National Mentor 10Q 2009 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2009
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission file number: 333-138362

NATIONAL MENTOR HOLDINGS, INC.
(Exact name of registrant as specified in its charter)


Delaware		31-1757086
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
313 Congress Street, 6th Floor Boston, Massachusetts 02210		(617) 790-4800
(Address of principal executive offices, including zip code)		(Registrant's telephone number, including area code)

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

The Company is a voluntary filer of reports required of companies with public securities under Sections 13 or 15(d) of the Securities Exchange Act of 1934 and has filed all reports which would have been required of the Company during the past 12 months had it been subject to such provisions.

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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 the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.


Large accelerated filer o		Accelerated filer o		Non-accelerated filer ý (Do not check if smaller reporting company)		Smaller reporting company o

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

As of May 14, 2009, there were 100 shares outstanding of the registrant's common stock, $.01 par value.

Table of Contents

Index
National Mentor Holdings, Inc.

		Page

PART I.	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited)	3
	Condensed Consolidated Balance Sheets as of March 31, 2009 and September 30, 2008	3
	Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2009 and 2008	4
	Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2009 and 2008	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31
Item 4.	Controls and Procedures	31
Item 4T.	Controls and Procedures	32
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3.	Defaults Upon Senior Securities	46
Item 4.	Submission of Matters to a Vote of Security Holders	46
Item 5.	Other Information	46
Item 6.	Exhibits	46
Signatures		47

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

National Mentor Holdings, Inc.

Condensed Consolidated Balance Sheets

(In thousands)

(Unaudited)

		March 31, 2009			September 30, 2008

Assets
Current assets
	Cash and cash equivalents	$	15,869		$	38,908
	Restricted cash		7,295			5,773
	Accounts receivable, net		122,200			113,933
	Deferred tax assets, net		13,021			10,355
	Prepaid expenses and other current assets		13,252			23,268

Total current assets			171,637			192,237
	Property and equipment, net		150,653			144,233
	Intangible assets, net		446,706			462,987
	Goodwill		199,977			199,392
	Investment in related party debt securities		6,672			—
	Other assets		15,737			17,584

Total assets		$	991,382		$	1,016,433

Liabilities and shareholders' equity
Current liabilities
	Accounts payable	$	18,445		$	20,840
	Accrued payroll and related costs		57,425			59,146
	Other accrued liabilities		49,326			52,437
	Obligations under capital lease, current		152			201
	Current portion of long-term debt		3,735			3,735

Total current liabilities			129,083			136,359
	Other long-term liabilities		11,316			10,859
	Deferred tax liabilities, net		119,235			122,103
	Obligations under capital lease, less current portion		1,729			1,806
	Long-term debt, less current portion		506,311			508,178

Total liabilities			767,674			779,305
Shareholders' equity
	Common stock		—			—
	Additional paid-in-capital		250,378			256,648
	Other comprehensive loss, net of tax		(9,409	)		(5,781	)
	Accumulated deficit		(17,261	)		(13,739	)

Total shareholders' equity			223,708			237,128

Total liabilities and shareholders' equity		$	991,382		$	1,016,433

See accompanying notes.

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National Mentor Holdings, Inc.

Condensed Consolidated Statements of Operations

(In thousands)

(Unaudited)

		Three Months Ended March 31						Six Months Ended March 31

		2009			2008			2009			2008
Net revenues		$	240,737		$	234,953		$	481,970		$	467,058
Cost of revenues			184,386			177,717			367,474			354,155

Gross profit			56,351			57,236			114,496			112,903
Operating expenses:
	General and administrative		32,724			33,045			67,326			64,128
	Depreciation and amortization		13,287			12,711			26,341			25,333

Total operating expenses			46,011			45,756			93,667			89,461

Income from operations			10,340			11,480			20,829			23,442
Other income (expense):
	Management fee of related party		(259	)		(339	)		(482	)		(791	)
	Other expense, net		(440	)		(217	)		(801	)		(183	)
	Interest income		28			162			144			452
	Interest income from related party		117			—			117			—
	Interest expense		(11,742	)		(12,000	)		(24,181	)		(24,183	)

Loss from continuing operations before income taxes			(1,956	)		(914	)		(4,374	)		(1,263	)
(Benefit) provision for income taxes			(700	)		393			(736	)		479

Loss from continuing operations			(1,256	)		(1,307	)		(3,638	)		(1,742	)
Income (loss) from discontinued operations, net of tax			74			(32	)		116			84

Net loss		$	(1,182	)	$	(1,339	)	$	(3,522	)	$	(1,658	)

See accompanying notes.

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National Mentor Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

			Six Months Ended March 31

			2009			2008
Operating activities
Net loss			$	(3,522	)	$	(1,658	)
Adjustments to reconcile net loss to cash provided by operating activities:
	Accounts receivable allowances			4,709			4,594
	Depreciation and amortization of property and equipment			10,095			9,397
	Amortization of other intangible assets			16,361			16,127
	Amortization of deferred financing costs			1,640			1,607
	Stock based compensation			835			594
	Loss on disposal of property and equipment			267			405
	Gain on disposal of business units			(38	)		(65	)
	Gain from sale of discontinued operations			(100	)		—
	Interest income from related party			(117	)		—
	Asset impairment charge			400			—
	Changes in operating assets and liabilities:
		Accounts receivable		(12,951	)		(7,124	)
		Other assets		10,252			5,001
		Accounts payable		(2,468	)		(1,887	)
		Accrued payroll and related costs		(1,721	)		(1,094	)
		Other accrued liabilities		2,791			5,109
		Deferred taxes		(3,071	)		(6,195	)
		Restricted cash		(1,522	)		(1,109	)
		Other long-term liabilities		456			1,005

Net cash provided by operating activities				22,296			24,707
Investing activities
Cash paid for acquisitions, net of cash received				(13,113	)		(5,876	)
Purchases of property and equipment				(17,263	)		(9,140	)
Purchases of related party debt securities				(6,555	)		—
Cash proceeds from sale of business units				76			125
Cash proceeds from sale of discontinued operations				116			—
Cash proceeds from sale of property and equipment				520			629

Net cash used in investing activities				(36,219	)		(14,262	)
Financing activities
Repayments of long-term debt				(1,868	)		(1,874	)
Repayments of capital lease obligations				(110	)		(176	)
Dividend to parent				(7,306	)		(36	)
Parent capital contribution				201			—
Payments of deferred financing costs				(33	)		(44	)

Net cash used in financing activities				(9,116	)		(2,130	)
Net (decrease) increase in cash and cash equivalents				(23,039	)		8,315
Cash and cash equivalents at beginning of period				38,908			29,373

Cash and cash equivalents at end of period			$	15,869		$	37,688

See accompanying notes.

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

March 31, 2009

(Unaudited)

1. Basis of Presentation

National Mentor Holdings, Inc., through its wholly owned subsidiaries (collectively, the "Company"), is a leading provider of home and community-based human services to adults and children with intellectual and/or developmental disabilities, acquired brain injury and other catastrophic injuries and illnesses; and to youth with emotional, behavioral and medically complex challenges. Since the Company's founding in 1980, the Company has grown to provide services to approximately 23,000 clients in 35 states and the District of Columbia. The Company designs customized service plans to meet the unique needs of its clients in home- and community-based settings. Most of the Company's services involve residential support, typically in small group home or host home settings, designed to improve the clients' quality of life and to promote client independence and participation in community life. Other services that the Company provides include day programs, vocational services, case management, early intervention, family-based services, post-acute treatment and neurorehabilitation services, among others. The Company's customized services offer its clients, as well as the payers of these services, an attractive, cost-effective alternative to human services provided in large, institutional settings.

On June 29, 2006, NMH MergerSub, Inc., a wholly owned subsidiary of NMH Investment, LLC ("NMH Investment"), merged with and into the Company, and the Company was the surviving corporation (the "Merger"). Vestar Capital Partners V, L.P. ("Vestar"), certain affiliates of Vestar and members of management and certain of the Company's directors own NMH Investment and, therefore, own the Company.

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and pursuant to the applicable rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal and recurring accruals) necessary to present fairly the financial statements in accordance with GAAP. All significant intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation. The unaudited condensed consolidated financial statements herein should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2008, which is on file with the SEC. Operating results for the three and six months ended March 31, 2009 may not necessarily be indicative of results to be expected for any other interim period or for the full year.

The preparation of financial statements in conformity with GAAP requires the appropriate application of certain accounting policies, many of which require the Company to make estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and the impact of those events cannot be determined with certainty, the actual results may differ from the Company's estimates. These differences could be material to the financial statements.

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

2. Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141 (revised 2007),Business Combinations (SFAS 141R), replacing SFAS 141,Business Combinations (SFAS 141). SFAS 141R retains the fundamental requirements of purchase method accounting for acquisitions as set forth previously in SFAS 141. However, this statement defines the acquirer as the entity that obtains control of a business in the business combination, thus broadening the scope of SFAS 141 which applied only to business combinations in which control was obtained through transfer of consideration. SFAS 141R also establishes principles and requirements for the recognition and measurement of identifiable assets acquired, the liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. Some of the changes, such as the accounting for contingent consideration and exclusion of transaction costs from acquisition accounting may introduce more volatility into earnings. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. With the adoption of SFAS 141R, the Company's accounting for business combinations will change on a prospective basis beginning in the first quarter of fiscal 2010.

