health and Nutrition Examination Survey reports that approximately 16% of the population between the ages of 6 and 19 are overweight.

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

 

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Eating Disorders

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

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

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

Our Business

We deliver our services through our recovery and healthy living divisions. Effective January 1, 2009, we realigned our operations and internal organizational structure by combining our “youth division” with our “healthy living division.” Performance of our two reportable segments (recovery division and healthy living division) is evaluated based on profit or loss from operations (“segment profit”).

Recovery division

Our recovery division provides treatment services both on an inpatient and outpatient basis to patients suffering from chronic addiction diseases and related behavioral disorders. We operated 31 inpatient facilities and 15 outpatient and 54 comprehensive treatment clinics in 21 states as of December 31, 2009. The majority of our treatment services are provided to patients who abuse addictive substances such as alcohol, illicit drugs or opiates, including prescription drugs. Some of our facilities also treat other addictions and behavioral disorders such as chronic pain, sexual compulsivity, compulsive gambling, mood disorders and emotional trauma.

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

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

 

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modalities are used in our treatment programs to support the individual, including the twelve step philosophy, cognitive/behavioral therapies, supportive therapies and continuing care.

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

Inpatient/Residential Treatment. We operated 31 residential facilities in 11 states. On average, our residential facilities have been operating for over 20 years. We have established strong relationships with referral sources and have longstanding ties to the local community and an extensive network of former patients and their families. Our residential treatment services are provided in a peaceful setting that is removed from the pressures, pace and temptations of a patient’s everyday life. Our inpatient facilities house and care for patients over an extended period (22 days on average) and typically treat patients from a broadly defined regional market. As of December 31, 2009, we had 1,923 available beds in our residential and extended care facilities and treated approximately 1,500 patients per day.

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

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

Outpatient and Intensive Outpatient Services. We provide outpatient substance abuse services at 69 treatment clinics in 17 states. Our clinics, which typically range in size from 3,000 to 7,000 square feet, are generally located within light commercial districts. As of December 31, 2009, our clinics treated on average approximately 25,900 patients on a daily basis.

During 2009, substantially all of our outpatient services were provided to individuals addicted to heroin and other opiates, including prescription analgesics. In 2009, 35 comprehensive treatment clinics were certified to provide at least one additional comprehensive outpatient substance abuse treatment service, which we refer to as our COSAT services.

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

 

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

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

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

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

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

Staffing and Local Management Structure. Our residential facilities are managed by an executive director experienced in substance abuse treatment services. Our executive directors have, on average, over 24 years of experience in healthcare and over ten years tenure at the treatment center they currently manage. The executive director is supported by a facility staff that consists of physicians, nurses, counselors, marketing professionals, reimbursement specialists, and administrative and facility maintenance employees. Our comprehensive treatment clinics are typically run by a clinic director experienced in substance abuse treatment services. A clinic director is supported by a staff that consists of a medical director, nurses, counselors and administrative employees.

Healthy living division

Our healthy living division provides a wide variety of therapeutic educational programs for adolescents through settings and solutions that match individual needs with the appropriate learning and therapeutic environment. Additionally, our healthy living division provides treatment services for eating disorders and obesity, each of which may be effectively treated through a combination of medical, psychological and social treatment programs.

Adolescent Services. We operated 24 programs in 8 states as of December 31, 2009, with services ranging from short-term intervention programs to longer-term residential treatment. Our programs are offered in boarding schools, residential treatment centers, outdoor experiential programs and summer

 

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camps. These programs exist at the intersection of education and therapy for adolescents who have demonstrated behavioral or learning challenges that are interfering with their performance in school and in life such as substance abuse, academic underachievement, anger and aggressive behavior, family conflict, special learning needs and depression. Since most of the targeted customer base for these programs faces a wide range of interrelated academic, emotional and behavioral disorders, our ability to offer a seamless continuum of care for a multitude of problems is an important competitive differentiator for us. All of our residential programs and approximately one half of our outdoor programs are accredited by an educational accreditation program, such as the Southern Association of Colleges and Schools (SACS). We are also in the process of pursuing CARF accreditation for a number of our adolescent programs.

Adolescent Residential Programs. We operated 17 residential programs in 7 states as of December 31, 2009. These programs are typically operated in traditional boarding school environments where a unique plan is crafted for each student that combines group therapy, individual counseling and specialized therapeutic experiences, such as equine therapy, which are designed to build the student’s personal and emotional skills. We treat both adolescents and young adults in our residential programs. Our residential programs provide a range of services. Our programs focus primarily on therapeutic programming and a strong peer environment to help students overcome self-defeating behaviors and acquire and practice positive behaviors. In addition, we have a number of programs that are tailored to students with attention deficit hyperactivity disorder, learning disabilities or acute emotional issues, and offer structured education in an intimate academic environment that emphasizes personalized student attention and development of organizational and social skills. Parent seminars and family resolution conferences play an important role in building mutually respectful and responsible relationships and preparing the student to face the real world challenges they face upon completion of the program. Each of our residential programs follows an accredited middle school, high school or college preparatory curriculum over a length of stay ranging from one to 17 months with an average duration of approximately nine months. Admissions are accepted year-round, subject to capacity, and campus sizes range from 17-132 students at both single gender and co-ed campuses.

Adolescent Outdoor Programs. We operated 7 outdoor programs in 4 states as of December 31, 2009. Outdoor programs emphasize student exposure to, and interaction with, natural environments and are based on either a base camp format, where students are housed in fixed structures between camping expeditions, or an expedition-only format. These programs are designed for adolescents and/or young adults who have typically undergone an acute personal crisis and require immediate intervention in a short-term, high-impact therapeutic program that emphasizes experiential learning and individualized counseling as a catalyst for positive behavioral change. Students enrolled in an outdoor program experience the challenges of living and working together in the outdoors as a means of identifying and working through internal conflicts and emotional obstacles that have kept them from responding to parental efforts, schools and prior treatment. In some cases, academic credit is offered upon completion of the program.

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

Adolescent Staffing and Local Management Structure. A typical youth treatment program is managed by an executive director experienced in education or other clinical areas, and many of our executive directors hold post-graduate degrees. Our executive directors have on average over 17 years of experience in education/healthcare and over seven years tenure at the treatment center they currently manage. The executive director is supported by a staff that consists of therapists, clinical professionals, teachers, counselors, field staff, admissions, finance and operational personnel as well as administrative and maintenance employees.

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

 

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Eating Disorder Treatment and Weight Management Services

Eating Disorder Treatment. We operated 4 residential eating disorder facilities/programs in 3 states as of December 31, 2009. The total number of beds as of December 31, 2009 was 36. Our residential facilities are located in home-like settings with scenic and peaceful surroundings and provide individuals with a variety of treatment options focusing on their individual needs. The full range of services includes residential inpatient, day program and intensive outpatient treatment for anorexia nervosa, bulimia nervosa, binge eating and related disorders. All of our residential facilities are accredited by CARF, making them eligible for reimbursement by third party payors.

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

Structure House, our residential weight loss facility for adults offers a behavioral approach to weight loss and healthy lifestyle change. As of December 31, 2009, this facility had 92 available beds. Emphasizing a medically sound approach to healthy living, Structure House provides individual nutrition counseling, behavioral workshops, exercise and individual sessions with a psychologist to empower participants and teach them how to integrate healthy eating principles into their daily lives.

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

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

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

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

Staffing and Local Management Structure. A typical eating disorder or adult weight management residential facility is managed by an executive director experienced in treatment services. Our

 

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

Competition

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

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

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

Technology Infrastructure

We utilize computer systems for billing, general ledger and all corporate accounting. As of December 31, 2009, we expect to invest $5.0 million over the next 24 months to finalize implementation of a company-wide customer relationship management system, to expand our data centers, and to continue our investment, initiated in 2007, for the implementation of a comprehensive and fully integrated system encompassing clinical, marketing, regulatory, financial and management reporting systems.

Regulatory Matters

Overview

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

The laws and regulations that affect healthcare providers are complex, change frequently and require that we regularly review our organization and operations and make changes as necessary to comply with the new rules. Significant public attention has focused in recent years on the healthcare industry, directing attention not only to

 

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the conduct of industry participants but also to the cost of healthcare services. In recent years, there have been heightened coordinated civil and criminal enforcement efforts by both federal and state government agencies relating to the healthcare industry. The ongoing investigations relate to, among other things, various referral practices, cost reporting, billing practices, credit balances, physician ownership and joint ventures involving hospitals and other health care providers. We expect that healthcare costs and other factors will continue to encourage both the development of new laws and increased enforcement activity.

Licensure, Accreditation and Certification

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

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

Our healthy living, adolescent treatment programs and adolescent weight management programs must comply with state and local laws that vary based on the locations in which they operate. A typical adolescent youth services or adolescent weight management program will be subject to licensure by the state department of education or health services, as well as local land use and health and safety laws. In addition, approximately one half of our youth treatment programs are accredited by an educational accreditation program, such as the Southern Association of Colleges and Schools (SACS). We are also in the process of pursuing CARF accreditation for a number of our adolescent treatment programs. A number of our youth programs within our healthy living division maintain federal land use permits for their outdoor education and ranching activities.

Our eating disorder facilities within the healthy living division are subject to licensure by the state department of health services. In addition, the facilities and programs that are accredited must comply with the guidelines of the applicable accrediting agencies.

We believe that all of our facilities and programs are in substantial compliance with current applicable federal, state and local licensure and certification requirements. In addition, we believe that all are in compliance

 

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with the standards of the agencies, including JCAHO and CARF, which have accredited them. Periodically, federal, state and accreditation regulatory organizations conduct surveys of our facilities and may find from time to time that a facility is out of compliance with certain requirements. Upon receipt of any such finding, the facility timely submits a plan of correction and corrects any cited deficiencies.

Fraud, Abuse and Self-Referral Laws

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

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

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

The Federal False Claims Act

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

 

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

Privacy and Security Requirements

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

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

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

Health Planning and Certificates of Need

The construction of new healthcare facilities, the expansion of existing facilities, the transfer or change of ownership of existing facilities and the addition of new beds, services or equipment may be subject to state laws that require prior approval by state regulatory agencies under certificate of need laws. These laws generally require that a state agency determine the public need for construction or acquisition of facilities or the addition of

 

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new services. Review of certificates of need and other healthcare planning initiatives may be lengthy and may require public hearings. Violations of these state laws may result in the imposition of civil sanctions or revocation of a facility’s license. The states in which we operate that have certificate of need laws include Indiana, West Virginia and North Carolina.

Local Land Use and Zoning

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

Corporate Practice of Medicine and Fee Splitting

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

Employees

As of December 31, 2009, we employed approximately 4,405 people throughout the United States. Approximately 3,965 of our employees are full-time and the remaining approximately 440 are part-time employees. There were approximately 2,781 employees in our recovery division and 1,471 employees in our healthy living division. The remaining approximately 153 employees are in corporate management, administration and other services. Certain of our employees are represented by a labor union.

Available Information

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

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

 

ITEM 1A. Risk Factors

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

 

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Business Risks

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

Economic conditions have negatively impacted our revenues. If the economic downturn continues or deteriorates further or if other adverse economic conditions arise such as inflation, it could have a material adverse effect on our business. Tightening credit markets, depressed consumer spending and higher unemployment rates continue to pressure many industries. Substantially all of the revenue from our healthy living division and certain residential treatment facilities such as Sierra Tucson and our extended care facilities is derived from private-pay funding. In addition, a substantial portion of our revenue from our comprehensive substance abuse treatment clinics is from self-payors. In 2009, we experienced a significant decrease in demand for services in our healthy living division as a result of declining economic conditions and the inability of families to access the credit markets to fund tuition. A sustained downturn in the U.S. economy has, and could continue to, restrain the ability of our patients and the families of our students to pay for our services in all of our divisions. Other risks that we face as a result of general economic weakness include potential declines in the population covered by health insurance and patient decisions to postpone care. Moreover, reduced revenues as a result of a softening economy may also reduce our working capital and interfere with our long-term business strategy.

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

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

We are highly leveraged. The following chart shows our level of indebtedness as of December 31, 2009 (in thousands):

 

Term Loans and Revolving Line of Credit (1)

   $ 452,149

Senior Subordinated Notes

     175,690

Other

     3,237
      

Total Debt

   $ 631,076
      

Total Stockholder’s Equity

   $ 288,542
      

 

(1) In addition, as of December 31, 2009, we had $8.9 million of letters of credit outstanding under our revolving line of credit leaving approximately $44.6 million available for additional borrowings under our revolving credit facility. The revolving line of credit commitment expires on February 6, 2012.

Our parent company has incurred $147.4 million of indebtedness as of December 31, 2009 pursuant to which an interest payment of $80 million is due in May 2012. Additionally, we had additional indebtedness related to discontinued operations of $2.1 million in seller notes and $0.1 million in lessor financing. During 2009 we incurred $44.2 million in interest expense on our indebtedness including term loans, revolving line of credit, seller notes, senior subordinated notes and interest rate swaps. At December 31, 2009, we recognized a liability of $8.7 million related to its interest rate swaps. Our substantial indebtedness and the indebtedness of our parent company could make it more difficult for us to satisfy our obligations with respect to our indebtedness, increase our vulnerability to general adverse economic and industry conditions, require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes, limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, place us at a competitive disadvantage compared to our competitors that have less debt and limit our ability to borrow additional funds.

 

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

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

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

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

For 2009, we derived approximately 19.9% of our revenue from government programs and 80.1% of our revenue from non-government payors such as self pay, managed care organizations, private health insurance programs and labor unions. Government payors, such as Medicaid and Medicare, generally reimburse us on a fee-for-service basis based on predetermined reimbursement rate schedules. As a result, we are limited in the amount we can record as revenue for our services from these government programs, and if we have a cost increase, we typically will not be able to recover this increase. In addition, the federal government and many state governments are operating under significant budgetary pressures, and they may seek to reduce payments under their Medicaid programs for services such as those we provide. They also tend to pay on a slower schedule. Thus, while 19.9% of our revenue was attributable to governmental payors, such payors accounted for 38.3% of our gross accounts receivable as of December 31, 2009. Therefore, if governmental entities reduce the amounts they will pay for our services, or if they elect not to continue paying for such services altogether, our revenue and profitability may decline. In addition, if governmental entities slow their payment cycles further, our cash flow from operations could be negatively affected.

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

We are subject to restrictions that limit our flexibility in operating our business as a result of our debt financing agreements.

Our debt financing agreements contain a number of significant covenants that, among other things, restrict our ability to incur additional indebtedness, create liens on our assets, restrict our ability to engage in sale and leaseback transactions, mergers, acquisitions or asset sales and make investments. Under some circumstances, these restrictive covenants may not allow us the flexibility we need to operate our business in an effective and efficient manner and may prevent us from taking advantage of strategic and financial opportunities that could benefit our business. In addition, we are required under our senior secured credit facility to satisfy specified financial ratios and tests. Our ability to comply with those financial ratios and tests may be affected by events beyond our control, and we may not be able to meet those ratios and tests. A breach of any of those covenants could result in a default under our senior secured credit facility and in our being unable to borrow additional

 

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amounts under our revolving facility. If an event of default occurs, the lenders could elect to declare all amounts borrowed under our senior secured credit facility, together with accrued interest, to be immediately due and payable and could proceed against the collateral securing that indebtedness. Substantially all of our assets are pledged as collateral pursuant to the terms of our senior secured credit facility. In such an event, we could not assure that we would have sufficient assets to pay amounts under our secured indebtedness.