In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133 (SFAS 161), which expands the disclosure requirements in SFAS 133 about an entity's derivative instruments and hedging activities. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company adopted the provisions of SFAS 161 on January 1, 2009. The adoption of SFAS 161 did not have a material impact on its financial position, results of operations or cash flows.

3. Comprehensive Income (Loss)

SFAS No. 130,Reporting Comprehensive Income (SFAS 130), requires classifying items of other comprehensive income (loss) by their nature in a financial statement and displaying the accumulated balance of other comprehensive income (loss) separately from retained earnings and additional paid in capital in the equity section of the balance sheet. The components of other comprehensive income (loss) and related tax effects are as follows:

	Three Months Ended March 31						Six Months Ended March 31

(in thousands)	2009			2008			2009			2008
Net loss	$	(1,182	)	$	(1,339	)	$	(3,522	)	$	(1,658	)
Changes in unrealized gains (losses) on derivatives		3,485			(8,852	)		(6,091	)		(14,888	)
Income tax effect		(1,409	)		3,580			2,463			6,021

Comprehensive income (loss)	$	894		$	(6,611	)	$	(7,150	)	$	(10,525	)

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

4. Long-Term Debt

The Company's long-term debt consists of the following:

(in thousands)		March 31, 2009		September 30, 2008

Senior term B loan, principal and interest due in quarterly installments through June 29, 2013
	—fixed interest rate of 7.32%	$	134,991	$	137,844
	—fixed interest rate of 6.89%		177,118		183,930
	—variable interest rate of 3.22% and 5.71% at March 31, 2009 and September 30, 2008, respectively		13,678		5,689
Senior revolver, due June 29, 2012; quarterly cash interest payments at a variable interest rate			—		—
Senior subordinated notes, due July 1, 2014; semi-annual cash interest payments due each January 1^st and July 1^st (interest rate of 11.25%)			180,000		180,000
Term loan mortgage, principal and interest due in monthly installments through May 20, 2010; variable interest rate (4.75% and 6.50% at March 31, 2009 and September 30, 2008, respectively)			4,259		4,450

			510,046		511,913
Less current portion			3,735		3,735

Long-term debt		$	506,311	$	508,178

The Company's senior credit facility consists of a $335.0 million seven-year senior secured term B loan facility (the "term B loan"), a $125.0 million senior secured revolving credit facility (the "senior revolver") and a $20.0 million senior secured synthetic letter of credit facility (together, the "senior secured credit facilities"). Any amounts outstanding under the senior revolver are due June 29, 2012. The $335.0 million term B loan has a term of seven years and amortizes one percent per year, paid quarterly, for the first six years, with the remaining balance due in the seventh year. The senior credit agreement also includes a provision for the prepayment of a portion of the outstanding term loan amounts at any year-end equal to an amount ranging from 0-50% of a calculated amount, depending on the Company's leverage ratio, if the Company generates certain levels of cash flow. In connection with the Merger and the related transactions on June 29, 2006 (the "Transactions"), the Company issued $180.0 million of 11.25% senior subordinated notes due 2014 (the "senior subordinated notes").

The Company issued approximately $24.0 million in standby letters of credit as of March 31, 2009 related to the Company's workers' compensation insurance coverage. These letters of credit are secured by the $20.0 million synthetic letter of credit facility. The availability under our senior revolver was reduced by $4.0 million to a balance of $121.0 million as letters of credit in excess of $20.0 million under our synthetic letters of credit facility were outstanding.

The variable interest rate on the term B loan is equal to LIBOR plus 2.00% or Prime plus 1.00%, at the Company's option. The interest rate on the term B loan outstanding at March 31, 2009 was

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

4. Long-Term Debt (Continued)

equal to LIBOR plus 2.00%. The interest rates for any senior revolver borrowings are equal to either LIBOR plus 2.25% or Prime plus 1.25%, at the Company's option, and subject to reduction depending on the Company's leverage ratio. Cash paid for interest amounted to approximately $16.0 million and $16.4 million for the three months ended March 31, 2009 and 2008, respectively, and approximately $22.5 and $22.7 million for the six months ended March 31, 2009 and 2008, respectively.

The Company is exposed to changes in interest rates as a result of its outstanding variable rate debt. To reduce the interest rate exposure, the Company entered into interest rate swap agreements whereby the Company fixed the interest rate on approximately $221.2 million of its $335.0 million term B loan, effective as of August 31, 2006 and maturing on June 30, 2010 and fixed the interest rate on approximately $113.3 million of its remaining $335.0 million term B loan, effective as of August 31, 2007 and maturing on September 30, 2010. In total, as of March 31, 2009, the Company fixed the interest rate on approximately $312.1 million of its $325.8 million term B loan.

The table below provides information about the Company's interest rate swap agreements and remaining variable rate debt related to the term B loan.

	Agreement					31-Mar-09					31-Mar-10					31-Mar-11

	Swap Value					Swap Value					Swap Value					Swap Value
(in thousands)			Rate					Rate					Rate					Rate
Interest Swap effective date			Rate					Rate					Rate					Rate
August 31, 2006(1)	$	221,200		5.32	%	$	134,991		5.32	%	$	85,703		5.32	%		—		—
August 31, 2007(1)		113,297		4.89	%		177,118		4.89	%		206,547		4.89	%		—		—
Variable rate debt							13,678		—			30,188		—			320,763		—

Total term B loan						$	325,787		—		$	322,438		—		$	320,763		—

(1): Interest rates do not include 2.00% spread on LIBOR loans.

The swap is a derivative and is accounted for under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The fair value of the swap agreements, representing the price that would be paid to transfer a liability in an orderly transaction between market participants, was approximately $15.8 million, or approximately $9.4 million after taxes. The fair value of these agreements was determined based on pricing models and independent formulas using current assumptions.

Since the Company has the ability to elect different interest rates on the debt at each reset date, the hedging relationship does not qualify for use of the shortcut method under SFAS 133. Therefore, the effectiveness of the hedge relationships is assessed on a quarterly basis during the term of the hedge by comparing whether the critical terms of the hedge continue to match the terms of the debt. Under this approach, the Company exactly matches the terms of the interest rate swap to the terms of the underlying debt and, therefore, assumes 100% hedge effectiveness. The entire change in fair market value is recorded in shareholders' equity, net of tax, on the unaudited condensed consolidated balance sheets as other comprehensive loss.

The senior credit agreement and the indenture governing the senior subordinated notes contain both affirmative and negative financial and non-financial covenants, including limitations on the Company's ability to incur additional debt, sell material assets, retire, redeem or otherwise reacquire

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

4. Long-Term Debt (Continued)

capital stock, acquire the capital stock or assets of another business, pay dividends, and, in the case of the senior credit agreement, require the Company to meet or exceed certain financial ratios. At March 31, 2009, the Company is in compliance with all covenants.

The priority with regard to the right of payment on the Company's debt is such that the senior credit facilities and the term loan mortgage have priority over all of the Company's long-term debt. The senior credit facilities are guaranteed by the Company's subsidiaries, except for the captive insurance subsidiary, and are secured by substantially all of the assets of the Company. The term loan mortgage is secured by certain buildings and land of the Company. The senior subordinated notes are guaranteed by the Company's subsidiaries, except for the captive insurance subsidiary. The results and operations of the captive insurance subsidiary are not material to the Company's consolidated results.

The unaudited condensed consolidated balance sheets as of both March 31, 2009 and September 30, 2008 include deferred financing costs of approximately $22.8 million related to the 2006 refinancing: $3.2 million in current assets (under Prepaid expenses and other current assets) and $19.6 million at March 31, 2009 and $19.5 million at September 30, 2008 in other long-term assets (under Other assets). The Company incurred amortization expense of $0.8 million for both the three months ended March 31, 2009 and 2008 and $1.6 million for both the six months ended March 31, 2009 and 2008. Amortization of these deferred financing costs is included in interest expense in the unaudited condensed consolidated statements of operations.

5. Related Party Transactions

Investment in Related Party Debt Securities

NMH Holdings, Inc. ("NMH Holdings") is a wholly owned subsidiary of NMH Investment, LLC ("NMH Investment"). NMH Holdings, LLC ("Parent") is a wholly owned subsidiary of NMH Holdings and Parent is the sole stockholder of the Company.

During the second quarter of fiscal 2009, the Company purchased approximately $11.5 million in aggregate principal amount of the NMH Holdings senior floating rate toggle notes due 2014 ("NMH Holdings notes") for approximately $6.6 million. This is reflected on the Company's unaudited condensed consolidated balance sheets as Investment in related party debt securities. The NMH Holdings notes were issued by the Company's indirect parent, NMH Holdings, and cash interest on the NMH Holdings notes accrues at a rate per annum, reset quarterly, equal to LIBOR plus 6.375%, and PIK Interest (defined below) accrues at the cash interest rate plus 0.75%. NMH Holdings may elect to pay interest on the NMH Holdings notes (a) entirely in cash, (b) entirely by increasing the principal amount of the NMH Holdings notes or issuing new notes ("PIK Interest") or (c) 50% in cash and 50% in PIK Interest. NMH Holdings is a holding company with no direct operations. Its principal assets are the direct and indirect equity interests it holds in its subsidiaries, including the Company, and all of its operations are conducted through the Company and the Company's subsidiaries. As a result, NMH Holdings will be dependent upon dividends and other payments from the Company to generate the funds necessary to meet its outstanding debt service and other obligations, including its obligations on the notes held by the Company. The purchase of the NMH Holdings notes was accounted for as a debt

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

5. Related Party Transactions (Continued)

security under SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities (SFAS 115) and classified as Available for Sale.