If we fail to comply with the restrictions in our debt financing agreements, a default may allow the creditors to accelerate the related indebtedness, as well as any other indebtedness to which a cross-acceleration or cross-default provision applies. In addition, lenders may be able to terminate any commitments they had made to supply us with further funds.

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligation to increase significantly.

Certain of our borrowings, primarily borrowings under our senior secured credit facility, are at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash flows would decrease.

Despite our current leverage, we may still be able to incur additional indebtedness. This could further exacerbate the risks that we face.

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

Unfavorable student loan markets and the lack of available credit have and could continue to negatively impact our revenues in our healthy living division.

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

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

For 2009, Pennsylvania facilities accounted for approximately 13.3% of our total revenue, our California facilities accounted for approximately 12.1% of our total revenue, our Arizona facilities accounted for approximately 11.0% of our total revenue, our North Carolina facilities accounted for approximately 10.8% of our total revenue, and our Utah facilities accounted for approximately 10.3% of our total revenue. If our treatment facilities in these states are adversely affected by changes in regulatory and economic conditions, our revenue and profitability may decline.

 

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

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

 

   

integrate operations and personnel at acquired programs;

 

   

retain key management and healthcare professional personnel;

 

   

maintain and attract patients and students to acquired programs;

 

   

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

 

   

realize our investment return on acquisitions.

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

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

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

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

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

Federal, state and local regulations determine the capacity at which our therapeutic education programs for adolescents may be operated. Some of our programs in our healthy living 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.

 

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In addition, federal, state and local regulations may be enacted that impose additional requirements on our facilities. For example, in 2008, Indiana passed legislation imposing new regulations affecting our operations. Further, in 2009, legislators in California, West Virginia and Pennsylvania sponsored legislation that could impact our operations and increase our operating expenses. In addition, U.S. Representative Miller introduced federal legislation in April 2008, which, if adopted, would impose an additional layer of federal regulation on all private residential and outdoor treatment programs for youth under the age of 18. Adoption of legislation or the creation of new regulations affecting our facilities could increase our operating costs, restrain our growth and harm our operating results.

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

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

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

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

Currently, we only have one facility represented by a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreements were significantly different from our current compensation arrangements, it could increase our costs and adversely impact our business. The Employee Free Choice Act of 2007 (“EFCA”), which was passed in the U.S. House of Representatives in 2008, or a variation of such bill could be enacted in the future and could have an adverse impact on our business.

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

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

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

The success of our business depends on our ability to identify, hire and retain a professional team of addiction counselors, nurses, psychiatrists, physicians, licensed counselors and clinical technicians across our network of treatment facilities. Competition for skilled employees is intense. For example, there are currently national shortages of qualified addiction counselors and registered nurses. The process of locating and recruiting

 

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skilled employees with the qualifications and attributes required to treat those suffering from addiction and other behavioral health illnesses can be lengthy and competition for these workers could cause the salaries, wages and benefits we must pay to increase faster than anticipated. Furthermore, many states require specified staff to patient ratios for residential and outpatient treatment facilities. If we are unable to identify, hire and retain sufficient numbers of qualified professional employees, or to continue to offer competitive salaries and benefits, we may be unable to staff our facilities with the appropriate personnel or to maintain required staff ratios and may be required to turn away patients. Certain of our treatment facilities are located in remote geographical areas, far from population centers, which increases this risk. These factors could increase our operating costs, restrain our growth and reduce our revenue.

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

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

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

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

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

For 2009, our Sierra Tucson facility represented approximately 9.5% of our total revenue and approximately 56.7% of our operating income before corporate and divisional overhead. Historically, our Sierra Tucson facility has had a high occupancy rate as well as a favorable average length of stay and price of treatment which made it our most profitable facility for 2009. As discussed above, we rely primarily on self payor patients at our Sierra Tucson facility. We have experienced a significant decrease in demand at certain facilities as a result of the inability of patients and students to pay for our services due to tightening credit markets and the downturn in the U.S. economy. Should Sierra Tucson’s revenues or profitability decline as a result of the inability or unwillingness of patients to pay for the services or for other reasons or its operations be interrupted, our total revenue and profitability would likely decline. For example, a terrorist act, significant terrorist threat or other disruption to air travel may reduce the willingness or ability of Sierra Tucson’s national and international patient base to travel to the facility or a fire or other casualty loss could interrupt its operations. These events could negatively affect our consolidated operating results.

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

Accidents resulting in physical injuries to our students or staff, or incidents that attract negative attention to the youth treatment industry generally, such as those involving death or criminal conduct against, or by a student could result in regulatory action against us, including but not limited to the suspension of our license, possible

 

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legal claims and lost referrals or student withdrawals. For example, at one of our youth programs within our healthy living division, we received notice of an investigation by the state, department of human services due to the death of one of our students. In connection with such an investigation, the department requested that we remove all students. Similar accidents or incidents at programs operated by our competitors could negatively impact public perception of the therapeutic education industry and harm our operations as well. No assurance can be given that accidents or other incidents at our programs or those of our competitors will not adversely affect our operations.

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

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

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

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

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

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

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

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

 

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Borrowers of our loan program may default, resulting in loss.

We maintain a private loan program pursuant to which our students and/or patients who meet predetermined credit standards can obtain third-party financing to pay a portion of the cost of participating in certain of our programs. As of December 31, 2009, there were $4.0 million outstanding in loans. The loans are unsecured. If the borrowers default on these loans, we will incur losses.

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

We began operations in August 2002, and our predecessor organizations began operations in September 1995. We recorded net losses in 2002, 2003 and 2006 of approximately $11.5 million, $1.6 million and $35.5 million, respectively, primarily as a result of transaction costs and the write-off of capitalized financing costs. For 2007, 2008 and 2009 we recorded a net profit of approximately $1.5 million, a net loss of $141.9 million, and a net loss of $26.6 million respectively. We cannot assure that we will operate profitably in the future. In addition, we may experience significant quarter-to-quarter variations in operating results.

We depend on our key management personnel.

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

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

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

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

Regulatory Risks

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

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

 

   

licensure, certification and accreditation;

 

   

handling of controlled substances;

 

   

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

 

   

referrals of patients and relationships with physicians;

 

   

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

 

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billings for reimbursement from commercial and government payors;

 

   

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

 

   

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

 

   

state and local land use and zoning requirements; and

 

   

corporate practice of medicine and fee splitting.

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

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

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

Licensure, accreditation and certification

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

Handling of controlled substances

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

Referrals of patients and relationships with physicians

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

If we fail to comply with the federal anti-kickback statute and its safe harbors, the Stark Law or other related state and federal laws and regulations, we could be subjected to criminal and civil penalties, we could lose our license to operate, and our residential and outpatient treatment programs could be excluded from participation in Medicaid and other federal and state healthcare programs and could be required to repay governmental payors amounts received by our residential and outpatient treatment programs for services resulting from prohibited

 

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referrals. In lieu of repayment, the OIG may impose civil monetary assessments of three times the amount of each item or service wrongfully claimed. In addition, if we do not operate our treatment facilities in accordance with applicable law, our residential and outpatient treatment programs may lose their licenses or the ability to participate in third-party reimbursement programs.

Coding and billing rules

If we fail to comply with federal and state documentation, coding and billing rules, we could be subject to criminal and civil penalties, loss of licenses, loss of payment for past services and exclusion from Medicaid programs, which could harm us. Approximately 19.9% of our revenue for 2009 consisted of payments from Medicaid and other government programs. In billing for our services to government payors, we must follow complex documentation, coding and billing rules. Failure to follow these rules could result in potential criminal or civil liability under the federal False Claims Act, under which extensive financial penalties can be imposed. It could further result in criminal liability under various federal and state criminal statutes, or in our being ineligible for reimbursement under Medicaid programs. The rules are complex and we submit a large number of claims per year for Medicaid and other federal program payments and we cannot assure that governmental investigators, commercial insurers or whistleblowers will not challenge our practices or that there will be no errors. Any such challenges or errors could result in increased costs and have an adverse effect on our profitability, and could result in a portion of our recorded revenue being uncollectible or subject to repayment to governmental payors.

Privacy and security requirements

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

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

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

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

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

 

ITEM 1B. Unresolved Staff Comments

None.

 

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ITEM 2. Properties

Recovery division. The following tables list our residential treatment facilities, as of December 31, 2009.

 

Program

   City    State    Owned /Leased

Inpatient Residential Treatment Facilities

        

Azure Acres

   Sebastopol    CA    Owned

Bayside Marin (with multiple licensed treatment programs)

   San Rafael    CA    Leased

Brandywine

   Kennett Square    PA    Owned

Burkwood

   Hudson    WI    Owned

Camp Recovery Center

   Scotts Valley    CA    Owned

Echo Malibu

   Malibu    CA    Leased

Galax Treatment Center

   Galax    VA    Owned

Keystone Treatment Center

   Canton    SD    Owned

Life Healing Center

   Santa Fe    NM    Owned

New Life Lodge

   Burns    TN    Owned

New Life Lodge Extended Care Program

   Burns    TN    Leased

Sierra Tucson

   Tucson    AZ    Leased

Sober Living by the Sea—Extended Care

   Newport Beach    CA    Leased

Sober Living by the Sea—Sunrise Ranch

   Riverside    CA    Leased

Sober Living by the Sea—Victorian

   Newport Beach    CA    Leased

Sober Living by the Sea—The Rose

   Newport Beach    CA    Leased

Sober Living by the Sea—The Landing

   Newport Beach    CA    Leased

Starlite Recovery Center

   Center Point    TX    Owned

Twelve Oaks

   Navarre    FL    Owned

Wellness Resource Center

   Boca Raton    FL    Leased

White Deer Run (WDR)—Allenwood

   Allenwood    PA    Owned

WDR—Blue Mountain

   Blue Mountain    PA    Owned

WDR—Lancaster

   Lancaster    PA    Leased

WDR—Lebanon

   Lebanon    PA    Leased

WDR—Johnstown New Directions

   Johnstown    PA    Owned

WDR—Johnstown Renewal Center

   Johnstown    PA    Leased

WDR—Torrance

   Torrance    PA    Leased

WDR—Williamsburg

   Williamsburg    PA    Leased

WDR—Williamsport

   Williamsport    PA    Owned

WDR—York/Adams

   York    PA    Leased

Wilmington Treatment Center

   Wilmington    NC    Owned

Outpatient Treatment Facilities

        

Azure

   Sacramento    CA    Leased

Bayside Marin

   San Rafael    CA    Leased

Camp San Jose

   San Jose    CA    Leased

Keystone—Sioux Falls

   Sioux Falls    SD    Leased

Sober Living—Costa Mesa

   Costa Mesa    CA    Leased

Wilmington—Myrtle Beach

   Myrtle Beach    NC    Leased

Wilmington—Wilmington

   Wilmington    NC    Leased

Wilmington—Shallotte

   Shallotte    NC    Leased

WDR—Allentown

   Allentown    PA    Leased

WDR—Altoona

   Altoona    PA    Leased

WDR—Erie

   Erie    PA    Leased

WDR—Harrisburg

   Harrisburg    PA    Leased

WDR—Lewisburg

   Lewisburg    PA    Leased

WDR—New Castle

   New Castle    PA    Leased

WDR—Pittsburgh

   Pittsburgh    PA    Leased

 

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Recovery division. The following table lists our comprehensive treatment centers by state and number, as of December 31, 2009.

 

State

   Clinics   

Owned / Leased

California

   12    All clinics leased

Delaware

   1    All clinics leased

Georgia

   1    Leased

Indiana

   5    All clinics leased

Kansas

   1    Leased

Louisiana

   1    Leased

Maryland

   3    All clinics leased

North Carolina

   3    All clinics leased

Oregon

   5    All clinics leased

Pennsylvania

   2    All clinics leased

Tennessee

   1    Leased

Virginia

   3    All clinics leased

Washington

   4    All clinics leased

West Virginia

   7    All leased except for one owned property

Wisconsin

   5    All clinics leased
       

Total

   54   
       

Healthy living division. The following table lists our youth treatment programs within our healthy living division as of December 31, 2009.

 

Program

   City    State    Owned /Leased

Residential Treatment Centers

        

Aspen Institute for Behavioral Assessment

   Syracuse    UT    Leased

Aspen Ranch

   Loa    UT    Leased

Island View

   Syracuse    UT    Leased

Pine Ridge Academy

   Jordan    UT    Leased

SunHawk Adolescent Recovery Center

   St George    UT    Leased

Turn-About Ranch

   Escalante    UT    Owned/Leased

Youth Care

   Draper    UT    Owned/Leased

Therapeutic Boarding Schools

        

Academy at Swift River

   Cummington    MA    Leased

Bromley Brook School

   Manchester    VT    Leased

Copper Canyon Academy

   Rimrock    AZ    Leased

New Leaf Academy of Oregon

   Bend    OR    Leased

New Leaf Academy of North Carolina

   Hendersonville    NC    Leased

NorthStar Center

   Bend    OR    Leased

Oakley School

   Oakley    UT    Leased

Stone Mountain School

   Black Mountain    NC    Leased

Special Learning Needs

        

Camp Huntington

   High Falls    NY    Leased

Talisman Summer Camps

   Zirconia    NC    Leased

Outdoor Programs

        

Adirondack Leadership Expeditions

   Saranac Lake    NY    Leased

Aspen Achievement Academy

   Loa    UT    Leased

Four Circles Recovery Center

   Horseshoe    NC    Leased

Outback Therapeutic Expeditions

   Loa    UT    Leased

Passages to Recovery

   Loa    UT    Leased

SUWS of the Carolinas / Phoenix Outdoor

   Old Fort    NC    Leased

SUWS of Idaho

   Shoshone    ID    Leased

 

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Healthy living division. The following table lists our eating disorder facilities, residential weight management program, and weight management schools and camps as of December 31, 2009.

 

Program

   City    State    Owned /Leased

Eating Disorder Facilities

        

Montecatini

   Carlsbad    CA    Owned

Montecatini IOP

   Carlsbad    CA    Leased

Center for Hope of the Sierras

   Reno    NV    Owned/Leased

Carolina House

   Durham    NC    Owned

Residential Weight Management Program

        

Structure House

   Durham    NC    Owned

Weight Management Schools and Camps

        

Wellspring Academy of the Carolinas

   Brevard    NC    Leased

Wellspring Academy of California

   Reedley    CA    Leased

Wellspring Adventure Camp NC

   Canton    NC    Leased

Wellspring Family Camp

   Village of Pinehurst    NC    Leased

Wellspring California

   La Jolla    CA    Leased

Wellspring Florida

   St. Petersburg    FL    Leased

Wellspring Hawaii

   Captain Cook    HI    Leased

Wellspring New York

   Saranac Lake    NY    Leased

Wellspring Pennsylvania

   Saltsburg    PA    Leased

Wellspring Texas

   San Marcos    TX    Leased

Wellspring Wisconsin

   Platteville    WI    Leased

Wellspring UK

   Exeter    UK    Leased

Wellspring Vancouver

   Vancouver, BC    Canada    Leased

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

 

ITEM 3. Legal Proceedings

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

 

ITEM 4. Reserved

 

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PART II

 

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

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

 

ITEM 6. Selected Financial Data

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

Set forth below is selected historical consolidated financial information at the dates and for the periods indicated. The summary of historical financial information as of and for the years ended December 31, 2009, 2008, 2007, 2006 and 2005 has been derived from our audited financial statements. The date of the purchase of our company by investment funds managed by Bain Capital was February 6, 2006, but for accounting purposes and to coincide with our normal financial accounting closing dates, we have utilized February 1, 2006, as the effective date of the close of the transaction. As a result, we have reported operating results and financial position for all periods presented prior to February 1, 2006 as those of the Predecessor Company (“Predecessor”) and for all periods from and after February 1, 2006 as those of the Successor Company (“Successor”) due to the resulting change in the basis of accounting. For the purpose of presenting a comparison of our 2006 results to all other years, we have presented the year ended December 31, 2006 as the mathematical addition of our operating results for January 2006 to the operating results of the eleven months ended December 31, 2006. This approach is not consistent with generally accepted accounting principles and may yield results that are not strictly comparable on a period-to-period basis primarily due to the impact of purchase accounting entries recorded as a result of the Transactions. For purposes of this management’s discussion and analysis of financial condition and results of operations, however, management believes that it is the most meaningful way to present our results of operations for the year ended December 31, 2006.