The Company received its first quarterly interest payment on March 15, 2009 in PIK Interest. The Company recorded $0.1 million of interest income related to the NMH Holdings notes for both the three and six months ended March 31, 2009 which is recorded under Interest income from related party on the unaudited condensed consolidated statements of operations

As of March 31, 2009, the Company's available-for-sale debt securities had an amortized cost of $6.6 million, which also approximated its estimated fair value. The debt security is scheduled to mature after three years on June 15, 2014, but actual maturities may differ from the contractual or expected maturities since borrowers may have the right to prepay obligations with or without prepayment penalties.

Management evaluates available-for-sale securities for other-than-temporary impairment at least quarterly. Securities are evaluated individually based on various factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to hold the investment for a period of time sufficient to allow for any anticipated recovery of cost. Declines in the fair value of securities below their cost that are deemed to be other than temporarily impaired, are recognized through earnings as realized losses in the period in which the impairment is identified. There were no securities deemed impaired on an other-than-temporary basis for the three and six months ended March 31, 2009.

Dividend to Parent

The holders of the Company's common stock are entitled to receive dividends when and as declared by the Company's Board of Directors. On January 23, 2009, the Company paid a $7.0 million dividend to Parent, which used the proceeds of the dividend to make a distribution to NMH Holdings. NMH Holdings used the proceeds of the distribution to repurchase approximately $13.9 million in aggregate principal amount of the NMH Holdings notes.

6. Fair Value Measurements

SFAS No. 157,Fair Value Measurements (SFAS 157) defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. SFAS 157 applies to accounting pronouncements that require or permit assets or liabilities to be measured at fair value and does not expand the use of fair value in any new circumstances. In February 2008, the FASB issued FASB Staff Position (FSP) No. 157-2, which delayed until the first quarter of 2010 the effective date of SFAS No. 157 for nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis.

The Company adopted SFAS 157 as of October 1, 2008 for financial assets and financial liabilities. The Company is currently assessing the impact of FSP No. 157-2 for nonfinancial assets and nonfinancial liabilities on the Company's consolidated financial position and results of operations.

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

6. Fair Value Measurements (Continued)

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

SFAS 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost).

Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

In that regard, SFAS 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:


Level 1:		Unadjusted quoted market prices in active markets for identical assets or liabilities.
Level 2:		Unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
Level 3:		Unobservable inputs for the asset or liability.

Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach, and may use unobservable inputs such as projections, estimates and management's interpretation of current market data. These unobservable inputs are only utilized to the extent that observable inputs are not available or cost-effective to obtain.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

(in thousands):	Total		Unadjusted Quoted Market Prices (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Interest rate swap agreements	$	15,797	$	—	$	15,797	$	—
Investment in related party debt securities	$	6,587	$	—	$	6,587	$	—

Interest rate swap agreements. The fair value of the swap agreements was approximately $15.8 million, or approximately $9.4 million after taxes. The fair value of these agreements was determined based on pricing models and independent formulas using current assumptions.

Investment in related party debt securities. The fair value of the investment in related party debt securities was approximately $6.6 million. The fair value measurements consider observable market data that may include, among other data, credit ratings, credit spreads, future interest rates and risk free rates of return.

7. Stock-Based Compensation

In connection with the Transactions, NMH Investment adopted a new equity-based compensation plan and issued units of limited liability company interests consisting of Class B Units, Class C Units, Class D Units and Class E Units. The units are limited liability company interests and are available for issuance to the Company's employees and members of the Board of Directors for incentive purposes. As of March 31, 2009, there were 192,500 Class B Units, 202,000 Class C Units, 388,881 Class D Units and 6,375 Class E Units authorized for issuance under the plan.

The Class B Units vest over 61 months. Assuming continued employment of the employee with the Company, 40 percent vest at the end of 37 months from the grant date, and the remaining 60 percent vest monthly over the remainder of the term. Assuming continued employment, the Class C Units and Class D Units vest after three years, subject to certain performance conditions and/or investment return conditions being met or achieved in each of the first three years. The performance conditions relate to the Company achieving certain financial targets for the fiscal years ending September 30, 2007, 2008 and 2009, and the investment return conditions relate to Vestar receiving a specified multiple on its investment upon a liquidation event.

If an employee holder's employment is terminated, NMH Investment may repurchase the holder's Class B, C and D units. If the termination occurs within 12 months after the relevant measurement date, all of the B units will be repurchased at the initial purchase price, or cost. If the termination occurs during the following four-year period, the proportion of the B units that may be purchased at fair market value will be determined depending on the circumstances of the holder's departure and the date of termination. From month 13 to month 60, if the holder is terminated without cause, or resigns for good reason, he or she is entitled to receive a higher proportion of the purchase price at fair market value than if he or she resigns voluntarily. This proportion increases ratably each month. For the C and D units, the holder is entitled to receive fair market value if he or she is terminated without cause or resigns for good reason or, after the third anniversary of the relevant measurement date, upon

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

7. Stock-Based Compensation (Continued)

termination for any reason except for cause. Before the third anniversary, all the C and D units are callable at cost if the holder resigns without good reason. In the event of a termination for cause at any time, all of the units would be callable at cost. The Class E Units vest over time given continued service of the director as a member of the Board of Directors of the Company.

For purposes of determining the compensation expense associated with these grants, management valued the business enterprise using a variety of widely accepted valuation techniques which considered a number of factors such as the financial performance of the Company, the values of comparable companies and the lack of marketability of the Company's equity. The Company then used the option pricing method to determine the fair value of the units granted.

The fair value of the units granted during fiscal 2009 was calculated using the following assumptions: a term of 3.5 years, which is based on the expected term in which the units will be realized; a risk-free interest rate of 1.27%, which is the 3.5 year U.S. federal treasury bond rate consistent with the term assumption; and expected volatility of 40%, which is based on the historical data of equity instruments of comparable companies.

The estimated fair value of the units, less an assumed forfeiture rate of 9.0%, will be recognized in expense in the Company's financial statements on a straight-line basis over the requisite service periods of the awards. For Class B and E Units, the requisite service period is five years, and for Class C and D Units, the requisite service period is three years. The assumed forfeiture rate is based on an average of the Company's historical forfeiture rates. The historical trend of forfeitures is deemed reasonable to use in determining expected forfeitures.

In accordance with SFAS 123(R), the Company recorded $0.3 million of stock-based compensation expense for the three months ended March 31, 2009 and 2008 and recorded $0.8 million and $0.6 million of stock-based compensation expense for the six months ended March 31, 2009 and 2008, respectively. Stock-based compensation expense is included in general and administrative expense in the accompanying unaudited condensed consolidated statements of operations. The summary of activity under the plan is presented below:

(in thousands)			Weighted Average Grant-Date Fair Value

Nonvested balance at September 30, 2008	757,971		$	6.94
Granted	24,439			4.45
Forfeited	(33,468	)		7.54
Vested	—			—

Nonvested balance at March 31, 2009	748,942		$	7.14

As of March 31, 2009, there was $1.2 million of total unrecognized compensation expense related to the units. These costs are expected to be recognized over a weighted average period of 3.5 years. For purposes of this table above, no units were vested as of March 31, 2009 such that value was realized, as NMH Investment could repurchase at cost the units of any employee who terminated his or her employment voluntarily up to that date. However, in most cases, if an employee is terminated without

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

7. Stock-Based Compensation (Continued)

cause or resigns for good reason, he or she is entitled to receive fair market value for a portion of his or her units, calculated in accordance with the applicable Management Unit Subscription Agreement.

8. Income Taxes

The Company's effective income tax rate for the interim periods was based on management's estimate of the Company's effective tax rate for the applicable year and differs from the federal statutory income tax rate primarily due to nondeductible permanent differences such as meals and nondeductible compensation. For the three months ended March 31, 2009, the Company's effective income tax rate was 35.8% compared to an effective tax rate of (43.0)% for the three months ended March 31, 2008. For the six months ended March 31, 2009, the Company's effective income tax rate was 16.8% compared to an effective tax rate of (37.9)% for the six months ended March 31, 2008. The change in the effective tax rate was primarily due to the benefit of employment tax credits recorded in the 2009 quarterly periods.

The Company files a federal consolidated return and files various state income tax returns and, generally, the Company is no longer subject to income tax examinations by the taxing authorities for years prior to September 30, 2003. The Company's policy is to recognize interest and penalties related to unrecognized tax benefits as income tax.

9. Discontinued Operations and Assets Held for Sale

The Company has adopted a plan to sell REM Health, Inc., REM Health of Wisconsin, Inc., and REM Health of Iowa, Inc. (together, "REM Health") in fiscal 2009. REM Health is reported under the Human Services segment. Assets held for sale are recorded at the lower of their carrying amount or their fair value less cost to sell. For the six months ended March 31, 2009, the Company recorded a pre-tax impairment charge of $0.3 million related to the write-down of the REM Health assets to their fair value less cost to sell.

The REM Health assets classified as held for sale at March 31, 2009 are summarized as follows:

(in thousands)

Assets
Goodwill and other intangibles	$	4,838
Property and equipment		165
Other assets		24

Total assets held for sale	$	5,027

REM Health's assets to be sold are immaterial to the Company and, as a result, are not reported separately as assets held for sale on the unaudited condensed consolidated balance sheets.