 

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

 

    Successor          Predecessor  
    Year Ended
December 31,
2009
    Year Ended
December 31,
2008
    Year Ended
December 31,
2007
    Combined
Year Ended
December 31,
2006
    Eleven
Months Ended
December 31,
2006
         One
Month Ended
January 31,
2006
    Year Ended
December 31,
2005
 

Statement of Operations Data:

                 

Net revenue

  $ 429,590      $ 454,204      $ 429,711      $ 263,440      $ 243,962          $ 19,478      $ 204,834   

Operating expenses (1)

  $ 399,169      $ 536,121      $ 368,241      $ 255,100      $ 197,211          $ 57,889      $ 156,718   
                                                           

Operating income (loss)

  $ 30,421      $ (81,917   $ 61,470      $ 8,340      $ 46,751          $ (38,411   $ 48,116   

Interest expense

    (44,158     (54,104     (60,262     (43,844     (41,338         (2,506     (19,744

Gain on debt repurchase and other financing costs

    —          8,086        —          (10,655     —              (10,655     (2,185

Other (expense) income

    (82     1        (1,771     167        112            55        2,232   
                                                           

Loss from continuing operations before income taxes

  $ (13,819   $ (127,934   $ (563   $ (45,992   $ 5,525          $ (51,517   $ 28,419   

Income tax expense (benefit)

    4,016        (6,276     1,007        (9,800     2,672            (12,472     10,741   
                                                           

(Loss) income from continuing operations, net of tax

  $ (17,835   $ (121,658   $ (1,570   $ (36,192   $ 2,853          $ (39,045   $ 17,678   

(Loss) income from discontinued operations, net of tax

    (8,826     (20,400     3,223        683        631            52        323   
                                                           

Net (loss) income

  $ (26,661   $ (142,058   $ 1,653      $ (35,509   $ 3,484          $ (38,993   $ 18,001   

Less: net (loss) income attributable to the noncontrolling interest

    (62     (153     189        (38     (38         —          —     
                                                           

Net (loss) income attributable to CRC Health Corporation

  $ (26,599   $ (141,905   $ 1,464      $ (35,471   $ 3,522          $ (38,993   $ 18,001   
                                                           

Amounts attributable to CRC Health Corporation:

                 

(Loss) income from continuing operations,
net of tax

  $ (17,778   $ (121,496   $ (1,759   $ (36,154   $ 2,891          $ (39,045   $ 18,001   

Discontinued operations,
net of tax

    (8,821     (20,409     3,223        683        631            52        —     
                                                           

Net (loss) income attributable to CRC Health Corporation

  $ (26,599   $ (141,905   $ 1,464      $ (35,471   $ 3,522          $ (38,993   $ 18,001   
                                                           

 

    Successor          Predecessor  
    Year Ended
December 31,
2009
    Year Ended
December 31,
2008
    Year Ended
December 31,
2007
    Eleven
Months Ended
December 31,
2006
         One
Month Ended
January 31,
2006
    Year Ended
December 31,
2005
 

Balance Sheet Data (at period end):

               

Working capital (2)

  $ (15,285   $ (14,468   $ (56,539   $ (18,730         $ 2,284   

Property and equipment, net

    125,215        129,728        122,937        94,976              49,074   

Cash and cash equivalents

    4,982        2,540        5,118        4,206              5,077   

Total assets

    1,108,334        1,169,175        1,322,291        1,288,788              424,154   

Long-term debt

    631,076        653,152        648,367        626,528              259,931   

Mandatorily redeemable stock

    —          —          —          —                115,625   

Shareholders’ equity

    288,542        303,222        445,749        437,174              11,985   
 

Other Financial Data:

               

Cash paid for interest

  $ 42,707      $ 51,758      $ 56,418      $ 29,118          $ 1,336      $ 18,101   

Depreciation and amortization

    22,857        21,971        21,373        10,112            360        3,836   

Capital expenditures

    12,999        25,279        30,159        14,189            411        11,480   

Cash flows from operating activities

    37,028        24,176        56,420        (4,486         1,201        23,902   

Cash flows from investing activities

    (12,378     (39,645     (70,947     (746,811         (315     (159,228

Cash flows from financing activities

    (22,208     12,891        15,439        755,080            (5,540     129,840   

 

(1) Operating expenses for the one month ended January 31, 2006 and the twelve months ended December 31, 2006 includes $43.7 million in acquisition related costs incurred in connection with the purchase of our company by Bain Capital. During the years ended December 31, 2009 and 2008, the Company recognized $30.5 million and $142.2 million in non-cash goodwill impairment charges related to its healthy living division.
(2) We define working capital as our current assets (including cash and cash equivalents) minus our current liabilities, which includes the current portion of long-term debt and accrued interest thereon.

 

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

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

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

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

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 two divisions, the recovery 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 healthy living division provides education to underachieving young people through residential schools and wilderness programs. Our healthy living division also provides treatment services through adolescent and adult weight management programs as well as eating disorder facilities.

We have two operating segments: recovery division and healthy living division. As of December 31, 2009, our recovery division, which operates 31 inpatient, 15 outpatient facilities, and 54 comprehensive treatment centers (“CTCs”) in 21 states, provides treatment services to patients suffering from chronic addiction related diseases and related behavioral disorders. As of December 31, 2009, our recovery division treated approximately 27,500 patients per day. As of December 31, 2009, our healthy living division, which operates 24 adolescent and young adult programs in 8 states, provides a wide variety of therapeutic educational programs for underachieving young people. Our healthy living division also operates 18 facilities in 9 states inclusive of one facility each in the United Kingdom and Canada with a focus on providing treatment services for eating disorders and weight management. Other activities classified as corporate 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-based compensation expense that are not allocated to the segments.

Management uses segment profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Intersegment sales and transfers are insignificant. We report in two segments: recovery division, healthy living division. In addition to the two reportable segments, the Company has activities classified as Corporate which represent revenue and expenses associate with eGetgoing, an online internet treatment option, as well as certain corporate-level operating general and administrative costs. The recovery division includes all inpatient and outpatient drug and alcohol treatment programs consistent with our long-term objective of being a full spectrum chemical dependency provider that integrates the best of the various treatment modalities into a seamless web of service. The healthy living division includes adolescent residential and outdoor programs as well as eating disorders and adult weight management facilities and adolescent weight management programs.

 

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Basis of Presentation

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

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

Principles of consolidation. The consolidated financial statements include the accounts of the Company and our wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to the prior year consolidated statements of operations to conform to the 2009 presentation. The Company combined other revenue into net client service revenue to represent how the Company currently manages its business.

Discontinued Operations. We have reflected certain facility closures, and facilities held for sale, as discontinued operations in our consolidated statements of operations for all periods presented and as discontinued operations, facility exits for 2009.

Acquisitions

2009 Acquisitions

We did not complete any acquisitions during the year ended December 31, 2009.

2008 Acquisitions

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

2007 Acquisitions

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

EXECUTIVE SUMMARY

We generate revenue by providing substance abuse treatment services and adolescent treatment services in the United States. We also generate revenue by providing treatment services for other specialized behavioral disorders. Revenue is recognized when rehabilitation and treatment services are provided to a patient. Client service revenue is reported at the estimated net realizable amounts from clients, third-party payors and others for services rendered. Revenue under third-party payor agreements is subject to audit and retroactive adjustment. Provisions for estimated third-party payor settlements are provided for in the period the related services are rendered and adjusted in future periods as final settlements are determined. Revenue for therapeutic educational services provided to adolescent services 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

 

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recognized over the average student length of stay, approximately nine months. Alumni fees revenue represents upfront fees for post graduation services and these fees are deferred and recognized systematically over the contracted life, which is twelve months. During the years ended December 31, 2009 and December 31, 2008, we generated 80.1% and 83.6% of our net revenue from non-governmental sources, including 64.3% and 68.5% from self payors, respectively, and 15.8% and 15.1% 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 year ended December 31, 2009 our consolidated same-facility net revenue decreased $28.0 million or 6.2% compared to an increase of $10.2 million or 2.4% for the same period in 2008. “Same-facility” refers to the comparison of each facility owned during the periods 2009 compared to 2008 and 2008 compared to 2007.

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 healthy living 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.

Effective April 1, 2009, the Company created a private loan program (“the Loan Program”) pursuant to which students and/or patients (“the Borrowers”) who meet predetermined credit standards can obtain third-party financing to pay a portion of the cost of participating in certain of our programs. The Company initiated this program in response to the lack of credit availability for our students/patients, particularly in the healthy living division, to secure financing to access our services. The Board of Directors has approved a loan pool of up to $20.0 million for 2009 and 2010.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Long-Lived Assets — The Company tests its long-lived assets and intangible assets subject to amortization for impairment whenever events or changes in circumstances indicate that the carrying value of certain of its assets may not be recoverable. If the undiscounted future cash flows from the asset tested are less than the carrying value, a loss equal to the difference between the carrying value and the fair market value of the asset is recorded.

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

Goodwill and Other Intangible Assets The Company tests goodwill and indefinite lived intangible assets for impairment annually, at the beginning of its fourth quarter or more frequently if evidence of possible impairment arises.

The Company performs a two-step impairment test on goodwill. In the first step, the Company compares the fair value of the reporting unit being tested to its carrying value. The Company’s reporting units are consistent with the operating segments identified in Note 20 to the consolidated financial statements. The Company determines the fair value of its reporting units using a combination of income approach and a market approach. Under the income approach, the Company calculates the fair value of a reporting unit based on the present value of estimated future cash flows. Under the market approach, the Company estimates fair value based on what investors have paid for similar interests in comparable companies through the development of ratios of market prices to various earnings indications of comparable companies taking into consideration adjustments for growth prospects, debt levels and

 

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overall size. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and the Company is not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the Company must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then the Company records an impairment loss equal to the difference. During 2009, the Company tested its recovery reporting unit for possible impairment in accordance with its annual goodwill impairment testing policy. The Company determined that the fair value of its recovery reporting unit exceeded its carrying value by approximately 165%. Accordingly, the Company determined that the second step of goodwill impairment testing was not required. As a result of impairment testing at December 31, 2009, the Company determined that the carrying value of its healthy living reporting unit exceeded the reporting unit’s fair value by approximately 4.5%. The Company recognized a non-cash goodwill impairment loss of $6.2 million. In addition, the Company recorded an impairment loss of $24.3 million in the healthy living reporting unit related to goodwill impairment testing during the third quarter of 2009. At December 31, 2009, the Company’s healthy living reporting unit had $72.1 million in goodwill recorded on the consolidated balance sheet. Future declines in value may result in additional impairment charges.

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

Changes in assumptions or circumstances could result in an additional impairment in the period in which the change occurs and in future years. Factors which could cause the Company additional goodwill impairment include, but are not limited to:

 

  1. Decreases in revenues

 

  2. Increases in the Company’s borrowing rates or weighted average cost of capital

 

  3. Increase in the blended tax rate

 

  4. Changes in its working capital

 

  5. Significant alteration of market multiples utilized in the valuation process

 

  6. Significant decrease in market value of comparable companies

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

 

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Stock-Based Compensation — The Company measures and recognizes compensation expense for all stock-based payment awards, including employee stock options, granted after January 1, 2006, based on the grant-date fair value. The Company estimates grant date fair value of its awards by utilizing the Black Scholes Merton model for time-based awards and a closed-form lattice model for awards containing market conditions.

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

Interest Rate Swaps — Interest rate swaps are used exclusively in the management of the Company’s interest rate exposures and are recorded on the balance sheet at fair value. As part of its hedging strategy, the Company has designated its interest rate swaps as cash flow hedges.

The fair value of the interest rate swaps are estimated based upon terminal value models. If the swaps are designated as a cash flow hedge, the effective portions of changes in the fair value of the swap are recorded in other comprehensive income. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. Additionally, reclassifications of deferred gains or losses related to ineffectiveness of interest rate swaps are recognized as interest expense on the consolidated statement of operations. If the swaps are not designated as cash flow hedges, the changes in the fair value of the swaps are recorded in other income (expense) on the consolidated statement of operations. See Note 9.

Recently Issued Accounting Guidance — In January 2010, the FASB issued updated authoritative guidance, which, among other things, requires entities to separately present purchases, sales, issuances, and settlements in their reconciliation of Level 3 fair value measurements (i.e., to present such items on a gross basis rather than on a net basis), and which clarifies existing disclosure requirements regarding the level of disaggregation and the inputs and valuation techniques used to measure fair value for measurements that fall within either Level 2 or Level 3 of the fair value hierarchy. The updated guidance is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements (which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years). The Company is currently assessing the impact that the adoption of the updated guidance will have on the consolidated financial statement disclosures.

During the third quarter of 2009, the Company adopted the new Accounting Standards Codification (ASC) as issued by the Financial Accounting Standards Board (FASB). The ASC has become the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. The ASC is not intended to change or alter existing GAAP. The adoption of the ASC did not have a material impact on the Company’s consolidated financial statements.

In August 2009, the FASB issued a new accounting standard which provides additional guidance on the measurement of liabilities at fair value. Specifically, when a quoted price in an active market for the identical liability is not available, the new standard requires that the fair value of a liability be measured using one or more of the valuation techniques that should maximize the use of relevant observable inputs and minimize the use of unobservable inputs. In addition, an entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability. We adopted this standard in the fourth quarter of 2009 and the adoption did not have a material impact on our consolidated financial statements.

In May 2009, the FASB issued new accounting and disclosure guidance for recognized and non-recognized subsequent events that occur after the balance sheet date but before financial statements are issued. The new

 

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guidance required disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. The new accounting guidance was effective for the Company beginning with three and six months ended June 30, 2009. The guidance was subsequently amended in February 2010 and is being applied prospectively. Under the amended guidance, the Company is required to evaluate for subsequent events through the date the financial statements are issued. We adopted the amended guidance in February 2010. This change in accounting policy had no impact on the consolidated financial statements.

On January 1, 2009, we adopted a new standard in regard to noncontrolling interests in consolidated financial statements. This standard establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary (minority interest) is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and separate from the parent company’s equity. This statement also requires disclosure, on the face of the consolidated statements of operations, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. These disclosure requirements have been applied retrospectively to all periods presented. The adoption of this standard impacted certain captions previously used on the consolidated statements of operations, largely identifying net income including noncontrolling interests and net income attributable to CRC Health Corporation. Certain captions on the consolidated balance sheets and consolidated statements of cash flows have also changed.