The operations of REM Health have been presented as discontinued operations on the unaudited condensed consolidated statements of operations and the prior periods have been reclassified. Income (loss) from discontinued operations, net of tax, for the six months ended March 31, 2009 includes

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

9. Discontinued Operations and Assets Held for Sale (Continued)

$0.3 million of impairment charge. The components of the REM Health discontinued operations for the three and six months ended March 31, 2009 and 2008 are summarized as follows:

	Three Months Ended March 31					Six Months Ended March 31

(in thousands)	2009		2008			2009		2008
Net revenue	$	5,387	$	5,254		$	11,177	$	10,548
Income (loss) before income tax		117		(50	)		85		135

10. Segment Information

In accordance with the criteria of SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information (SFAS 131), the Company's Human Services segment is the only reportable segment. The Human Services segment provides home and community-based human services to adults and children with intellectual and/or developmental disabilities, to youth with emotional, behavioral and medically complex challenges, and to individuals in specific markets with acquired brain injuries. Human Services is organized in a reporting structure composed of two operating segments. The two operating segments are aggregated into one reportable segment under SFAS 131 based on similarity of the economic characteristics of the segments.

The column entitled "Other" in the table below is composed of a mix of health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses. The operations included in the "Other" column do not qualify as reportable segments under SFAS 131. Activities classified as "Corporate" in the table below relate primarily to unallocated home office items.

The Company generally evaluates the performance of its operating segments based on income from operations. Segment disclosures for the three and six months ended March 31, 2008 have been restated to reflect the change in the composition of the Company's reportable operating segment effective October 1, 2008. The following is a financial summary by reportable segment for the periods indicated.

Three Months Ended March 31,	Human Services		Other		Corporate			Consolidated

(in thousands)
2009
Net revenue	$	218,707	$	22,030	$	—		$	240,737
Income (loss) from operations		17,797		3,201		(10,658	)		10,340
Total assets		860,715		92,403		38,264			991,382
2008
Net revenue	$	214,599	$	20,354	$	—		$	234,953
Income (loss) from operations		18,646		3,264		(10,430	)		11,480
Total assets		865,622		90,800		49,938			1,006,360

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

10. Segment Information (Continued)

Six Months Ended March 31,	Human Services		Other		Corporate			Consolidated

(in thousands)
2009
Net revenue	$	438,941	$	43,029	$	—		$	481,970
Income (loss) from operations		37,316		5,965		(22,452	)		20,829
Total assets		860,715		92,403		38,264			991,382
2008
Net revenue	$	427,242	$	39,816	$	—		$	467,058
Income (loss) from operations		38,095		5,956		(20,609	)		23,442
Total assets		865,622		90,800		49,938			1,006,360

11. Accruals for Self-Insurance and Other Commitments and Contingencies

The Company maintains employment practices liability, professional and general liability, workers' compensation, automobile liability and health insurance policies that include self-insured retentions. The Company intends to maintain such coverage in the future and is of the opinion that its insurance coverage is adequate to cover potential losses on asserted claims. Employment practices liability is fully self-insured and professional and general liability has a self-insured retention of $1.0 million per claim and $2.0 million in the aggregate, with additional insurance coverage above the retention. In connection with the Merger, subject to the same retentions, the Company purchased additional insurance for certain claims relating to pre- Merger periods. For workers' compensation, the Company has a $350 thousand per claim retention with statutory limits. Automobile liability has a $100 thousand per claim retention, with additional insurance coverage above the retention. The Company purchases specific stop loss insurance as protection against extraordinary claims liability for health insurance claims. Stop loss insurance covers claims that exceed $300 thousand on a per member basis.

Beginning November 1, 2005, the Company's self-insured portion of professional and general liability claims was transferred into the Company's wholly-owned subsidiary captive insurance company. The captive insurance company also provides coverage for the Company's employment practices liability beginning October 1, 2007. The accounts of the captive insurance company are fully consolidated with those of the other operations of the Company in the accompanying unaudited condensed consolidated financial statements.

The Company is in the human services business and, therefore, has been and reasonably expects it will continue to be subject to claims alleging that the Company, its independently contracted host-home caregivers (called "Mentors"), or its employees failed to provide proper care for a client, as well as claims by the Company's clients, Mentors, employees or community members against the Company for negligence, intentional misconduct or violation of applicable law. Included in the Company's recent claims are claims alleging personal injury, assault, battery, abuse, wrongful death and other charges. Regulatory agencies may initiate administrative proceedings alleging that the Company's programs, employees or agents violate statutes and regulations and seek to impose monetary penalties on the Company. The Company could be required to incur significant costs to respond to regulatory investigations or defend against civil lawsuits and, if the Company does not prevail, the Company could

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National Mentor Holdings, Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

March 31, 2009

(Unaudited)

11. Accruals for Self-Insurance and Other Commitments and Contingencies (Continued)

be required to pay substantial amounts of money in damages, settlement amounts or penalties arising from these legal proceedings.

The Company accrues for costs related to contingencies when a loss is probable and the amount is reasonably estimable. While the Company believes the provision for contingencies is adequate, the outcome of the legal and other such proceedings is difficult to predict and the Company may settle claims or be subject to judgments for amounts that differ from the Company's estimates.

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

The following discussion of our financial condition and results of operations should be read in conjunction with the historical condensed consolidated financial statements and the related notes included elsewhere in this report. This discussion may contain forward-looking statements about our markets, the demand for our services and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons, including those discussed in the "Risk factors" and "Forward-looking statements" sections of this report.

Overview

Founded in 1980, we are a leading provider of home and community-based human services to adults and children with intellectual and/or developmental disabilities ("I/DD"), acquired brain injury and other catastrophic injuries and illnesses ("ABI"); and to youth with emotional, behavioral and medically complex challenges ("ARY"). As of March 31, 2009, we provided our services to approximately 23,000 clients in 35 states and the District of Columbia through approximately 16,800 full-time equivalent employees. Most of our services involve residential support, typically in small group homes, ICFs-MR or host home settings, designed to improve our clients' quality of life and to promote client independence and participation in community life. Our non-residential services consist primarily of day programs and periodic services in various settings. We derive most of our revenues from state and county governmental payors, as well as smaller amounts from private sector payors, mostly in our ABI services.

The largest part of our business is the delivery of services to adults and children with developmental disabilities. Our I/DD programs include residential support, day habilitation, vocational services, case management, home health care and personal care. We also provide a variety of services to youth with emotional, behavioral and medically complex challenges. Our ARY services include therapeutic foster care, independent living, family reunification, family preservation, alternative schools and adoption services. We also provide a range of post-acute treatment and care services to adults and children with an acquired brain injury and other catastrophic injuries and illnesses. Our ABI services range from post-acute care to assisted independent living and include neurobehavioral rehabilitation, neurorehabilitation, adolescent integration, outpatient or day treatment and pre-vocational services.

We previously operated our business in two operating segments and aggregated those two segments as one reportable segment, described as Human Services. Effective October 1, 2008, we began managing the majority of our services to individuals with acquired brain injuries and other catastrophic injuries and illnesses separately from the other services provided by the two operating segments which include services to adults and children with intellectual and/or developmental disabilities, youth with emotional, behavioral and medically complex challenges, and to individuals in specific markets with acquired brain injuries. As a result, we changed the composition of our reportable segment in accordance with SFAS No. 131Disclosures about Segments of an Enterprise and Related Information (SFAS 131) to reflect our one reportable segment, Human Services, and an Other category. Human Services continues to consist of two operating segments which are aggregated under SFAS 131 based on the similarity of the economic characteristics of the segments. The Other category consists of a mix of health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses. The operations included in the Other category do not qualify as a reportable segment under SFAS 131. Operating segment performance is evaluated primarily based on income from operations.

As detailed in note 1 in the unaudited condensed consolidated financial statements included elsewhere in this report, on June 29, 2006, we were merged with a wholly owned subsidiary of NMH Investment. The Merger was accounted for under the purchase method of accounting in accordance

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with Financial Accounting Standard No. 141,Business Combinations (SFAS 141). Under purchase accounting, fixed assets and identifiable intangible assets acquired and liabilities assumed are recorded at their respective fair values. We have accounted for the Merger in accordance with Staff Accounting Bulletin No. 54,Push Down Accounting (SAB 54), whereby NMH Holdings, LLC has "pushed down" the purchase price in revaluing our assets and liabilities.

Factors affecting our operating results

Demand for Home and Community-Based Human Services

Our growth in revenues has historically been related to increases in the rates we receive for our services as well as increases in the number of individuals served. This growth has depended largely upon development-driven activities, including the maintenance and expansion of existing contracts and the award of new contracts, and upon acquisitions. We also attribute the continued growth in our client base to certain trends that are increasing demand in our industry, including demographic, medical and political developments.

Demographic trends have a particular impact on our I/DD business. Increases in the life expectancy of I/DD individuals, we believe, have resulted in steady increases in the demand for I/DD services. In addition, caregivers currently caring for their relatives at home are aging and may soon be unable to continue with these responsibilities. Each of these factors affects the size of the I/DD population in need of services. Similarly, our ARY service line has been driven by favorable demographics. In addition, demand for our ABI services has been increased by increased life expectancy resulting from faster emergency response and improved medical techniques that have resulted in more people surviving an ABI.