In March 2008, the FASB amended existing disclosure requirements related to derivative and hedging activities, which became effective for the Company on January 1, 2009, and is being applied prospectively. As a result of the amended disclosure requirements, the Company is required to provide expanded qualitative and quantitative disclosures about derivatives and hedging activities in each interim and annual period. The adoption of the new disclosure requirements had no material impact on the consolidated financial statements.

In December 2007, the FASB amended its guidance on accounting for business combinations. The new accounting guidance resulted in a change in the Company’s accounting policy effective January 1, 2009, and is being applied prospectively to all business combinations subsequent to the effective date. Among other things, the new guidance amends the 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. It also establishes new disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The adoption of this new accounting policy did not have a significant impact on the consolidated financial statements, and the impact it will have on the consolidated financial statements in future periods will depend on the nature and size of business combinations completed subsequent to the date of adoption.

 

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RESULTS OF OPERATIONS

The following table presents our results of operations by reportable segments for the years ended December 31, 2009, 2008 and 2007 (dollars in thousands, except for percentages; percentages are calculated as percentage of total net revenue).

 

    Years Ended December 31,  
    2009     %     2008     %     2007     %  

Statement of Operations Data:

           

Net revenue:

           

Recovery division

  $ 311,835      72.6 %   $ 309,379      68.1 %   $ 286,091      66.6 %

Healthy living division

    117,515      27.3 %     144,507      31.8 %     143,194      33.3 %

Corporate

    240      0.1 %     318      0.1 %     426      0.1 %
                                         

Total net revenue

    429,590      100.0 %     454,204      100.0 %     429,711      100.0 %

Operating expenses:

           

Recovery division

    214,436      49.9 %     224,446      49.4 %     206,204      48.0 %

Healthy living division

    153,098      35.6 %     282,491      62.2 %     135,467      31.5 %

Corporate

    31,635      7.4 %     29,184      6.4 %     26,570      6.2 %
                                         

Total operating expenses

    399,169      92.9     536,121      118.0 %     368,241      85.7 %

Operating income (loss):

           

Recovery division

    97,399      22.7 %     84,933      18.7 %     79,887      18.6 %

Healthy living division

    (35,583 )   (8.3 )%     (137,984 )   (30.4 )%     7,727      1.8 %

Corporate

    (31,395 )   (7.3 )%     (28,866 )   (6.4 )%     (26,144   (6.1 )%
                                         

Operating income (loss)

    30,421      7.1 %     (81,917 )   (18.1 )%     61,470      14.3 %

Interest expense

    (44,158       (54,104 )       (60,262  

Gain on debt repurchase

    —            8,086          —       

Other income (expense)

    (82 )       1          (1,771  
                             

Loss from continuing operations before income taxes

    (13,819       (127,934 )       (563  

Income tax expense (benefit)

    4,016          (6,276 )       1,007     
                             

Loss from continuing operations, net of tax

    (17,835 )       (121,658 )       (1,570  

(Loss) income from discontinued operations (net of tax (benefit) expense of ($4,961) in 2009, ($10,855) in 2008, and $2,136 in 2007, respectively)

    (8,826 )       (20,400 )       3,223     
                             

Net (loss) income

    (26,661       (142,058 )       1,653     

Less: net (loss) income attributable to the noncontrolling interest

    (62 )       (153 )       189     
                             

Net (loss) income attributable to CRC Health Corporation

  $ (26,599 )     $ (141,905 )     $ 1,464     
                             

Amounts attributable to CRC Health Corporation:

           

Loss from continuing operations, net of tax

  $ (17,778       (121,496 )       (1,759  

Discontinued operations, net of tax

    (8,821 )       (20,409 )       3,223     
                             

Net (loss) income attributable to CRC Health Corporation

  $ (26,599 )     $ (141,905 )     $ 1,464     
                             

 

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Continuing Operations Year Ended December 31, 2009 Compared to Continuing Operations Year Ended December 31, 2008

Consolidated net revenue decreased $24.6 million, or 5.4%, to $429.6 million in 2009 from $454.2 million in 2008. Of the total net revenue decrease, healthy living division net revenue decreased $27.0 million, or 18.7% year over year. On a consolidated basis, the decline in healthy living revenue was partially offset by a net revenue increase of $2.5 million or 0.8% within the recovery division year over year. Recovery division revenue growth is primarily attributable to increases of $6.9 million and $0.2 million in comprehensive treatment centers (“CTCs”) and outpatient facilities, respectively offset by revenue decreases in residential treatment centers of $4.6 million. Of the $27.0 million decrease in healthy living division revenue, $14.8 million is primarily attributable to residential schools, $10.1 million in outdoor programs, and $1.9 million in weight management. The Company’s healthy living division revenue has continued to be adversely affected by the negative economic environment which has impacted the ability of families to access the credit markets and student loan programs to fund the tuition. During 2009, the Company initiated its own student loan program to facilitate credit to eligible families for purchase of the Company’s client services. At December 31, 2009, the Company had facilitated client service financing for approximately $4.0 million in loans to enable eligible clients to obtain services from the Company’s healthy living division.

Healthy living division same-facility net revenue decreased $27.8 million, or 19.3%, due to a $14.8 million decrease in same-facility residential boarding schools, $10.1 million decrease in outdoor camps, and $2.8 million decrease in weight management. Same-facility revenue growth in the recovery division decreased $0.2 million. The decrease was primarily due to a same-facility decrease of $7.4 million, or 3.7% in residential facilities offset by increases of $7.0 million, or 6.6% in CTCs and $0.2 million in outpatient services.

Consolidated operating expenses decreased $137.0 million, or 25.5%, to $399.2 million from $536.1 million in the same period of 2008. Of the $137.0 million decrease in operating expenses, the recovery division incurred a decrease of $10.0 million, or 4.5%. The healthy living division incurred a decrease of $129.4 million, or 45.8%. Consolidated operating expense decreases are primarily driven by a $4.5 million decrease in non-cash intangible asset impairment charges within the recovery division as well as by a $111.7 million decrease in non-cash goodwill impairment charges within the healthy living division to $30.5 million in 2009 from $142.2 in 2008. The remaining decrease of $20.8 million in consolidated operating expenses reflects the effect of expense controls and cost reduction efforts across the Company.

Without considering the effects of impairments, recovery division and healthy living division operating expenses decreased $5.5 million or 2.5% and $19.9 million or 14.2% respectively. Of the $5.5 million recovery division operating expense decrease, $2.9 million and $1.1 million were due to salary and benefits expenses decreases in residential facilities and CTCs respectively. Additionally, supplies facilities and other costs decreased by $2.4 million and $0.3 million within residential facilities and CTCs respectively. The decreases in recovery division operating expenses were partially offset by a non-cash revenue reclassification of $1.3 million into bad debt expense. Without considering impairment effects, operating expenses within the healthy living division decreased $19.9 million of which $12.6 million are attributable to decreases in salaries and benefits as well as to decreases of $6.6 million in supplies, facilities and other expenses.

Corporate operating expenses increased $2.5 million, or 8.4% due to increases of $2.5 million in salaries and benefits with the remaining increase due to a $1.2 million increase in depreciation expenses offset by a decrease of $1.3 million in supplies, facilities, and other costs. The $2.5 million increase in salaries and benefits was attributable to salary increases of $2.0 million due to the consolidation of certain healthy living division administrative functions into the corporate administrative function and by a $0.5 million actuarial reserve for the Company’s self-insured medical program. Stock compensation expense decreased by $0.5 million year over year.

Without considering the effects of impairments, recovery division same-facility decrease in operating expenses was $6.9 million, or 3.4% of which $4.0 million and $1.1 million was related to salary decreases within residential facilities and CTCs respectively driven by cost controls across the Company. Additionally, decreases

 

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of $3.2 million and $0.3 million in supplies, facilities and other costs within residential facilities and CTCs, respectively, further contributed to the decrease partially offset by increases of $1.5 million and $0.2 million in allowance for doubtful accounts and depreciation and amortization expenses, respectively, within residential facilities. Healthy living same-facility operating expenses decreased $16.9 million or 13.8% due to decreases of $10.8 million, and $6.4 million in salaries and supplies, facilities, and other costs respectively slightly offset by net increases in allowance for doubtful accounts and amortization and depreciation expenses. Of the $10.8 million same-facility salary decreases, $4.9 million, $4.6 million and $1.3 million were attributable to residential facilities, outdoor programs and weight management programs, respectively. The $6.4 million decrease in same-facility healthy living supplies, facilities and other costs were due to decreases of $2.6 million, $1.9 million, and $1.9 million in residential facilities, outdoor programs and weight management, respectively.

Our consolidated operating margin was 7.1% in 2009 compared to (18.1) % in 2008. Excluding healthy living division non-cash asset impairment charges of $2.3 million and non-cash goodwill impairment charges of $30.5 million, consolidated operating margin was 14.7% for the year ended December 31, 2009. Without considering recovery division non-cash asset impairment charges of $4.5 million and healthy living, non-cash goodwill impairment charges of $142.2 million, consolidated operations margins for the year ended December 31, 2008 were 14.3%. Without considering impairment charges, our same-facility consolidated operating margin increased to 30.0% in 2009 compared to 29.1% in 2008. Recovery division same-facility operating margin increased to 37.8% in 2009 compared to 35.6 % in 2008. Healthy living division same-facility operating margin was 9.5% in both 2009 and in 2008. Healthy living division operating margin remained flat due to expense controls despite lessening in demand for healthy living division services as a result of declining economic conditions and the inability of families to access the credit markets and student loan markets to fund the tuition.

For the year ended December 31, 2009, net loss attributable to the Company, decreased by $115.3 million or 81.3% to a net loss attributable to the Company of $26.6 million compared to a net loss of $141.9 million for same period in 2008. The decrease in net loss attributable to the Company in 2009 is primarily driven by a $4.5 million decrease in non-cash intangible asset impairment charges within the recovery division and by a $111.7 million decrease in non-cash goodwill impairment charges within the healthy living division to $30.5 million in 2009 from $142.2 million in 2008. Additionally, a decrease of $22.9 million in consolidated, non-impairment operating expenses, and a net revenue increase of $2.5 million in the recovery division further contributed to the lower net loss attributable to the Company in 2009 compared to 2008. The Company also recognized a $1.3 million non-cash gain related to its interest rate derivatives. Income tax expense increased by $10.3 million in 2009 due to an income tax expense of $4.0 million in 2009 compared to a $6.3 million income tax benefit in 2008. The effective tax rate in 2009 was (29.2) % compared to 4.9% in 2008. The effective tax rate decrease from 2008 to 2009 is attributable primarily to the effect on federal income tax expenses of non-deductible goodwill impairment and the effect of deductible losses on state income tax rates.

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

Consolidated net revenue increased $24.5 million, or 5.7%, to $454.2 million in 2008 from $429.7 million in 2007. Of the total net revenue increase, the recovery division contributed an increase of $23.3 million, representing 8.1% growth for the division, with the remaining net revenue growth driven by an increase of $1.3 million, or 0.9% in the healthy living division slightly offset by a revenue decrease of $0.1 million in the corporate division. During the year ended December 31, 2007, the Company recorded a deferred revenue adjustment of $2.7 million related to 2007 acquisition activity within its healthy living division. Without considering the deferred revenue adjustment, healthy living division revenue decreased $1.4 million. The decrease is attributable to revenue increases of $5.3 million and $1.1 million in weight management and residential boarding schools, respectively, offset by a $7.8 million revenue decrease in outdoor programs. There has been a significant lessening in demand for healthy living division services as a result of declining economic conditions and the inability of families to access the credit markets and student loan markets to fund the tuition.

 

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Our healthy living division same-facility net revenue decreased $7.1 million, or 4.9%, due primarily to an $8.9 million decrease in same-facility outdoor programs offset by increases of $1.1 million and $0.6 million in residential boarding schools and weight management respectively. Revenue growth in the recovery division was primarily due to same-facility growth of $17.3 million, or 6.1%. The remaining $6.0 million revenue increase in the recovery division was primarily due to acquisitions completed in 2007 and in 2008 respectively as well as by increases in census and start-ups.

Consolidated operating expenses increased $167.9 million, or 45.6%, to $536.1 million from $368.2 million in the same period of 2007. Of the $167.9 million increase in operating expenses, the recovery division incurred an increase of $18.2 million, or 8.8%, the healthy living division incurred an increase of $147.0 million, or 108.5%, and the corporate division incurred an increase of $2.6 million, or 9.8%. Of the $18.2 million increase in recovery division operating expenses, $4.5 million was due to non-cash intangible asset impairment charge. The remaining recovery division increase in operating expenses was primarily due to a $7.2 million increase in salaries and benefits expenses and a $6.0 million increase in supplies, facilities and other costs. The increase in operating expenses within the healthy living division was primarily due to a $142.2 million non-cash impairment charge for goodwill.

Without considering the $142.2 million in healthy living division impairment charge, healthy living division operating expenses increased $4.8 million or 3.5% compared to the same period in the prior year. The $4.8 million increase in healthy living operating expenses is attributable to net increases of $5.5 million in weight management and $4.6 million in residential facilities offset by decreases of $1.1 million in outdoor programs and $4.2 million in divisional administrative functions. Operating expense increases in weight management resulted primarily from increases of $2.7 million and $2.5 million in salaries and benefits and supplies facilities and other costs, respectively. Operating expense increases in residential facilities resulted mainly from increases of $2.3 million and $1.5 million in salary and benefits and supplies, facilities and other costs, respectively, with increases in depreciation and amortization expenses contributing an additional $0.8 million. Operating expense decreases in outdoor programs were primarily due to salary decreases of $0.8 million and decreases of $0.3 million in supplies, facilities, and other costs. Decreases in divisional administrative function operating expenses were primarily related to a decrease of $2.8 million in supplies, facilities and other costs, and a decrease of $2.3 million in depreciation and amortization, offset by an increase of $0.9 million in salaries, due to facility consolidation activities within the division.

For our recovery division, same-facility increase in operating expenses was $14.5 million, or 7.9% of which $4.5 million was related to non-cash asset impairment charges for one of our residential facilities. Without consideration of impairments, recovery division same-facility operating expense increased $9.9 million or 5.5% year over year. Of the $9.9 million increase, $5.0 million and $1.0 million was contributed by salary and benefits increases within residential facilities and CTCs respectively. Residential facilities and CTCs each contributed increases of $1.7 million in supplies, facilities, and other operating costs, respectively. The remaining increase was due to a $0.8 million increase in amortization and depreciation expense offset by a $0.4 million decrease in provision for doubtful accounts. Healthy living same-facility operating expenses increased $3.7 million or 3.2% year over year. Of the $3.7 million increase in same-facility healthy living operating expenses, increases in salaries and benefits expenses within residential facilities contributed $2.3 million offset by decreases of $1.1 million within outdoor programs. Of the remaining $2.5 million operating expense increase, increases of $1.5 million and $0.6 million are attributable to increases in supplies, facilities and other operating costs within residential facilities and weight management, respectively. The increases in supplies, facilities and other operating costs were offset by a decrease of $0.8 million within outdoor programs. Healthy living residential same-facility operating expenses were also increased by a $0.8 million increase in depreciation and amortization expenses.

Our consolidated operating margin was (18.1) % in 2008 compared to 14.3% in 2007. Without considering healthy living division non-cash impairment charges of $142.2 million and the aforementioned acquisition

 

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related deferred revenue adjustment, consolidated operating margin was 14.3% for the year ended December 31, 2008. Without considering non-cash impairment charges, on a same-facility basis, our consolidated operating margin decreased to 29.7% in 2008 compared to 31.2% in 2007. Recovery division same-facility operating margin increased to 36.2% in 2008 compared to 35.8 % in 2007. Healthy living division same-facility operating margin decreased to 15.4% in 2008 compared to 22.2% in 2007. The significant decrease in our healthy living division same-facility operating margin is primarily due to a revenue decrease of $7.1 million within the healthy living division due to a significant lessening in demand for healthy living division services driven by declining economic conditions and the inability of families to access the credit markets and student loan markets to fund the tuition and an increase in healthy living division operating expenses of $3.7 million.

For the year ended December 31, 2008, losses attributable to the Company were $141.9 million compared to net income attributable to the Company of $1.5 million during the same period in 2007. The decrease in net income in 2008 is primarily attributable to a $142.2 million non-cash goodwill impairment charge within the healthy living division, a $4.5 million non-cash impairment charge of intangible assets slightly offset by net revenue increases in the recovery and healthy living divisions. Other income increased by $1.8 million in 2008 due to decreased losses related to interest rate swaps. Additionally, the Company recognized an $8.1 million gain due to debt retirement activities. Income tax expense decreased by $7.3 million to a net tax benefit of $6.3 million in 2008 compared to a $1.0 million income tax expense in 2007. The effective tax rate in 2008 was 4.9% compared to (178.9)% in 2007. The effective tax rate increase for continuing operations relates primarily to changes in state effective tax rates for deductible losses and release of tax reserves in 2007.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity for operating activities are payments from self pay patients, students, commercial payors and government programs for treatment services. We receive most of our cash from self payors in advance or upon completion of treatment. Cash revenue from commercial payors and government programs is typically received upon the collection of accounts receivable, which are generated upon delivery of treatment services. Additionally, the competitive health care environment and the Company’ desire to make its services more accessible to a greater number of potential clients maintains a competitive pricing pressure on many of the Company’s services.

Working Capital

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

We had negative working capital of $15.3 million at December 31, 2009, compared to negative working capital of $14.5 million at December 31, 2008. The $0.8 million increase in negative working capital from December 31, 2008 to December 31, 2009 was driven by the following: a reduction in working capital of $13.8 million related to discontinued operations/facility closures, a reclassification of $3.2 million from long-term debt to current portion of long-term debt related to planned term loan repayments under the credit agreement, offset by several increases in working capital. Such increases in working capital included: decrease in tax payable of $1.2 million, decrease in other current liabilities of $5.7 million primarily related to change in value of interest rate swaps, decrease in accounts payable of $3.2 million, increase in deferred tax assets of $2.3 million, and an increase in cash and cash equivalents of $2.4 million. During 2009, the Company reduced its operating cost structure, closed and sold several facilities, executed no acquisitions and obtained benefits from lower interest rates.

 

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Sources and Uses of Cash

 

     Years Ended December 31,  
     2009     2008     2007  
     (In thousands)  

Net cash provided by operating activities

   $ 37,028      $ 24,176      $ 56,420   

Net cash used in investing activities

     (12,378     (39,645 )     (70,947 )

Net cash (used in) provided by financing activities

     (22,208     12,891        15,439   
                        

Net increase (decrease) in cash

   $ 2,442      $ (2,578   $ 912   
                        

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Cash provided from operating activities was $37.0 million in 2009 and $24.2 million in 2008. The $12.8 million increase in cash flows from operating activities in fiscal 2009 was primarily the result of a reduction in payments for interest. Interest payments decreased to $42.7 million in 2009 from $51.8 million in 2008 due to lower interest rates and lower debt levels due to repayments during the year. Other changes totaling $3.7 million resulted from higher levels of operating profit year over year.

Cash used in investing activities was $12.4 million in 2009, compared to $39.6 million in 2008. The decrease of $27.2 million in the cash used for investing activities during 2009 was due primarily to decreases in acquisition related activity of $11.6 million compared to 2008 as well as to a decrease of $12.2 million in purchases of property and equipment and a decrease of $2.7 million in payments made under earnout arrangements. The Company expects its additions of property and equipment to increase in 2010 as a result of planned capacity expansion projects which are expected to add approximately 250 beds to our residential facilities in both our recovery and in our healthy living divisions. Cash provided by sale of discontinued operations relates to the sale of four facilities within the recovery division.

Cash used in financing activities was $22.2 million in 2009, compared to cash provided by financing activities of $12.9 million in 2008. The increase of cash used in financing activities of $35.1 million was due primarily to $15.0 million in net repayments during 2009 compared to $35.0 million in net borrowings activity in 2008 under the revolving line of credit mostly offset by a reduction of $13.6 million in repurchase of long-term debt and a reduction of $1.2 million in repayment of long term debt.

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

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

Cash used in investing activities was $39.6 million in 2008, compared to $70.9 million in 2007. The decrease of $31.3 million in the cash used for investing activities during 2008 was due to decreases in acquisition related activity of $21.3 million compared to 2007 as well as to a decrease of $4.9 million in purchases of property and equipment and a decrease of $5.7 million in payments made under earnout arrangements.

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

 

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Financing and Liquidity

We intend to fund our ongoing operations through cash generated by operations, funds available under the revolving portion of our senior secured credit facility and existing cash and cash equivalents. As of December 31, 2009, our senior secured credit facility was comprised of a $405.6 million senior secured term loan facility and a $100.0 million revolving credit facility. At December 31, 2009, the revolving credit facility had $44.6 million available for borrowing, $46.5 million outstanding and classified on our balance sheet as long-term debt, and $8.9 million of letters of credit issued and outstanding. As part of the Transactions, we issued $200.0 million in aggregate principal amount of senior subordinated notes of which $177.3 million, excluding discount, remained outstanding at December 31, 2009. We anticipate that cash generated by current operations, the remaining funds available under the revolving portion of our senior secured credit facility and existing cash and cash equivalents will be sufficient to meet working capital requirements, service our debt and finance capital expenditures over the next 12 months.

In addition, we may expand existing recovery and healthy living 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, additions of property and equipment, or for other corporate purposes. In negotiating such financing, there can be no assurance that we will be able to raise additional capital on terms satisfactory to us. Failure to obtain additional financing on reasonable terms could have a negative effect on our plans to acquire additional treatment facilities. We expect to spend approximately $6.8 million for maintenance related expenditures and up to an additional $17.5 million over the next 12 months for expansion projects, systems upgrades and other related initiatives.

Under the terms of our borrowing arrangements, we are required to comply with various covenants, including the maintenance of certain financial ratios. As of December 31, 2009, we were in compliance with all such covenants. A breach of these could result in a default under our credit facilities and in our being unable to borrow additional amounts under our revolving credit facility. If an event of default occurs, the lenders could elect to declare all amounts borrowed under our credit facilities to be immediately due and payable and the lenders under our term loans and revolving credit facility could proceed against the collateral securing the indebtedness.

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

Funding Commitments

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

Certain agreements contain contingent earnout provisions that provide for additional payments if the acquisitions meet performance milestones as specified in the agreements. During the year ended December 31, 2008, the Company made payments of $2.9 million related to earnout provisions. During 2009, the Company paid $0.2 million due to buyout of an earnout commitment related to a 2008 acquisition. The Company is not subject to any future earnout repayment commitments at December 31, 2009.

 

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Off-Balance Sheet Obligations

As of December 31, 2009, we did not have any off-balance sheet obligations other than $8.9 million of letters of credit.

Obligations and Commitments

The following table sets forth our contractual obligations as of December 31, 2009 (dollars in millions):

 

     Total    Less Than 1
Year
   1-3 Years    4-5 Years    Thereafter

Term loans, including interest (i)

   $ 438.5    $ 14.4    $ 28.6    $ 395.5    $ —  

Senior subordinated notes, including interest (ii)

     301.2      19.1      38.1      38.1      205.9

Revolving line of credit, including interest (iii)

     49.2      1.3      47.9      —        —  

Seller notes, including interest

     5.8      2.1      3.5      0.2      —  

Operating leases

     127.7      19.1      29.8      20.6      58.2

Consulting agreements and other service contracts

     9.9      3.6      4.4      1.9      —  

Liability for income taxes associated with uncertain tax positions

     1.1      0.5      —        —        0.6
                                  

Total obligations

   $ 933.4    $ 60.1    $ 152.3    $ 456.3    $ 264.7
                                  

 

(i) Interest rate is calculated using published three month LIBOR at December 31, 2009, plus 2.25%, which equals 2.501%.
(ii) Stated interest rate of 10.75% per the indenture.
(iii) Interest rate is calculated using published one month LIBOR at December 31, 2009, plus 2.50%, which equals 2.73%.

 

ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk

Interest rate risk

We are subject to interest rate risk in connection with our long-term debt. Our principal interest rate exposure relates to the term loans outstanding under our amended and restated senior secured credit facility. As of December 31, 2009 we have $405.6 million in term loans outstanding, bearing interest at variable rates. A hypothetical quarter point increase or decrease in market interest rates compared to the interest rates at December 31, 2009 would result in a $0.4 million change in annual interest expense on our term loans. We also have a revolving credit facility, which provides for borrowings of up to $100.0 million, which bears interest at variable rates. Assuming the revolving line of credit is fully drawn, each quarter point change in interest rates compared to the interest rates at December 31, 2009 would result in an immaterial change in the annual interest expense on our revolving credit facility. In conjunction with our term loans, we entered into an interest rate swap agreement on February 28, 2006 in the amount of $115.0 million as provided under our credit agreement and retained in our amended and restated credit agreement to exchange floating for fixed interest rate payments to reduce interest rate volatility. The effective date of the swap agreement was March 31, 2006 and has a maturity date of March 31, 2011. 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.

 

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ITEM 8. Financial Statements and Supplementary Data

TABLE OF CONTENTS

 

Report of Independent Registered Public Accounting Firm

   45

Consolidated Balance Sheets as of December 31, 2009 and 2008

   46

Consolidated Statements of Operations for the years ended December 31, 2009, 2008, and 2007

   47

Consolidated Statements of Changes in Equity for the years ended December 31, 2009, 2008, and  2007

   48

Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008, and 2007

   49

Notes to Consolidated Financial Statements

   51

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

CRC Health Corporation:

We have audited the accompanying consolidated balance sheets of CRC Health Corporation and subsidiaries, (the “Company”), (a wholly owned subsidiary of CRC Health Group, Inc.) as of December 31, 2009 and 2008, and the related consolidated statements of operations, changes in equity, and cash flows for the years ended December 31, 2009, 2008 and 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CRC Health Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for the years ended December 31, 2009, 2008, and 2007 in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the consolidated financial statements, the 2008 and 2007 consolidated financial statements have been revised for the retrospective adoption and new presentation and disclosure requirements for noncontrolling interests in subsidiaries.

 

/s/    DELOITTE & TOUCHE LLP

San Francisco, California

March 24, 2010

 

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CRC HEALTH CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

    December 31,
2009
    December 31,
2008
 

ASSETS

   

CURRENT ASSETS:

   

Cash and cash equivalents

  $ 4,982      $ 2,540   

Restricted cash

    420        —     

Accounts receivable, net of allowance for doubtful accounts of $5,327 in 2009 and $5,409 in 2008

    31,558        30,826   

Prepaid expenses

    7,489        7,703   

Other current assets

    1,306        1,618   

Income taxes receivable

    676        —     

Deferred income taxes

    6,346        4,029   

Current assets of discontinued operations, facility exits

    1,720        14,125   
               

Total current assets

    54,497        60,841   

PROPERTY AND EQUIPMENT-Net

    125,215        129,728   

GOODWILL

    573,594        604,078   

INTANGIBLE ASSETS-Net

    335,409        354,463   

OTHER ASSETS-Net

    19,619        20,065   
               

TOTAL ASSETS

  $ 1,108,334      $ 1,169,175   
               

LIABILITIES AND EQUITY

   

CURRENT LIABILITIES:

   

Accounts payable

  $ 3,011      $ 6,165   

Accrued liabilities

    29,851        29,061   

Income taxes payable

    —          1,201   

Current portion of long-term debt

    8,814        6,522   

Other current liabilities

    25,992        31,657   

Current liabilities of discontinued operations, facility exits

    2,114        703   
               

Total current liabilities

    69,782        75,309   

LONG-TERM DEBT-Less current portion

    622,262        646,630   

OTHER LONG-TERM LIABILITIES

    8,735        7,553   

LIABILITIES OF DISCONTINUED OPERATIONS, FACILITY EXITS

    1,679        1,909   

DEFERRED INCOME TAXES

    117,334        134,331   
               

Total liabilities

    819,792        865,732   
               

COMMITMENTS AND CONTINGENCIES (Note 12)

   

CRC HEALTH CORPORATION STOCKHOLDER’S EQUITY:

   

Common stock, $0.001 par value-1,000 shares authorized; 1,000 shares issued and outstanding at December 31, 2009 and 2008

    —          —     

Additional paid-in capital

    454,880        444,275   

Accumulated deficit

    (161,363     (134,764

Accumulated other comprehensive loss

    (4,975     (6,289
               

Total CRC Health Corporation stockholder’s equity

    288,542        303,222   
               

NONCONTROLLING INTEREST

    —          221   
               

Total equity

    288,542        303,443   
               

TOTAL LIABILITIES AND EQUITY

  $ 1,108,334      $ 1,169,175   
               

See notes to consolidated financial statements.