Political trends can also affect our operations. In particular, budgetary changes can influence the overall level of payments for our services, the number of clients and the preferred settings for many of the services we provide. Pressure from client advocacy groups for the populations we serve has generally helped our business, as these groups generally seek to pressure governments to fund residential services that use our small group home or host home models, rather than large, institutional models. In addition, our ARY service line has historically been positively affected by the trend toward privatization of services. Furthermore, we believe that successful lobbying by these groups has preserved I/DD and ARY services and, therefore, our revenue base, from significant cutbacks as compared with certain other human services. In addition, a number of states have developed community-based waiver programs to support long-term care services for survivors of ABI.

Expansion

We have grown our business through expansion of existing markets and programs as well as through acquisitions.

Organic Growth

We believe that our future growth will depend heavily on our ability to expand existing service contracts and to win new contracts. Our organic expansion activities can consist of both new program starts in existing markets and geographical expansion in new markets. Our new program starts typically require us to fund operating losses for a period of approximately 18-24 months. If a new program start does not become profitable during such period, we may terminate it. During the 12 months ended March 31, 2009, losses on new program starts for programs started within the last 18 months that generated operating losses were $4.2 million.

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Acquisitions

As of March 31, 2009, we have completed more than 25 acquisitions since 2003, including several acquisitions of rights to government contracts or fixed assets from small providers, which we refer to as "tuck-in" acquisitions. We have pursued larger strategic acquisitions in markets with significant opportunities.

We also "cross-sell" new services in existing markets. Depending on the nature of the program and the state or local government involved, we will seek new programs through either unsolicited proposals to government agencies or by responding to a request, generally known as a request for proposal, from a public sector agency.

Divestitures

We regularly review and consider the divestiture of underperforming or non-strategic businesses to improve our operating results and better utilize our capital. We have made divestitures from time to time and expect that we may make additional divestitures in the future. Divestitures could have a material impact on our consolidated financial statements.

Net revenues

Revenues are reported net of allowances for unauthorized sales, expected sales adjustments by business units and changes in the allowance for doubtful accounts. Revenues are also reported net of any state provider taxes or gross receipts taxes levied on services we provide. For the six months ended March 31, 2009, we derived more than 90% of our net revenues from states, counties or regional entities (e.g., Departments of Mental Retardation). The payment terms and rates of these contracts vary widely by jurisdiction and service type, and may be based on per person per diems, rates established by the jurisdiction, cost-based reimbursement, hourly rates and/or units of service. We bill most of our residential services on a per diem basis, and we bill most of our non-residential services on an hourly basis. Some of our revenues are billed pursuant to cost-based reimbursement contracts, under which the billed rate is tied to the underlying costs. Lower than expected cost levels may require us to return previously received payments after cost reports are filed. In addition, our revenues may be affected by adjustments to our billed rates as well as write-offs of previously billed amounts. Revenues in the future may be affected by changes in rate-setting structures, methodologies or interpretations that may be proposed in states where we operate or by the federal government which provides matching funds. We cannot determine the impact of such changes or the effect of any possible governmental actions.

Occasionally, timing of payment streams may be affected by delays by the state related to bill processing systems, staffing or other factors. While these delays have historically impacted our cash position in particular periods, they have not resulted in long-term collections problems.

Expenses

Expenses directly related to providing services are classified as cost of revenues. Direct costs and expenses principally include salaries and benefits for service provider employees, per diem payments to our Mentors, residential occupancy expenses, which are primarily comprised of rent and utilities related to facilities providing direct care, certain client expenses such as food and medicine and transportation costs for clients requiring services. General and administrative expenses primarily include salaries and benefits for administrative employees, or employees that are not directly providing services, administrative occupancy and insurance costs, as well as professional expenses such as consulting, legal and accounting services. Depreciation and amortization includes depreciation for fixed assets utilized in both facilities providing direct care and administrative offices, and amortization related to intangible assets.

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Wages and benefits to our employees and per diem payments to our Mentors constitute the most significant operating cost in each of our operations. Most of our employee caregivers are reimbursed on an hourly basis, with hours of work generally tied to client need. Our Mentors are paid on a per diem basis, but only if the Mentor is currently caring for a client. Our labor costs are generally influenced by levels of service and these costs can vary in material respects across regions.

Occupancy costs represent a significant portion of our operating costs. As of March 31, 2009, we owned 412 facilities and two offices, and we leased 883 facilities and 271 offices. We incur no facility costs for services provided in the home of a Mentor.

Expenses incurred in connection with liability insurance and third-party claims for professional and general liability totaled approximately 0.5% and 0.4% of our net revenues for the three months ended March 31, 2009 and 2008, respectively, and 0.4% for the six months ended March 31, 2009 and 2008. We have incurred professional and general liability claims and insurance expense for professional and general liability of $1.3 million and $0.9 million for the three months ended March 31, 2009 and 2008, respectively, and $2.2 million and $1.7 million for the six months ended March 31, 2009 and 2008, respectively. We currently insure through our captive subsidiary professional and general liability claims for amounts of up to $1.0 million per claim and up to $2.0 million in the aggregate. Above these limits, we have limited additional third-party coverage. We also insure through our captive subsidiary employment practices liability claims of up to $240,000 per claim and up to $1.0 million in the aggregate.

Our cost of net revenues as a percentage of revenues for our different services may vary, with our ABI services, generally, having the highest margin (or lowest costs as a percentage of revenues). Our ability to maintain our margin in the future is dependent upon obtaining increases in rates and/or controlling our expenses. In fiscal 2008 and 2009, we invested in our infrastructure initiatives and business process improvements, which had a negative impact on our margin. If we choose to continue to invest in our infrastructure initiatives and business process improvements our margin will continue to be negatively impacted.

Results of Operations

		Three Months Ended March 31,						Six Months Ended March 31,

		2009			2008			2009			2008
Revenue:
	Human Services	$	218,707		$	214,599		$	438,941		$	427,242
	Other		22,030			20,354			43,029			39,816
	Corporate		—			—			—			—

	Consolidated	$	240,737		$	234,953		$	481,970		$	467,058

Income (loss) from operations:
	Human Services	$	17,797		$	18,646		$	37,316		$	38,095
	Other		3,201			3,264			5,965			5,956
	Corporate		(10,658	)		(10,430	)		(22,452	)		(20,609	)

	Consolidated	$	10,340		$	11,480		$	20,829		$	23,442

Three months ended March 31, 2009 compared to three months ended March 31, 2008

Consolidated

Consolidated revenue for the three months ended March 31, 2009 increased 2.5% compared to consolidated revenue for the three months ended March 31, 2008. The increase in revenue was

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primarily related to organic growth of $4.4 million, including growth related to new programs that began operations during the last three quarters of fiscal 2008 and the first two quarters of fiscal 2009, in our Human Services segment and the Other category. In addition, our Human Services segment experienced growth in revenue of $3.4 million as a result of acquisitions that closed during the last three quarters of fiscal 2008 and the first two quarters of fiscal 2009. Revenue growth was partially offset by a reduction in revenue of approximately $2.0 million from businesses we divested in fiscal 2008.

Consolidated income from operations for the three months ended March 31, 2009 was $10.3 million, compared to $11.5 million for the three months ended March 31, 2008. Consolidated operating margins were 4.3% and 4.9% for the three months ended March 31, 2009 and 2008, respectively. The decreases in income from operations and in operating margins were primarily due to an increase in labor costs and a payor contract settlement in the Human Services segment. The decrease in income from operations was also due to increased investment in growth initiatives in the Other category.

Interest expense decreased $0.3 million for the three months ended March 31, 2009 compared to the three months ended March 31, 2008. The decrease in interest expense was primarily the result of a decrease in our outstanding debt and our weighted average interest rates. The operations of REM Health have been presented as discontinued operations on the consolidated statements of operations and the prior periods have been reclassified. Our effective income tax rate for the three months ended March 31, 2009 was 35.8% as compared to (43.0)% for the three months ended March 31, 2008. The change in the effective tax rate was primarily due to the benefit of employment tax credits recorded during the three months ended March 31, 2009.

Human Services

Human Services revenue for the three months ended March 31, 2009 increased by 1.9% compared to the three months ended March 31, 2008. The increase was due to organic growth of $2.7 million, which included growth related to new programs that began operations during the last three quarters of fiscal 2008 and the first two quarters of fiscal 2009. In addition, acquisitions contributed additional revenue growth of $3.4 million. Human Services revenue growth was partially offset by a reduction in revenue of approximately $2.0 million from businesses we divested in fiscal 2008. Operating margin decreased from 8.7% during the three months ended March 31, 2008 to 8.1% during the three months ended March 31, 2009 primarily due to an increase in labor costs and a payor contract settlement.

Other

Included in the Other category are our health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses. Revenue for the Other category during the three months ended March 31, 2009 increased by 8.2% compared to the three months ended March 31, 2008. This increase was due primarily to organic growth of $1.7 million, which included growth related to new programs that began operations during the last three quarters of fiscal 2008 and the first two quarters of fiscal 2009. Operating margin decreased from 16.0% for the three months ended March 31, 2008 to 14.5% for the three months ended March 31, 2009. The decrease in operating margin was primarily due to an increase in growth initiatives in the current quarter.

Corporate

Corporate represents corporate general and administrative expenses. Total corporate expense increased by approximately $0.2 million, or 2.2% from the three months ended March 31, 2008 to $10.7 million for the three months ended March 31, 2009.

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Six months ended March 31, 2009 compared to six months ended March 31, 2008

Consolidated

Consolidated revenue for the six months ended March 31, 2009 increased 3.2% compared to consolidated revenue for the six months ended March 31, 2008. The increase in revenue was primarily related to organic growth of $12.5 million, including growth related to new programs that began operations during fiscal 2008 and the first two quarters of fiscal 2009, in our Human Services segment and the Other category. In addition, our Human Services segment experienced growth in revenue of $6.5 million as a result of acquisitions that closed during fiscal 2008 and the first two quarters of fiscal 2009. Revenue growth was partially offset by a reduction in revenue of approximately $4.1 million from businesses we divested in fiscal 2008.

Consolidated income from operations for the six months ended March 31, 2009 was $20.8 million, compared to $23.4 million for the six months ended March 31, 2008. Consolidated operating margins were 4.3% and 5.0% for the six months ended March 31, 2009 and 2008, respectively. The decreases in income from operations and in operating margins were primarily due to an increase in labor costs and a payor contract settlement in the Human Services segment. The decrease in income from operations was also due to increased investment in growth initiatives in the Other category as well as increased investment in business process improvements and growth initiatives in Corporate.

Interest expense remained essentially constant from the six months ended March 31, 2008 compared to the six months ended March 31, 2009 despite the decrease in our outstanding debt and our weighted average interest rates. Interest expense increased by approximately $0.4 million due to borrowings under our senior secured revolving credit facility (the "senior revolver"). During the first quarter of fiscal 2009, we borrowed $40.0 million under our senior revolver and repaid the amount in full prior to the end of the first quarter. The operations of REM Health have been presented as discontinued operations on the consolidated statements of operations and the prior periods have been reclassified. Loss from discontinued operations for the six months ended March 31, 2009 included a $0.3 million impairment charge related to the write-down of the REM Health assets to their fair value less cost to sell. Our effective income tax rate for the six months ended March 31, 2009 was 16.8% as compared to (37.9)% for the six months ended March 31, 2008. The change in the effective tax rate was primarily due to the benefit of employment tax credits recorded during the six months ended March 31, 2009.

Human Services

Human Services revenue for the six months ended March 31, 2009 increased by 2.7% compared to the six months ended March 31, 2008. The increase was due mostly to organic growth of $9.4 million, which included growth related to new programs that began operations during fiscal 2008 and the first two quarters of fiscal 2009. In addition, acquisitions contributed additional revenue growth of $6.5 million. Human Services revenue growth was partially offset by a reduction in revenue of approximately $4.1 million from businesses we divested in fiscal 2008. Operating margin decreased from 8.9% during the six months ended March 31, 2008 to 8.5% during the six months ended March 31, 2009 primarily due to an increase in labor costs and a payor contract settlement.

Other

Included in the Other category are our health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses. Revenue for the Other category during the six months ended March 31, 2009 increased by 8.1% compared to the six months ended March 31, 2008. This increase was due primarily to organic growth of $3.2 million, which included growth related to new programs that began operations during fiscal 2008 and the first two quarters of fiscal 2009. Operating margin decreased from 15.0% for the six months ended March 31,

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2008 to 13.9% for the six months ended March 31, 2009. The decrease in operating margin was primarily due to an increase in growth initiatives in the current period.

Corporate

Corporate represents corporate general and administrative expenses. Total corporate expense increased by approximately $1.8 million, or 8.9% from the six months ended March 31, 2008 to $22.5 million for the six months ended March 31, 2009. The increase was primarily due to increased investment in business process improvements and growth initiatives.

Liquidity and Capital Resources

Our principal uses of cash are to meet working capital requirements, to fund debt obligations and to finance capital expenditures and acquisitions. Cash flows from operations have historically been sufficient to meet these cash requirements. Our principal sources of funds are cash flows from operating activities and available borrowings under the senior credit facilities.

Cash flows provided by operating activities for the six months ended March 31, 2009 were $22.3 million compared to $24.7 million for the six months ended March 31, 2008. The decrease from the six months ended March 31, 2008 to the six months ended March 31, 2009 was primarily due to a decrease in operating income. Our days sales outstanding increased approximately 1.7 days from 45.8 days at September 30, 2008 to 47.5 days at March 31, 2009.

Net cash used in investing activities, primarily consisting of cash paid for acquisitions and purchases of property and equipment, was $36.2 million for the six months ended March 31, 2009 compared to $14.3 million for the six months ended March 31, 2008.

Cash paid for acquisitions for the six months ended March 31, 2009 was $13.1 million, primarily reflecting the earnout payment of $12.0 million associated with the CareMeridian acquisition and the acquisition of RIA, Inc. for approximately $0.9 million. Cash paid for acquisitions for the six months ended March 31, 2008 was $5.9 million, primarily reflecting the earnout payment of $5.5 million associated with the CareMeridian acquisition.

Cash paid for property and equipment was $17.3 million, or 3.6% of net revenues, for the six months ended March 31, 2009, compared to $9.1 million, or 2.0% of net revenues, for the six months ended March 31, 2008. Approximately $4.4 million of cash paid for property and equipment for the six months ended March 31, 2009 was related to the purchase of real estate and approximately $1.4 million was related to the implementation of a new billing system.

Investing activities also included the purchase of $11.5 million in aggregate principal amount of the senior floating rate toggle notes due 2014 issued by NMH Holdings (the "NMH Holdings notes") for $6.6 million during the six months ended March 31, 2009.

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Net cash used in financing activities was $9.1 million for the six months ended March 31, 2009 compared to $2.1 million for the six months ended March 31, 2008. During the six months ended March 31, 2009, we paid a dividend of approximately $7.0 million to our direct parent company, which used the proceeds to make a distribution to NMH Holdings and NMH Holdings used the proceeds of the distribution to repurchase an aggregate principal amount of $13.9 million of the NMH Holdings notes. As a result, as of March 31, 2009, the aggregate principal amount of the NMH Holdings notes outstanding was $196.2 million, $11.5 million of which was held by us. Our financing activities also included the repayment of long-term debt of $1.9 million for the six months ended March 31, 2009 and 2008.

We may seek to purchase a portion of our outstanding debt or the debt of NMH Holdings from time to time. The amount of debt that may be purchased, if any, would be decided at the sole discretion of our Board of Directors and management and will depend on market conditions, prices, contractual restrictions, our liquidity and other factors.

As mentioned above, our principal sources of funds are cash flows from operating activities and available borrowings under the senior credit facilities. As of March 31, 2009, the availability under our senior revolver was $121.0 million. The availability under the senior revolver was reduced by $4.0 million as letters of credit in excess of $20.0 million under our synthetic letters of credit facility were outstanding. We believe that these funds will provide sufficient liquidity and capital resources to meet our near term and future financial obligations, including scheduled principal and interest payments, as well as to provide funds for working capital, capital expenditures and other needs for the foreseeable future. No assurance can be given, however, that this will be the case.

Contractual Commitments Summary

The following table summarizes our contractual obligations and commitments as of March 31, 2009:

(in thousands)	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years

Long-term debt obligations(1)	$	510,046	$	3,735	$	10,573	$	315,738	$	180,000
Operating lease obligations(2)		118,392		31,900		45,356		23,999		17,137
Capital lease obligations		1,881		152		147		134		1,448
Standby letters of credit		24,018		24,018		—		—		—

Total obligations and commitments	$	654,337	$	59,805	$	56,076	$	339,871	$	198,585

(1): Does not include interest on long-term debt or the $193.8 million of senior floating rate toggle notes due 2014, net of discount, issued by NMH Holdings. Approximately $11.5 million of the outstanding notes are held by us.
(2): Includes the fixed rent payable under the leases and does not include additional amounts, such as taxes, that may be payable under the leases.

Off-balance sheet arrangements

We have no significant off-balance sheet transactions or interests.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of financial statements in

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conformity with GAAP requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and the impact of those events cannot be determined with certainty, the actual results may differ from our estimates. These differences could be material to the financial statements.

We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change.

The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Revenues are reported net of any state provider taxes or gross receipts taxes levied on services we provide. Revenues are also reported net of allowances for unauthorized sales and estimated sales adjustments by business units. Sales adjustments are estimated based on an analysis of historical sales adjustments and recent developments in the payment trends in each business unit. We follow Staff Accounting Bulletin 104,Revenue Recognition (SAB 104), which requires that revenue can only be recognized when evidence of an arrangement exists, the service has been provided, the price is fixed or determinable and collectibility is probable.

We recognize revenues for services performed pursuant to contracts with various state and local government agencies and private health care agencies as follows: cost-reimbursement contract revenues are recognized at the time the service costs are incurred and units-of-service contract revenues are recognized at the time the service is provided. For our cost-reimbursement contracts, the rate provided by the payor is based on a certain level of service and types of costs incurred in delivering the service. From time to time, we receive payments under cost-reimbursement contracts in excess of the allowable costs required to support those payments. In such instances, we estimate and record a liability for such excess payments. At the end of the contract period, any balance of excess payments is maintained as a liability until it is reimbursed to the payor. Revenues in the future may be affected by changes in rate-setting structures, methodologies or interpretations that may be enacted in states where we operate or by the federal government.

Accounts Receivable

Accounts receivable primarily consist of amounts due from government agencies, not-for-profit providers and commercial insurance companies. An estimated allowance for doubtful accounts is recorded to the extent it is probable that a portion or all of a particular account will not be collected. In evaluating the collectibility of accounts receivable, we consider a number of factors, including payment trends in individual states, age of the accounts and the status of ongoing disputes with third party payors. Complex rules and regulations regarding billing and timely filing requirements in various states are also a factor in our assessment of the collectibility of accounts receivable. Actual collections of accounts receivable in subsequent periods may require changes in the estimated allowance for doubtful accounts. Changes in these estimates are charged or credited to revenue in the statement of operations in the period of the change in estimate.