 

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CRC HEALTH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands)

 

    Year Ended
December 31,
2009
    Year Ended
December 31,
2008
    Year Ended
December 31,
2007
 

NET REVENUE:

     

Net client service revenue

  $ 429,590      $ 454,204      $ 429,711   
                       

OPERATING EXPENSES:

     

Salaries and benefits

    212,149        226,613        211,157   

Supplies, facilities and other operating costs

    123,570        134,366        128,920   

Provision for doubtful accounts

    7,839        6,408        6,791   

Depreciation and amortization

    22,857        21,971        21,373   

Asset impairment

    2,257        4,525        —     

Goodwill impairment

    30,497        142,238        —     
                       

Total operating expenses

    399,169        536,121        368,241   
                       

OPERATING INCOME (LOSS)

    30,421        (81,917     61,470   

INTEREST EXPENSE

    (44,158     (54,104     (60,262

GAIN ON DEBT REPURCHASE

    —          8,086        —     

OTHER (EXPENSE) INCOME

    (82     1        (1,771
                       

LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

    (13,819     (127,934     (563

INCOME TAX EXPENSE (BENEFIT)

    4,016        (6,276     1,007   
                       

LOSS FROM CONTINUING OPERATIONS, NET OF TAX

    (17,835     (121,658     (1,570

(LOSS) INCOME FROM DISCONTINUED OPERATIONS (net of tax (benefit) expense of ($4,961) in 2009, ($10,855) in 2008, and $2,136 in 2007, respectively)

    (8,826     (20,400     3,223   
                       

NET (LOSS) INCOME

    (26,661     (142,058     1,653   

LESS: NET (LOSS) INCOME ATTRIBUTABLE TO THE NONCONTROLLING INTEREST

    (62     (153     189   
                       

NET (LOSS) INCOME ATTRIBUTABLE TO CRC HEALTH CORPORATION

  $ (26,599   $ (141,905   $ 1,464   
                       

AMOUNTS ATTRIBUTABLE TO CRC HEALTH CORPORATION:

     

LOSS FROM CONTINUING OPERATIONS, NET OF TAX

  $ (17,778   $ (121,496   $ (1,759

DISCONTINUED OPERATIONS, NET OF TAX

    (8,821     (20,409     3,223   
                       

NET (LOSS) INCOME ATTRIBUTABLE TO CRC HEALTH CORPORATION

  $ (26,599   $ (141,905   $ 1,464   
                       

See notes to consolidated financial statements

 

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CRC HEALTH CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(In thousands, except share amounts)

 

                CRC Health Corporation Stockholder’s Equity      
    Total     Comprehensive
Income (Loss)
    Accumulated
(Deficit)
Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Series A
Common Stock
  Additional
Paid-in
Capital
  Noncontrolling
Interest
 
          Shares   Amount    

BALANCE—December 31, 2006

  $ 437,425      $ —        $ 3,522      $ —        1,000   $ —     $ 433,652   $ 251   

Cumulative effect of adoption of FIN48

    2,155          2,155             

Reclassification to other current liabilities

    (66                 (66

Net income for the year ended December 31, 2007

    1,653        1,653        1,464                189   

Capital contributed by Parent, net

    4,956                  4,956  
                                                       

BALANCE—December 31, 2007

  $ 446,123      $ 1,653      $ 7,141      $ —        1,000   $ —     $ 438,608   $ 374   
                                                       

Comprehensive loss:

               

Net loss for the year ended December 31, 2008

    (142,058     (142,058     (141,905             (153

Other comprehensive income, net of tax:

               

Unrealized loss on cash flow hedges, net of tax benefit of $4,161

    (6,289     (6,289       (6,289        
                           

Other comprehensive income

    (6,289     (6,289            
                           

Comprehensive loss

    (148,347   $ (148,347            
                           

Capital contributed by Parent, net

    5,667                  5,667  
                                                 

BALANCE—December 31, 2008

  $ 303,443        $ (134,764   $ (6,289   1,000   $ —     $ 444,275   $ 221   
                                                 

Noncontrolling interest buyout

    (138               21     (159

Comprehensive loss:

               

Net loss for the year ended December 31, 2009

    (26,661     (26,661     (26,599             (62

Other comprehensive income, net of tax:

               

Unrealized gain on cash flow hedges, net of tax expense of $865

    1,314        1,314          1,314           
                           

Other comprehensive income

    1,314        1,314               
                           

Comprehensive loss

    (25,347   $ (25,347            
                           

Capital contributed by Parent, net

    10,584                  10,584  
                                                 

BALANCE—December 31, 2009

  $ 288,542        $ (161,363   $ (4,975   1,000   $ —     $ 454,880   $ —     
                                                 

See notes to consolidated financial statements.

 

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CRC HEALTH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

    Year Ended
December 31,
2009
    Year Ended
December 31,
2008
    Year Ended
December 31,
2007
 

CASH FLOWS FROM OPERATING ACTIVITIES:

     

Net (loss) income

  $ (26,661   $ (142,058 )   $ 1,653   

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

     

Depreciation and amortization

    23,142        22,811        22,015   

Amortization of debt discount and capitalized financing costs

    4,290        4,536        4,476   

Goodwill impairment

    30,497        142,862        —     

Asset impairment

    11,500        30,836        —     

Write-off of prior year paid acquisition costs

    62        —          —     

Gain on debt repurchase

    —          (8,086 )     —     

(Gain)/ loss on interest rate swap agreement

    (1,272     (1 )     1,771   

Loss on sale of property and equipment

    1,509        68        218   

Loss on sale of discontinued operations

    47        —          —     

Provision for doubtful accounts

    8,002        6,561        6,857   

Stock-based compensation

    5,541        6,026        3,909   

Deferred income taxes

    (7,253     (19,756 )     1,306   

Changes in assets and liabilities:

     

Restricted cash

    (420     —          —     

Accounts receivable

    (8,771     (5,655 )     (4,962 )

Prepaid expenses

    44        (164 )     216   

Income taxes receivable

    (676     193        11,899   

Other current assets

    (3,989     494        56   

Accounts payable

    (3,189     (803 )     300   

Accrued liabilities

    1,216        (8,381 )     (2,877 )

Other current liabilities

    (1,814     (6,288 )     2,710   

Income taxes payable

    4,488        1,202        —     

Other long-term assets

    375        (19 )     840   

Other long-term liabilities

    360        (202 )     6,033   
                       

Net cash provided by operating activities

    37,028        24,176        56,420   
                       

CASH FLOWS FROM INVESTING ACTIVITIES:

     

Additions of property and equipment

    (12,999     (25,279 )     (30,159 )

Proceeds from sale of property and equipment

    148        188        90   

Proceeds from sale of discontinued operations

    732        —          —     

Acquisition of businesses, net of cash acquired

    —          (11,597 )     (32,912 )

Acquisition adjustments

    (59     (10 )     779   

Payments made under earnout arrangements

    (200     (2,947 )     (8,645 )

Purchase of intangible asset

    —          —          (100 )
                       

Net cash used in investing activities

    (12,378     (39,645 )     (70,947 )
                       

 

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CRC HEALTH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)

 

    Year Ended
December 31,
2009
    Year Ended
December 31,
2008
    Year Ended
December 31,
2007
 

CASH FLOWS FROM FINANCING ACTIVITIES:

     

Capital (distributed to) contributed by Parent

    (412     (359 )     252   

Capitalized financing costs

    —          (338 )     (640 )

Repayments of capital lease obligations

    (12     (22 )     (259 )

Repurchase of long term debt

    —          (13,607 )     —     

Borrowings under revolving line of credit

    14,000        59,000        63,500   

Repayments under revolving line of credit

    (29,000     (24,000     (40,600

Repayment of long-term debt

    (6,550     (7,783 )     (6,814 )

Noncontrolling interest buyout

    (234     —          —     
                       

Net cash (used in) provided by financing activities

    (22,208     12,891        15,439   
                       

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

    2,442        (2,578 )     912   

CASH AND CASH EQUIVALENTS—Beginning of period

    2,540        5,118        4,206   
                       

CASH AND CASH EQUIVALENTS—End of period

  $ 4,982      $ 2,540      $ 5,118   
                       

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

     

Assets acquired under capital lease

  $ —        $ —        $ 33   
                       

Notes payable issued in connection with earnout arrangements

  $ —        $ 897      $ 5,681   
                       

Note payable in connection to leasehold improvements

  $ —        $ 374      $ —     
                       

Payable in conjunction with contingent acquisition consideration

  $ —        $ —        $ 3,204   
                       

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

     

Cash paid for interest

  $ 42,707      $ 51,758      $ 56,418   
                       

Cash paid (received) for income taxes, net of refunds

  $ 2,164      $ 1,128      $ (10,062 )
                       

See notes to consolidated financial statements.

 

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CRC HEALTH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

CRC Health Corporation, (the “Company”) is headquartered in Cupertino, California and is a wholly owned subsidiary of CRC Health Group, Inc. referred to as the “Group” or the “Parent.” The Company is a leading provider of 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. Effective January 1, 2009, the Company realigned its operations and internal organizational structure by combining its “youth division” with its “healthy living division,” formerly included as a component of “corporate/other.” There were no organizational changes to the Company’s recovery division.

The Company delivers services through two divisions, the recovery division and the healthy living division. The recovery division provides substance abuse and behavioral disorder treatment services through our residential treatment facilities and outpatient treatment clinics. The healthy living division provides therapeutic and educational programs to underachieving young people through residential schools and wilderness programs. The healthy living division also provides treatment services through adolescent and adult weight management programs as well as eating disorder facilities. The healthy living division and recovery division are also its two operating segments.

As of December 31, 2009, the recovery division, operates 31 inpatient, 15 outpatient facilities, and 54 comprehensive treatment centers (“CTCs”) in 21 states, provides treatment services to patients suffering from chronic addiction related diseases and related behavioral disorders. As of December 31, 2009, the healthy living division, operates 24 adolescent and young adult programs in 8 states and provides a wide variety of therapeutic and educational programs for underachieving young people. Additionally, the healthy living division operates 18 weight management facilities in 9 states, one facility in the United Kingdom and one facility in Canada with a focus on providing treatment services for eating disorders and weight management. Other activities classified as corporate 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).

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation — These consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) applicable for annual financial information. The Company’s consolidated financial statements include the accounts of CRC Health Corporation and its consolidated subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the prior year consolidated statements of operations to conform to the 2009 presentation. The Company combined other revenue into net client service revenue to represent how the Company currently manages its business.

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

Cash and Cash Equivalents Cash includes amounts in demand accounts. At December 31, 2009 and 2008 substantially all cash was on deposit with financial institutions. Cash equivalents are short-term investments with original maturities of three months or less. Interest income for the years ended December 31, 2009, 2008 and 2007 was approximately $0.1 million, $0.1 million, and $0.7 million, respectively, and is recorded in interest expense on the consolidated statements of operations.

 

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CRC HEALTH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Cash Flows Related to Borrowings and Repayments under the Revolving Line of Credit — The Company has historically presented cash flows under its revolving line of credit on a net basis. For the year ended December 31, 2009, the Company is presenting activities under the revolving line of credit on a gross basis for both borrowings and repayments within the cash flows from financing activities section in the consolidated statement of cash flows. Due to the aforementioned change, the Company has corrected the consolidated statements of cash flows for the years ended December 31, 2008 and 2007 to reflect gross borrowings and repayments on the revolving line of credit.

There was no change to total net cash (used in) provided by financing activities within the consolidated statements of cash flows for any period presented.

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

Long-Lived Assets — The Company tests its long-lived assets and intangible assets subject to amortization for impairment whenever events or changes in circumstances indicate that the carrying value of certain of its assets may not be recoverable. If the undiscounted future cash flows from the asset tested are less than the carrying value, a loss equal to the difference between the carrying value and the fair market value of the asset is recorded.

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

Goodwill and Other Intangible Assets The Company tests goodwill and other indefinite lived intangible assets for impairment annually, at the beginning of its fourth quarter or more frequently if evidence of possible impairment arises. The Company’s other indefinite lived intangible assets consist of trademarks and trade names, certificates of need, and regulatory licenses. The Company applies a fair value-based impairment test to the net book value of other indefinite lived intangible assets using a combination of income and market approaches.

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

 

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CRC HEALTH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The process of evaluating the potential impairment of goodwill is subjective and requires significant estimates and assumptions at many points during the analysis. The Company’s estimated future cash flows are based on assumptions that are consistent with its annual planning process and include estimates for revenue and operating margins and future economic and market conditions. Actual future results may differ from those estimates. To the extent that the Company’s reporting unit revenues during any of its reporting periods decreases significantly, the Company may have to report an impairment loss with respect to the carrying value of the reporting units’ goodwill. The Company intends to closely monitor revenues within its reporting units during 2010 and, if warranted, will record an impairment loss to the carrying value of the reporting units’ goodwill.

The Company bases its fair value estimates on assumptions it believes to be reasonable at the time, but that are unpredictable and inherently uncertain. In addition, the Company makes certain judgments and assumptions in allocating shared assets and liabilities to determine the carrying values for each of its reporting units tested. Changes in assumptions or circumstances could result in an additional impairment in the period in which the change occurs and in future years. Factors that could cause the Company additional goodwill impairment include, but are not limited to:

 

  1. Decreases in revenues

 

  2. Increases in the Company’s borrowing rates or weighted average cost of capital

 

  3. Increase in the blended tax rate

 

  4. Changes in its working capital

 

  5. Significant alteration of market multiples utilized in the valuation process

 

  6. Significant decrease in market value of comparable companies

Impairment charges related to goodwill and intangible assets not subject to amortization are included in the consolidated statement of operations under goodwill impairment, asset impairment and discontinued operations. See Note 6.

Capitalized Financing Costs — Costs to obtain long-term debt financing are capitalized and amortized over the expected life of the debt instrument. As of December 31, 2009 and 2008, other assets include net capitalized financing costs of $14.7 million, and $18.7 million, respectively. Amortization expenses for the years ended December 31, 2009, 2008 and 2007 were $4.1 million, $4.2 million, and $4.2 million, respectively and are included in the Company’s consolidated statement of operations under interest expense.

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

 

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CRC HEALTH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Advertising Costs Advertising costs, included in supplies, facilities and other operating costs, are expensed as incurred. Advertising costs for the years ended December 31, 2009, 2008 and 2007, were approximately $4.0 million, $4.1 million, and $2.9 million, respectively.

Stock-Based Compensation — The Company measures and recognizes compensation expense for all stock-based payment awards, including employee stock options, based on the grant-date fair value. The Company estimates grant-date fair value of its awards by utilizing the Black Scholes Merton model for time-based awards and a closed-form lattice model for awards containing market conditions. Stock-based compensation is recognized over the required service or performance period of the awards.

Gain on Debt Repurchase During the year ended December 31, 2008 the Company retired senior subordinated notes with a par amount of $22.7 million. Excluding immaterial transaction related costs, the Company realized a gain of $8.1 million from debt retirement activities. The Company did not have any debt retirement activities in 2009 or 2007.

Noncontrolling Interest — The Company, through the acquisition of Aspen Education Group, acquired a seventy-five percent interest in certain weight loss programs. Additionally, a former employee acquired a 10% interest in two healthy living division programs as a result of a prior agreement in place from the Aspen acquisition. The Company consolidates its investment for financial reporting purposes. Losses are allocated based upon the “at risk” capital of each limited liability partner member. Losses in excess of the “at risk” capital are allocated to the Company without regard to the percentage of ownership. The Company retained an option to buy-out the non-controlling interest at a price to be calculated pursuant to the terms and conditions of the operating agreement. During the year ended December 31, 2009, the Company exercised its option to buy-out the non-controlling interests, related to the aforementioned two healthy living division programs, and paid a total consideration of $0.2 million.

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

The Company recognizes a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes based on technical merits.

Restructuring and Discontinued Operations The Company accounts for facility closures and restructuring costs in accordance with applicable accounting standards. The Company records as an obligation the estimated costs that will not be recovered. These costs include employment termination benefits, lease contract termination costs and other associated costs. Additionally, upon review of facility closures and those facilities held for sale, the Company assesses the classification of such facilities as discontinued operations. Should the Company classify certain facility closures and facilities held for sale as discontinued operations, the facility operations related to closures and facilities held for sale are classified as discontinued operations on the consolidated statements of operations for all periods presented. Assets and liabilities of discontinued operations are classified under assets and liabilities of discontinued operations, facility exits on the Company’s consolidated balance sheets. See Note 18 and Note 19.

 

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CRC HEALTH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist primarily of cash and accounts receivable. The Company’s cash accounts are maintained with financial institutions in the United States of America. At times, deposits in these institutions may exceed federally insured limits. The Company’s accounts receivable are primarily derived from methadone treatment, detoxification, psychological evaluations, counseling, education, weight loss management and other related rehabilitation services provided to clients. As of December 31, 2009 and 2008, approximately 38.3% and 36.2% of gross accounts receivable and approximately 19.9% and 16.4% of net client service revenue, respectively, was derived from county, state and federal contracts under Medicaid and other programs. In the event of cancellation or curtailment of these programs or default on these accounts receivable, the Company’s operating results and financial position would be adversely affected. The Company performs ongoing credit evaluations of its third-party insurance payors’ financial condition and generally requires advance payment from its clients who do not have verifiable insurance coverage. The Company maintains an allowance for doubtful accounts to cover potential credit losses based upon the estimated collectability of accounts receivable.

Interest Rate Swaps — Interest rate swaps are used exclusively in the management of the Company’s interest rate exposures and are recorded on the balance sheet at fair value. As part of its hedging strategy, the Company has designated its interest rate swaps as cash flow hedges.

The fair value of the interest rate swaps are estimated based upon terminal value models. The effective portions of changes in the fair value of the swap are recorded in other comprehensive income. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. Additionally, reclassifications of deferred gains or losses related to ineffectiveness of interest rate swaps, are recognized as interest expense on the consolidated statement of operations. If the swaps are not designated as cash flow hedges, the changes in the fair value of the swaps are recorded in other income (expense) on the consolidated statement of operations. See Note 9.

Other Comprehensive Income — Other comprehensive income (“OCI”) includes income, expenses, gains and losses that bypass the statement of operations and are reported directly as a separate component of equity. For the years ended December 31, 2009 and 2008, the effective portion of changes in fair value of its interest rate swaps designated as cash flow hedges was recorded to other comprehensive income. For the year ended December 31, 2007, the Company’s interest rate swap was not designated as a hedge; therefore, changes in its fair value were recorded in other income (expense) in the consolidated statements of operations. See Note 11.

Business Segments — Performance of the Company’s two reportable segments (recovery division and healthy living division) is evaluated based on profit or loss from operations before depreciation and amortization, gain on sale of assets, special charges or benefits, income taxes and minority interest (“segment profit”). Management uses segment profit information for internal reporting and control purposes and considers it important in making decisions regarding the allocation of capital and other resources, risk assessment and employee compensation, among other matters. Intersegment sales and transfers are insignificant. All prior period segment information is presented to conform to the Company’s current segment structure. See Note 1 and Note 20.

Student Loan Program — Effective April 1, 2009, the Company created a private loan program (“the Loan Program”) pursuant to which students and/or patients (“the Borrowers”) who meet predetermined credit standards can obtain third-party financing to pay a portion of the cost of participating in certain of our programs. The Company initiated this program in response to the lack of credit availability for our students/patients, particularly in the healthy living division, to secure financing to access our services. The Board of Directors has approved a loan pool of up to $20.0 million for 2009 and 2010.

 

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CRC HEALTH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company has entered into an agreement (“the Agreement”) with an unrelated third party (“the Lender”) to facilitate unsecured consumer loans for certain of the Company’s students and/or patients. The loans are funded by the Lender based on predetermined loan criteria, including risk profile and credit quality requirements. The loans are unsecured consumer loans with a floating interest rate. Under the terms of the Loan Program, the Company has agreed to purchase from the Lender on a recurring basis loan notes that meet Loan Program criteria. In accordance with the Agreement, the Company can terminate the Loan Program at any time upon a 120 day advance notice of termination to the Lender.

In connection with the Loan Program, the Company has agreed to purchase on a recurring basis loan notes that meet Loan Program criteria from the third-party lender that makes these loans. The Company considers the purchase commitments as off-balance sheet arrangements and maintains restricted cash for the fulfillment of its Loan Program note purchase commitments. At December 31, 2009, the Company did not have any loan purchase commitments related to its Loan Program.

The Company maintains balances in its restricted cash account for the purchase of notes pursuant to the Agreement. Restricted cash is recorded on the Company’s consolidated balance sheets under restricted cash. At December 31, 2009, the Company had $0.4 million classified as restricted cash under current assets on the Company’s consolidated balance sheets.

The Company has established a loan loss reserve to account for non-performing Loan Program notes. The Company has utilized a variety of data from the consumer and education loan industry to establish its initial loan loss reserve. On a periodic basis, the Company evaluates the adequacy of the allowance based on the Company’s past loan loss experience, known and inherent risks in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and current economic conditions. At December 31, 2009, the Company has recorded $0.2 million in loan loss reserves under other assets, net, on its consolidated balance sheets.

Recently Issued Accounting Guidance — In January 2010, the FASB issued updated authoritative guidance, which, among other things, requires entities to separately present purchases, sales, issuances, and settlements in their reconciliation of Level 3 fair value measurements (i.e., to present such items on a gross basis rather than on a net basis), and which clarifies existing disclosure requirements regarding the level of disaggregation and the inputs and valuation techniques used to measure fair value for measurements that fall within either Level 2 or Level 3 of the fair value hierarchy. The updated guidance is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements (which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years). The Company is currently assessing the impact that the adoption of the updated guidance will have on the consolidated financial statement disclosures.

During the third quarter of 2009, the Company adopted the new Accounting Standards Codification (ASC) as issued by the Financial Accounting Standards Board (FASB). The ASC has become the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. The ASC is not intended to change or alter existing GAAP. The adoption of the ASC did not have a material impact on the Company’s consolidated financial statements.

In August 2009, the FASB issued a new accounting standard which provides additional guidance on the measurement of liabilities at fair value. Specifically, when a quoted price in an active market for the identical liability is not available, the new standard requires that the fair value of a liability be measured using one or more of the valuation techniques that should maximize the use of relevant observable inputs and minimize the use of

 

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unobservable inputs. In addition, an entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability. We adopted this standard in the fourth quarter of 2009 and the adoption did not have a material impact on our consolidated financial statements.

In May 2009, the FASB issued new accounting and disclosure guidance for recognized and non-recognized subsequent events that occur after the balance sheet date but before financial statements are issued. The new guidance required disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. The new accounting guidance was effective for the Company beginning with three and six months ended June 30, 2009. The guidance was subsequently amended in February 2010 and is being applied prospectively. Under the amended guidance, the Company is required to evaluate for subsequent events through the date the financial statements are issued. We adopted the amended guidance in February 2010. This change in accounting policy had no impact on the consolidated financial statements.

On January 1, 2009, we adopted a new standard in regard to noncontrolling interests in consolidated financial statements. This standard establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary (minority interest) is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and separate from the parent company’s equity. This statement also requires disclosure, on the face of the consolidated statements of operations, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. These disclosure requirements have been applied retrospectively to all periods presented. The adoption of this standard impacted certain captions previously used on the consolidated statements of operations, largely identifying net income including noncontrolling interests and net income attributable to CRC Health Corporation. Certain captions on the consolidated balance sheets and consolidated statements of cash flows have also changed.

In March 2008, the FASB amended existing disclosure requirements related to derivative and hedging activities, which became effective for the Company on January 1, 2009, and is being applied prospectively. As a result of the amended disclosure requirements, the Company is required to provide expanded qualitative and quantitative disclosures about derivatives and hedging activities in each interim and annual period. The adoption of the new disclosure requirements had no material impact on the consolidated financial statements.

In December 2007, the FASB amended its guidance on accounting for business combinations. The new accounting guidance resulted in a change in the Company’s accounting policy effective January 1, 2009, and is being applied prospectively to all business combinations subsequent to the effective date. Among other things, the new guidance amends the 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. It also establishes new disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The adoption of this new accounting policy did not have a significant impact on the consolidated financial statements, and the impact it will have on the consolidated financial statements in future periods will depend on the nature and size of business combinations completed subsequent to the date of adoption.

 

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3. ACQUISITIONS

The Company did not complete any acquisitions during the year ended December 31, 2009.

2008 Acquisitions

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

Under purchase accounting the purchase price for each acquisition was allocated to the assets acquired and liabilities assumed based on their respective fair values. The Company has included the acquired entities’ results of operations in the consolidated statements of operations from the date of the acquisition. Pro forma results of operations have not been presented because the effect of the acquisitions was not material.

2007 Acquisitions

During the year ended December 31, 2007, the Company completed four acquisitions and paid total cash consideration of approximately $32.9 million, including acquisition related expenses. The acquisitions expanded its recovery division and healthy living division services into new geographic regions within the United States. The Company recorded $29.1 million of goodwill, of which $28.6 million is expected to be deductible for tax purposes. Goodwill assigned to the recovery division and healthy living division was $22.9 million and $6.2 million respectively.

Under purchase accounting the purchase price for each acquisition was allocated to the assets acquired and liabilities assumed based on their respective fair values. The Company has included the acquired entities’ results of operations in the consolidated statements of operations from the date of the acquisition. Pro forma results of operations have not been presented because the effect of the acquisitions was not material.

 

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4. BALANCE SHEET COMPONENTS

Balance sheet components at December 31, 2009 and 2008 consist of the following (in thousands):

 

     2009     2008  

Accounts receivable—gross

   $ 36,885      $ 36,235   

Less allowance for doubtful accounts

     (5,327 )     (5,409 )
                

Accounts receivable—net

   $ 31,558      $ 30,826   
                

Other assets-net:

    

Capitalized financing costs—net

   $ 14,663      $ 18,688   

Deposits

     925        912   

Note receivable

     4,031        465   
                

Total other assets-net

   $ 19,619      $ 20,065   
                

Accrued liabilities:

    

Accrued payroll and related expenses

   $ 8,698      $ 7,864   

Accrued vacation

     4,615        5,613   

Accrued interest

     8,019        8,289   

Accrued expenses

     8,519        7,295   
                

Total accrued liabilities

   $ 29,851      $ 29,061   
                

Other current liabilities:

    

Deferred revenue

   $ 9,650      $ 10,249   

Client deposits

     4,130        5,114   

Insurance premium financing

     —          2,226   

Interest rate swap liability

     8,659        12,110   

Other liabilities

     3,553        1,958   
                

Total other current liabilities

   $ 25,992      $ 31,657   
                

The following schedule reflects activity associated with the Company’s allowance for doubtful accounts for the years ended December 31, 2009, 2008 and 2007 (in thousands):

 

     2009     2008     2007  

Allowance for Doubtful Accounts

      

Balance—beginning of the period (1)

   $ 5,344      $ 6,849      $ 8,235   

Provision for doubtful accounts

     7,839        6,492        6,857   

Write-off of uncollectible accounts

     (7,856 )     (7,932 )     (8,191 )
                        

Balance—end of the period

   $ 5,327      $ 5,409      $ 6,901   
                        

 

(1) Beginning balance for the years ended December 31, 2009 and 2008 has been adjusted to exclude accounts receivable related to discontinued operations.

 

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5. PROPERTY AND EQUIPMENT

Property and equipment at December 31, 2009 and 2008 consists of the following (in thousands):

 

     2009     2008  

Land

   $ 21,373      $ 21,373   

Building and improvements

     74,551        65,733   

Leasehold improvements

     23,181        22,147   

Furniture and fixtures

     12,404        11,556   

Computer equipment

     10,855        9,474   

Computer software

     11,332        9,495   

Motor vehicles

     5,911        5,568   

Field equipment

     2,782        2,901   

Construction in progress

     6,363        12,013   
                
     168,752        160,260   

Less accumulated depreciation

     (43,537 )     (30,532 )
                

Property and equipment—net

   $ 125,215      $ 129,728   
                

Depreciation expense was $15.6 million, $13.9 million, and $10.9 million for the years ended December 31, 2009, 2008 and 2007, respectively.

The Company tests its long-lived assets for impairment whenever events and changes in circumstances indicate that the carrying value of certain of its assets may not be recoverable. If the undiscounted future cash flows from the assets tested are less than the carrying value, a loss equal to the difference between the carrying value and the fair market value of the asset is recorded. Fair market value is determined using discounted cash flow methods. The Company’s analysis of its undiscounted cash flows requires judgment with respect to many factors, including future cash flows, success at executing its business strategy, and future revenue and expense growth rates. It is possible that the Company’s estimates of undiscounted cash flows may change in the future resulting in the need to reassess the carrying value of its long-lived assets for impairment.

At September 30, 2009, the Company tested property and equipment within its healthy living segment for possible impairment as a result of triggering events related to declining enrollments. Consequently, for the year ended December 31, 2009, the Company recognized a non-cash impairment charge of $0.2 million related to impairment of property and equipment which is recorded under asset impairment on the consolidated statement of operations.

 

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6. GOODWILL AND INTANGIBLE ASSETS

Changes to goodwill by reportable segment for the years ended December 31, 2009 and 2008 are as follows (in thousands):

 

     Recovery     Healthy Living     Total  
     2009     2008     2009     2008     2009     2008  

Balance as of January 1

            

Goodwill

   $ 502,155      $ 488,318      $ 244,785      $ 242,366      $ 746,940      $ 730,684   

Accumulated impairment losses

     (624     —          (142,238     —          (142,862     —     
                                                

Balance as of January 1

     501,531        488,318        102,547        242,366        604,078        730,684   

Activity during the year:

            

Goodwill additions

     —          11,304        —          —          —          11,304   

Goodwill impairment

     —          (624     (30,497     (142,238     (30,497     (142,862

Goodwill related to earn-outs

     200        —          —          641        200        641   

Goodwill related to sale of facilities

     (236     —          —          —          (236     —     

Goodwill adjustments

     49        2,533        —          1,778        49        4,311   
                                                

Balance as of December 31

            

Goodwill

     502,168        502,155        244,785        244,785        746,953        746,940   

Accumulated impairment losses

     (624     (624     (172,735     (142,238     (173,359     (142,862
                                                

Balance as of December 31

   $ 501,544      $ 501,531      $ 72,050      $ 102,547      $ 573,594      $ 604,078   
                                                

Goodwill impairment

2009 Goodwill Impairment During 2009, the Company tested its recovery reporting unit for possible impairment in accordance with its annual goodwill impairment testing policy. The Company determined that the fair value of its recovery reporting unit exceeded its carrying value by approximately 165%. As a result of the impairment testing, the Company established that the second step of goodwill impairment testing was not required for its recovery reporting unit.

During the third quarter of 2009, the Company reduced its estimate of expected future cash flows for the healthy living reporting unit based upon current economic conditions including the lack of availability of student loans, credit for its clients and other factors. Accordingly, the Company tested its healthy living reporting unit in advance of the annual goodwill impairment test date as there was a significant adverse change in business climate and recognized a non-cash impairment charge of $24.9 million. Goodwill impairment charges, recognized by the Company during the three months ended September 30, 2009, were estimated amounts which were subsequently revised during the fourth quarter of 2009 resulting in a favorable goodwill adjustment of $0.6 million.

During the fourth quarter of 2009, the Company closed two facilities within its healthy living reporting unit. The closure of the two facilities negatively impacted the Company’s forecasted cash flows for the reporting unit. The decrease in forecasted cash flows was considered a triggering event that gave effect to additional goodwill impairment testing for the healthy living reporting unit. As a result of goodwill impairment testing for its healthy living reporting unit, the Company determined that the carrying value of its healthy living reporting unit exceeded the reporting unit’s estimated fair value and recognized a non-cash impairment charge of $6.2 million.

 

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Goodwill impairment charges for 2009 are reflected as goodwill impairment within continuing operations in the consolidated statement of operations.

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

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

Goodwill related to earnouts

Certain acquisition agreements contain contingent earnout provisions that provide for additional consideration to be paid to the sellers if the results of the acquired entity’s operations exceed negotiated benchmarks. During the year ended December 31, 2009, the recovery reporting unit recorded $0.2 million in additional goodwill related to the Company’s negotiated purchase of an earnout related to a 2008 acquisition.

During the year ended December 31, 2008, the healthy living reporting unit recorded $0.6 million in additional goodwill as a result of one of the entities meeting the benchmarks.