Accruals for Self-Insurance

We maintain employment practices liability, professional and general liability, workers' compensation, automobile liability and health insurance with policies that include self-insured retentions. We record expenses related to claims on an incurred basis, which includes estimates of fully developed losses for both reported and unreported claims. The accruals for the health and workers

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compensation, automobile and professional and general liability programs are based on actuarially determined estimates. Accruals relating to prior periods are periodically reevaluated and increased or decreased based on new information. As such, these changes in estimates are recorded as charges or credits to the statement of operations in a period subsequent to the change in estimate.

Goodwill and Indefinite-lived Intangible Assets

Pursuant to SFAS No. 142,Goodwill and Other Intangible Assets (SFAS 142), we review costs of purchased businesses in excess of net assets acquired (goodwill), and indefinite-life intangible assets for impairment at least annually, unless significant changes in circumstances indicate a potential impairment may have occurred sooner.

We are required to test goodwill on a reporting unit basis. We use a fair value approach to test goodwill for impairment and recognize an impairment charge for the amount, if any, by which the carrying amount of goodwill exceeds fair value. The impairment test for indefinite-life intangible assets requires the determination of the fair value of the intangible asset. If the fair value of the intangible asset were less than its carrying value, an impairment loss would be recognized in an amount equal to the difference. Fair values are established using discounted cash flow and comparative market multiple methods. We conduct our annual impairment test on July 1 of each year, and as of the date of the last test, there was no impairment and there have been no indicators of impairment since the date of the test.

Discounted cash flows are based on management's estimates of our future performance. As such, actual results may differ from these estimates and lead to a revaluation of our goodwill and intangible assets. If updated calculations indicate that the fair value of goodwill or any indefinite-life intangibles is less than the carrying value of the asset, an impairment charge would be recorded in the statement of operations in the period of the change in estimate.

Pursuant to SFAS No. 141,Business Combinations (SFAS 141), assets acquired and liabilities assumed are recorded at their respective fair values.

Impairment of Long-Lived Assets

Pursuant to SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), we review long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair value is recorded based upon various techniques to estimate fair value.

Income Taxes

We account for income taxes in accordance with SFAS No. 109,Accounting for Income Taxes (SFAS 109). Under SFAS 109, the asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. These deferred tax assets and liabilities are separated into current and long-term amounts based on the classification of the related assets and liabilities for financial reporting purposes. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts.

On October 1, 2007, the Company adopted FASB Interpretation 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the criteria that a tax position must satisfy for some or all of the benefits of that position to be recognized in an enterprise's financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition

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threshold of more-likely-than-not and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

Stock-Based Compensation

The Company adopted the provisions of SFAS No. 123 (revised 2004),Share-Based Payments (SFAS 123(R)), to account for share-based payments to employees. NMH Investment adopted an equity-based plan, and issued units of limited liability company interests pursuant to such plan. The units are limited liability company interests and are available for issuance to our employees and members of the Board of Directors for incentive purposes. For purposes of determining the compensation expense associated with these grants, management valued the business enterprise using a variety of widely accepted valuation techniques which considered a number of factors such as our financial performance, the values of comparable companies and the lack of marketability of our equity. We then used the option pricing method to determine the fair value of these units at the time of grant using valuation assumptions consisting of the expected term in which the units will be realized; a risk-free interest rate equal to the U.S. federal treasury bond rate consistent with the term assumption; expected dividend yield, for which there is none; and expected volatility based on the historical data of equity instruments of comparable companies. The Class B and Class E units vest over a five-year service period. The Class C and Class D units vest based on service and on certain performance and/or investment return conditions being met or achieved. The estimated fair value of the units, less an assumed forfeiture rate, is being recognized in expense on a straight-line basis over the requisite service/performance periods of the awards.

Derivative Financial Instruments

We account for derivative financial instruments in accordance with SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (SFAS 133), which requires that all derivative instruments be reported on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. Changes in the fair value of derivatives are recorded each period in current operations or in shareholders' equity as other comprehensive income (loss) depending upon whether the derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction.

We, from time to time, enter into interest rate swap agreements to hedge against variability in cash flows resulting from fluctuations in the benchmark interest rate, which is LIBOR, on our debt. These agreements involve the exchange of variable interest rates for fixed interest rates over the life of the swap agreement without an exchange of the notional amount upon which the payments are based. On a quarterly basis, the differential to be received or paid as interest rates change is accrued and recognized as an adjustment to interest expense in the accompanying consolidated statement of operations. In addition, on a quarterly basis the mark to market valuation is recorded as an adjustment to other comprehensive income (loss) as a change to shareholders' equity, net of tax. The related amount receivable from or payable to counterparties is included as an asset or liability in our consolidated balance sheets.

Available- for-Sale Securities

Pursuant to SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities (SFAS 115), our investments in marketable debt securities have been classified as available-for-sale securities and, accordingly, are valued at fair value at the end of each reporting period. Unrealized gains and losses arising from such valuation are reported, net of applicable income taxes, in other comprehensive income (loss).

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Legal Contingencies

From time to time, we are involved in litigation and regulatory proceedings in the operation of our business. We reserve for costs related to contingencies when a loss is probable and the amount is reasonably estimable. While we believe our provision for legal contingencies is adequate, the outcome of our legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that differ from our estimates. In addition, legal contingencies could have a material adverse impact on our results of operations in any given future reporting period. See "Part II, Item 1A. Risk Factors" for additional information.

Forward-Looking Statements

Some of the matters discussed in this report may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act").

These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential" or "continue," the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

The information in this report is not a complete description of our business or the risks associated with our business. There can be no assurance that other factors will not affect the accuracy of these forward-looking statements or that our actual results will not differ materially from the results anticipated in such forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to, those factors or conditions described under "Item 1A. Risk Factors" in this report as well as the following:

•: changes in Medicaid funding or changes in budgetary priorities by state and local governments;
•: current credit and financial market conditions;
•: our significant amount of debt, our ability to meet our debt service obligations and our ability to incur additional debt;
•: legal proceedings;
•: the size of our self-insurance accruals and changes in the insurance market that affect our ability to obtain coverage at reasonable rates;
•: our ability to control operating costs and collect accounts receivable;
•: our ability to maintain, expand and renew existing services contracts and to obtain additional contracts;
•: our ability to attract and retain experienced personnel, including members of our senior management team;
•: our ability to acquire new licenses or to maintain our status as a licensed service provider in certain jurisdictions;
•: government regulations and our ability to comply with such regulations or the interpretations thereof;
•: our ability to establish and maintain relationships with government agencies and advocacy groups;

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•: increased or more effective competition;
•: changes in reimbursement rates, policies or payment practices by our payors;
•: changes in interest rates;
•: successful integration of acquired businesses; and
•: possible conflict between the interests of our majority equity holder and those of the holders of our notes.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, we do not assume responsibility for the accuracy and completeness of the forward-looking statements. All written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the "Risk Factors" and other cautionary statements included herein. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to changes in interest rates as a result of our outstanding variable rate debt. To reduce our interest rate exposure, we entered into interest rate swap agreements whereby we fixed the interest rate on approximately $221.2 million of our $335.0 million term B loan, effective as of August 31, 2006 and maturing on June 30, 2010 and fixed the interest rate on approximately $113.3 million of our remaining $335.0 million term B loan, effective as of August 31, 2007 and maturing on September 30, 2010. In total, as of March 31, 2009, we fixed the interest rate on approximately $312.1 million of our $325.8 term B loan.

The table below provides information about the Company's interest rate swap agreements and remaining variable rate debt related to the term B loan.

	Agreement					31-Mar-09					31-Mar-10					31-Mar-11

(in thousands) Interest Swap effective date	Swap Value		Rate			Swap Value		Rate			Swap Value		Rate			Swap Value		Rate
August 31, 2006(1)	$	221,200		5.32	%	$	134,991		5.32	%	$	85,703		5.32	%		—		—
August 31, 2007(1)		113,297		4.89	%		177,118		4.89	%		206,547		4.89	%		—		—
Variable rate debt							13,678		—			30,188		—			320,763		—

Total term B loan						$	325,787		—		$	322,438		—		$	320,763		—

(1): Interest rates do not include 2.00% spread on LIBOR loans.

As a result of the interest rate swap agreements, the variable rate debt outstanding was effectively reduced from $330.0 million outstanding to $17.9 million outstanding at March 31, 2009. The variable rate debt outstanding relates to the term B loan, which has an interest rate based on LIBOR plus 2.00% or Prime plus 1.00%, the senior revolver, which has an interest rate based on LIBOR plus 2.25% or Prime plus 1.25%, subject to reduction depending on our leverage ratio, and the term loan mortgage, which has an interest rate based on Prime plus 1.50%. An increase in the interest rate by 100 basis points on the debt balance outstanding as of March 31, 2009, would increase annual interest expense by approximately $0.2 million.

Item 4. Controls and Procedures

None.