Goodwill related to sale of facilities

During the year ended December 31, 2009, the Company completed the sale of four facilities within its recovery reporting unit which were classified as held for sale at December 31, 2008. The Company allocated approximately $0.2 million of goodwill to the facilities upon completion of the sales.

Goodwill adjustments

For the year ended December 31, 2009, goodwill adjustments include an immaterial correction to an acquisition completed in 2007. For the year ended December 31 2008, goodwill adjustments include a $1.8 million correction related to an above market lease from an acquisition completed in 2007 and a $2.5 million correction of estimated deferred tax benefits related to acquisitions occurring in 2006.

 

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Intangible assets at December 31, 2009 and 2008 consist of the following (in thousands):

 

    December 31, 2009   December 31, 2008
    Useful
Life
  Gross
Carrying
Amount
  Accumulated
Amortization
    Net
Carrying
Amount
  Useful
Life
  Gross
Carrying
Amount
  Accumulated
Amortization
    Net
Carrying
Amount

Intangible assets subject to amortization:

               

Referral network

  20 years   $ 29,695   $ (4,632 )   $ 25,063   20 years   $ 35,914   $ (3,823 )   $ 32,091

Accreditations

  20 years     14,144     (2,219 )     11,925   20 years     16,118     (1,722 )     14,396

Curriculum

  20 years     7,425     (1,159 )     6,266   20 years     8,743     (929 )     7,814

Government including Medicaid contracts

  15 years     34,967     (9,131 )     25,836   15 years     34,979     (6,806 )     28,173

Managed care contracts

  10 years     14,400     (5,640 )     8,760   10 years     14,400     (4,200 )     10,200

Managed care contracts

  5 years     100     (45 )     55   5 years     100     (25 )     75

Core developed technology

  5 years     2,704     (2,122 )     582   5 years     2,704     (1,582 )     1,122

Covenants not to compete

  3 years     152     (152 )     —     3 years     152     (152 )     —  
                                           

Total intangible assets subject to amortization:

    $ 103,587   $ (25,100 )     78,487     $ 113,110   $ (19,239 )     93,871
                                           

Intangible assets not subject to amortization:

               

Trademarks and trade names

          174,821           176,587

Certificates of need

          44,600           44,600

Regulatory licenses

          37,501           39,405
                       

Total intangible assets not subject to amortization

          256,922           260,592
                       

Total intangible assets

        $ 335,409         $ 354,463
                       

Amortization expense related to intangible assets subject to amortization was $7.3 million, $8.1 million and $10.4 million, for the years ended December 31, 2009, 2008 and 2007, respectively.

During the year ended December 31, 2009, the Company continued its restructuring activities initiated in 2008 (the “FY08 Plan”). The Company recognized a non-cash impairment charge of $6.1 million related to finite-lived intangible assets and $3.2 million related to indefinite lived intangible assets. These impairment charges are based on the Company’s decision to close four of its healthy living program facilities and reduce the carrying value of certain of its finite-lived and indefinite lived intangible assets to their estimated fair value.

 

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Impairment charges related to facility closures are included under asset impairment in the consolidated statement of operations under results from discontinued operations. See Note 18.

During the third quarter ended September 30, 2009, the Company tested its finite lived intangible assets for possible impairment due to negative economic conditions including the lack of availability of student loans, credit for its clients and other factors which indicated that the carrying value of certain of its assets may not be recoverable. The Company records impairments when the undiscounted future cash flow from an asset tested is less than the carrying value of that asset. Losses are measured based on the difference between the carrying value and the estimated fair market value of the asset based on a discounted cash flow analysis. The Company determined that certain finite-lived intangible assets within its healthy living segment were impaired. Accordingly, for the year ended December 31, 2009, the Company recognized a non-cash charge of $2.0 million which is included in the consolidated statement of operations under asset impairment. These impairment charges reduce the carrying value of certain of its finite-lived intangible assets to their estimated fair value.

During 2008, as a result of impairment testing during the year, the Company recognized non-cash impairment charges of $16.9 million related to intangibles subject to amortization and $10.9 million related to intangible assets not subject to amortization. Of the total impairment charges, $4.5 million of charges related to intangible assets not subject to amortization are recognized in continuing operations on the Company’s consolidated statement of operations under asset impairment. The remaining impairment charges are recognized in discontinued operations.

Estimated future amortization expense related to the amortizable intangible assets at December 31, 2009 is as follows (in thousands):

 

Fiscal Year

    

2010

   $ 6,895

2011

     6,395

2012

     6,349

2013

     6,334

2014

     6,334

Thereafter

     46,180
      

Total

   $ 78,487
      

7. INCOME TAXES

The provision for income taxes attributable to income from continuing operations consists of the following (in thousands):

 

     2009     2008     2007  

Current:

      

Federal

   $ 5,691      $ 269      $ (855

State

     2,176        2,354        2,691   
                        

Total Current

     7,867        2,623        1,836   
                        

Deferred:

      

Federal

     (3,295     (8,156     (648

State

     (556     (743     (181
                        

Total Deferred

     (3,851     (8,899     (829
                        

Income tax expense (benefit) from continuing operations

   $ 4,016      $ (6,276   $ 1,007   
                        

 

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The reconciliation of income tax computed by applying the U.S. federal statutory rate to the effective tax rate for continuing operations is summarized in the following table:

 

     2009     2008     2007  

Statutory federal tax rate

   35.0   35.0   35.0

State income taxes (net of federal benefit)

   -11.8   -0.6   -342.2

Goodwill impairment

   -60.1   -28.2   —     

Non deductible expenses

   1.3   -0.2   -48.3

Prior year provision true-ups

   1.3   -0.3   -22.4

Release of tax reserve

   —        0.0   221.2

Change in valuation allowances for NOL

   1.8   -1.0   —     

Other

   3.4   0.2   -22.2
                  

Effective tax rate from continuing operations

   -29.1   4.9   -178.9
                  

Deferred tax — Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purpose and the amounts used for income tax purposes. The tax effects of items comprising deferred income taxes at December 31, 2009 and 2008 is as follows:

 

     2009     2008  

Deferred tax assets:

    

Reserves and allowances

   $ 6,491      $ 4,006   

Net operating loss carryforwards

     5,431        1,277   

Research credits

     1,068        1,295   

Acquisition costs

     2,674        3,184   

Flow through entity

     —          204   

Stock based compensation

     7,850        5,637   

Charitable contributions

     109        97   

State taxes

     351        8   

Interest rate swap

     3,451        5,356   
                

Gross deferred tax assets

   $ 27,425      $ 21,064   

Valuation allowance

     (5,763     (8,127
                

Total deferred tax assets

   $ 21,662      $ 12,937   
                

Deferred tax liabilities:

    

Acquired intangible assets

   $ (130,096   $ (142,999

Depreciation and amortization

     (1,223     (240

Flow through entity

     (1,331     —     
                

Gross deferred tax liabilities

   $ (132,650   $ (143,239
                

Total net deferred tax liabilities

   $ (110,988   $ (130,302
                

Current Net DTA

   $ 6,346      $ 4,029   

Non-Current Net DTL

   $ (117,334   $ (134,331

At December 31, 2009, the Company had $4.3 million and $72.7 million of U.S. federal and state net operating loss carry forwards, respectively, available to offset future taxable incomes, which expire in varying amounts beginning in 2022 and 2013 respectively, if not utilized. Under the Tax Reform Act of 1986, the

 

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amounts of and benefits from net operating loss carry forwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that the company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three-year period. At December 31, 2009, the Company’s net operating loss and credit carry forwards may be subject to such limitations.

At December 31, 2009, the Company had approximately $0.2 million of state research and development credit carry forward, respectively. The state credits carry forward indefinitely.

As of December 31, 2009, the Company also had $1.0 million of federal alternative minimum tax credit that can be carried forward indefinitely to offset the future federal regular tax liability.

Future tax benefits are recognized to the extent that realization of such benefits is more likely than not. A valuation allowance is established for those benefits that do not meet the more likely than not criteria. We have evaluated the need for a valuation allowance against deferred tax assets, and have recorded valuation allowance of $5.8 million at December 31, 2009.

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

Income Tax related to Impairments — During the year ended December 31, 2009, the Company recognized a total of $ 42.0 million in impairments related to goodwill, intangible assets and fixed assets. Of the $42.0 million in impairment, $41.8 million is related to impairment of goodwill and other intangible. The remaining $0.2 million is related to fixed asset impairments.

Of the $41.8 million in impairments related to goodwill and other intangibles, $23.6 million represents goodwill that is non-deductible for income tax purposes, resulting in an increase to federal income expense of $8.3 million. The $8.3 million increase in income tax expense reduced the income tax benefit to the Company’s total effective tax rate by 60.1%. The $8.3 million income tax expense is related to continuing operations.

Of the total impairments, $41.8 million impairment generated approximately $7.0 million of income tax benefits in the form of future tax deductions.

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

Of the $170.7 million in impairments related to goodwill and other intangibles, $102.9 million represents goodwill that is non-deductible for income tax purpose, resulting in an increase to federal income expense of $36.0 million. The $36.0 million increase in income tax expense reduced the income tax benefit to the Company’s total effective tax rate by 22.7%. Of the $36.0 million income tax expense, $35.8 million is related to continuing operations and $0.2 million is related to discontinued operations, representing an effective tax rate change of 28.2% and 0.7%, respectively.

Of the total impairments, $67.7 million impairment generated approximately $27.0 million of income tax benefits in the form of future tax deductions.

 

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Unrecognized tax benefits — At December 31, 2009, the Company’s total unrecognized tax benefits were approximately $1.1 million exclusive of interest and penalties described below. Included in this amount is approximately $0.7 million of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate in a future period. The Company expects that $0.4 million 2006 transaction cost will be taken off from the schedule and realize unrecognized tax benefits within the next six to eight months due to 2006 IRS audit close.

The Company recognizes interest related to unrecognized tax benefits within the income tax expenses line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet. At December 31, 2009 and 2008, the Company had $0.3 million and $0.1 million accrued for estimated interest and penalties.

The Company is no longer subject to U.S. federal, state and local income tax audits by taxing authorities for years through 2004. The tax years 2005 through 2008 remain open to examination by major taxing jurisdictions to which the Company is subject in the United States. In addition, the Company has net operating losses in certain states for which the statute of limitations relative to the net operating loss carryovers is open from 2001.

The following is a roll forward of our total gross unrecognized tax benefit liabilities for the years ended December 31, 2009, 2008 and 2007 (in thousands):

 

     2009     2008     2007  

Beginning Balance

   $ 1,097      $ 1,075      $ 1,918   

Tax positions related to

      

Additions

     —          —          —     

Reductions

     —          —          —     

Tax positions related to prior years:

      

Additions

     —          112        464   

Reductions

     —          —          —     

Settlements

      

Lapse of statute of limitations

     (16     (90     (1,307
                        

Balance, December 31,

   $ 1,081      $ 1,097      $ 1,075   
                        

8. LONG-TERM DEBT

Long-term debt at December 31, 2009 and 2008 consists of the following (in thousands):

 

     2009     2008  

Term loan

   $ 405,649      $ 409,841   

Revolving line of credit

     46,500        61,500   

Senior subordinated notes, net of discount of $1,606 in 2009 and $1,870 in 2008

     175,690        175,426   

Seller notes

     3,116        6,216   

Note payable, leasehold improvement

     121        157   

Capital lease obligations

     —          12   
                

Total debt

     631,076        653,152   

Less current portion

     (8,814     (6,522 )
                

Long-term debt—less current portion

   $ 622,262      $ 646,630   
                

 

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

Term Loan — Aggregate commitment of $419.3 million matures on February 6, 2013. The Term Loan is payable in quarterly principal installments of $1.05 million per quarter through December 31, 2012, and the remainder on February 6, 2013. Interest is payable quarterly at 90 day London Interbank Offered Rate (“LIBOR”) plus 2.25% (2.501% at December 31, 2009). Under the Amendment No. 2, the Company must comply with certain restrictive financial covenants that limit the amount of capital expenditures the Company may make on an annual basis and require the Company to maintain certain levels of liquidity, debt to income ratios and interest coverage ratios. The Company was in compliance with all such covenants as of December 31, 2009. The principal balance outstanding at December 31, 2009 was $405.6 million.

Under the Credit Agreement, the Company is required to apply a certain portion of excess cash to the principal amount of the Term Loan. Excess cash under the Credit Agreement is defined as net income attributable to the Company adjusted for certain cash and non-cash items.

Revolving Line of Credit — Maximum borrowings are not to exceed $100.0 million. At the Company’s option, interest is currently payable at LIBOR plus 2.50% or monthly at the Base Rate (defined as the higher of (a) the prime rate or (b) the overnight federal funds rate plus 50 basis points) plus 1.50% per annum. Principal is payable at the Company’s discretion based on available operating cash balances. The revolving line of credit commitment expires on February 6, 2012. At December 31, 2009, the outstanding balance under the revolving line of credit was $46.5 million. Based on periodic review of its debt structure, the Company determined it appropriate to classify $46.5 million related to the revolving line of credit as long-term debt as the company does not intend to repay such amount in 2010. From time to time the revolving line of credit may include one or more swing line loans at the Base Rate or one or more letters of credit (“LCs”). At December 31, 2009, there was no outstanding balance on the swing line loans. LCs outstanding at December 31, 2009 totaled $8.9 million, respectively, with interest payable quarterly at LIBOR plus 2.50% per annum. The LCs secure various liability and workers’ compensation policies in place for the Company and its subsidiaries. The Company has historically and currently intends to make payments to reduce borrowing under the revolving line of credit from operating cash flow. In addition, the Company expects that future financings will serve not only to partially fund acquisitions but also to repay all or part of any outstanding revolving line of credit balances then outstanding.

Senior Subordinated Notes — On November 16, 2006, the Company issued $200.0 million aggregate principal amount of 10 3/4% Senior Subordinated Notes (the “Notes”) due February 1, 2016. Interest is payable semiannually beginning August 1, 2006. The Notes were issued at a price of 98.511%, resulting in $3.0 million of original issue discount. The Company may redeem some or all of the Notes on or prior to February 1, 2011 at a redemption price equal to 100% of the principal amount of the Notes redeemed plus a “make-whole” premium or at the redemption prices set forth in the indenture governing the Notes. If there is a change of control as specified in the indenture, the Company must offer to repurchase the Notes. The Notes are subordinated to all of

 

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the Company’s existing and future senior indebtedness, rank equally with all of the Company’s existing and future senior subordinated indebtedness and rank senior to all of the Company’s existing and future subordinated indebtedness. The Notes are guaranteed on an unsecured senior subordinated basis by all the Company’s wholly owned subsidiaries.

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

Seller Notes — Represents notes payable for amounts owed by the Company to former shareholders of business acquired related to the achievement of certain earnout obligations. Interest rates on these notes range from 6.75% to 10.25%. Principal and interest are payable quarterly through January 2012.

Lessor Financing — Leasehold improvements at two facilities leased by the Company were financed by the lessor and the Company issued note payables for those amounts. Such amounts are due and payable in the aggregate amount of approximately $0.1 million as of December 31, 2009.

Interest expense on total debt was $45.7 million for the year ended December 31, 2009 inclusive of $1.4 million of capitalized interest, $54.9 million for the year ended December 31, 2008 inclusive of $0.8 million of capitalized interest, and $60.9 million for the year ended December 31, 2007.

At December 31, 2009, currently scheduled principal payments of total long-term debt, excluding discount on senior subordinated notes, are as follows (in thousands):

 

     Total