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Item 4T. Controls and Procedures

(a): Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC, and is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow for timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. As of March 31, 2009, the end of the period covered by this Quarterly Report on Form 10-Q, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of March 31, 2009, because they are not yet able to conclude that we have remediated the material weaknesses in internal control over financial reporting identified in Item 9A(T) of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

As reported in Item 9A(T) of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008, our management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our internal control over financial reporting as of September 30, 2008 (the last management's assessment of internal control over financial reporting). In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). In connection with this assessment, management identified material weaknesses in our internal control over financial reporting as of September 30, 2008.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. Our material weaknesses relate to our revenue recognition and our fixed asset balances, as detailed below:

Revenue

•: We have insufficient controls over revenue recognition. We maintain a revenue recognition policy in accordance with U.S. generally accepted accounting principles. However, we lack controls to ensure definitive, consistent and documented application of the revenue recognition criteria with respect to local payor contract requirements, which vary among payors and locations.
•: We have insufficient controls over revenue recognition for unauthorized sales. Generally, if we provide services without a current, valid authorization from the payor agency to provide those services, revenue associated with the unauthorized services may need to be deferred until such authorization is received. If authorization is ultimately not granted, revenues will not be recognized. We do not have adequate controls to ensure that all unauthorized sales are identified and recorded appropriately in the consolidated financial statements.

We are currently developing an approach to assess contract terms in each state to ensure that our revenue recognition policy is being consistently and appropriately interpreted and applied. We are also beginning to implement a new system and processes that are expected to ultimately improve our ability to identify and reserve for unauthorized sales. During the quarter ended March 31, 2009 we continued implementation of the new system.

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Fixed Assets

•: We have insufficient controls to verify the existence of our fixed asset balances reflected on our consolidated balance sheets. This increases the risk of overstating our fixed asset balances if we fail to record disposals of fixed assets as they occur.

We are continuing to implement processes to maintain and evaluate our fixed asset balances, which as designed, should provide adequate controls.

(b): Changes in Internal Control over Financial Reporting

In the three months ended September 30, 2008, we introduced a new billing and accounts receivable system in certain states. As discussed above, in the quarter ended March 31, 2009, we continued to implement a new billing and accounts receivable system in several states. The implementation of this billing and accounts receivable system will affect the processes that impact our internal control over financial reporting. As we continue with the system implementation, we will review the related controls and may take further steps to ensure that they are effective and integrated appropriately.

Except for the changes related to implementation of our new billing and accounts receivable system, during the quarter ended March 31, 2009, there were no significant changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are in the human services business and, therefore, we have been and continue to be subject to claims alleging that we, our Mentors or our employees failed to provide proper care for a client. We are also subject to claims by our clients, our Mentors, our employees or community members against us for negligence, intentional misconduct or violation of applicable laws. Included in our recent claims are claims alleging personal injury, assault, battery, abuse, wrongful death and other charges. Regulatory agencies may initiate administrative proceedings alleging that our programs, employees or agents violate statutes and regulations and seek to impose monetary penalties on us. We could be required to incur significant costs to respond to regulatory investigations or defend against civil lawsuits and, if we do not prevail, we could be required to pay substantial amounts of money in damages, settlement amounts or penalties arising from these legal proceedings.

We reserve for costs related to contingencies when a loss is probable and the amount is reasonably estimable. While we believe our provision for legal contingencies is adequate, the outcome of the legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that differ from our estimates.

See "Item 1A. Risk Factors" and "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional information.

Item 1A. Risk Factors

Reductions or changes in Medicaid funding or changes in budgetary priorities by the state and local governments that pay for our services could have a material adverse effect on our revenues and profitability.

We derive substantially all of our revenues from contracts with state and local governments. These governmental payors fund a significant portion of their payments to us through Medicaid, a joint federal/state health insurance program through which state expenditures are matched by federal dollars ranging from 50% to more than 77% of total costs, a number based largely on a state's per capita income. Our revenues, therefore, are determined by the size of federal, state and local governmental spending for the services we provide. Budgetary pressures, particularly during recessionary periods, as well as other economic, industry, political and other factors, could cause the federal and state governments to limit spending, which could significantly reduce our revenues, margins and profitability and adversely affect our growth strategy. If the current economic downturn continues, we expect budgetary pressure on federal, state and local governments to increase, and, as a result, certain appropriations could be reduced. Governmental agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If a government agency does not receive an appropriation sufficient to cover its contractual obligations with us, it may terminate a contract or defer or reduce our reimbursement. In addition, there is risk that previously appropriated funds could be reduced through subsequent legislation. Many states in which we operate are experiencing budgetary pressures and are considering implementing or are initiating service reductions, rate-freezes and/or rate reductions, which are measures states have taken in previous economic downturns. Similarly, programmatic changes such as conversions to managed care with related contract demands regarding billing and services, unbundling of services, governmental efforts to increase consumer autonomy and reduce provider oversight, coverage and other changes under state Medicaid plans, may cause unanticipated costs and risks to our service delivery. The loss or reduction of or changes to reimbursement under our contracts could have a material adverse effect on our business, financial condition and operating results.

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Failure to obtain increases in reimbursement rates could adversely affect our revenues, cash flows and profitability.

Our revenues and operating profitability depend on our ability to maintain our existing reimbursement levels and to obtain periodic increases in reimbursement rates to meet higher costs and demand for more services. Approximately 13% of our revenue is derived from contracts based on a cost reimbursement model where we are reimbursed for our services based on our costs plus an agreed-upon margin. If we are not entitled to, do not receive or cannot negotiate increases in reimbursement rates, or are forced to accept a reduction in our reimbursement rates at approximately the same time as our costs of providing services increase, including labor costs and rent, our margins and profitability could be adversely affected. Changes in how federal and state government agencies operate reimbursement programs can also affect our operating results and financial condition. Some states have, from time to time, revised their rate-setting or methodologies in a manner that has resulted in rate decreases. In some instances, changes in rate-setting methodologies have resulted in third-party payors disallowing, in whole or in part, our requests for reimbursement. Any reduction in or the failure to maintain or increase our reimbursement rates could have a material adverse effect on our business, financial condition and results of operations. Changes in the manner in which state agencies interpret program policies and procedures or review and audit billings and costs could also adversely affect our business, financial condition and operating results and our ability to meet obligations under our indebtedness.

Current credit and financial markets conditions could have a material adverse effect on our cash flows, liquidity and financial condition.

Due to the widespread and ongoing tightening of the credit markets, our government payors or other counterparties that owe us money could be delayed in obtaining, or may not be able to obtain, necessary funding and/or financing to meet their cash-flow need. Moreover, tax revenues are down in many jurisdictions due to the economic recession and widespread unemployment and government payors may not be able to pay us for our services until they collect sufficient tax revenues. Delays in payment could have a material adverse effect on our cash flows, liquidity and financial condition. In addition, in the event that our payors or other counterparties delay payments to us, our financial condition could be further impaired if we are unable, under our senior credit agreement, to borrow funds to finance our operations.

Our variable cost structure is directly related to our labor costs, which may be adversely affected by labor shortages, a deterioration in labor relations or increased unionization activities.

Our variable cost structure and operating profitability are directly related to our labor costs. Labor costs may be adversely affected by a variety of factors, including a limited supply of qualified personnel in any geographic area, local competitive forces, the ineffective utilization of our labor force, increases in minimum wages, health care costs and other personnel costs, and adverse changes in client service models. Some of our operating units have incurred higher labor costs in certain markets from time to time because of difficulty in hiring qualified direct service staff. These higher labor costs have resulted from increased wages and overtime and the costs associated with recruitment and retention, training programs and use of temporary staffing personnel. In part to help with the challenge of recruiting and retaining direct care employees, we offer these employees a benefits package that includes paid time off, health insurance, dental insurance, vision coverage, life insurance and a 401(k) plan, and these costs can be significant.

Our employees are generally not unionized. However, as of March 31, 2009, seventeen of our employees were represented by a labor union. We may not be able to negotiate labor agreements on satisfactory terms with our existing or any future labor unions. If any of the employees covered by collective bargaining agreements were to engage in a strike, work stoppage or other slowdown, we

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could experience a disruption of our operations and/or higher ongoing labor costs, which could adversely affect our business, financial condition and results of operations.

In addition, future unionization activities may result in an increase of our labor and other costs. The Employee Free Choice Act ("EFCA") of 2009 (H.R. 1409) seeks to amend the National Labor Relations Act to make it easier for workers to be represented by labor unions. If the EFCA or a variation of the legislation becomes law, it could result in increased unionization activities.

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

We have a significant amount of indebtedness. As of March 31, 2009, we had total indebtedness of approximately $511.9 million and $121.0 million of availability under our senior revolver. The senior secured credit facilities also include a $20.0 million synthetic letter of credit facility, all of which has been fully utilized. The availability under our senior revolver was reduced from $125.0 million as letters of credit in excess of $20.0 million under our synthetic letters of credit facility were outstanding.

Our substantial degree of leverage could have important consequences, including the following:

•: it may limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, debt service requirements, acquisitions, and general corporate or other purposes;
•: a substantial portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness and will not be available for other purposes, including our operations, future business opportunities and capital expenditures;
•: the debt service requirements of our indebtedness could make it more difficult for us to satisfy our financial obligations;
•: a portion of our variable interest rate borrowings under the senior secured credit facilities has not been hedged, exposing us to the risk of increased interest rates;
•: it may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt and a lower degree of leverage; and
•: we may be vulnerable if the current downturn in general economic conditions continues or if there is a downturn in our business, or we may be unable to carry out activities that are important to our growth.

In addition to our indebtedness noted above, our indirect parent company, NMH Holdings had $196.2 million aggregate principal amount of senior floating rate toggle notes due 2014 outstanding as of March 31, 2009 ($11.5 million of which was held by us). NMH Holdings is a holding company with no direct operations. Its principal assets are the direct and indirect equity interests it holds in its subsidiaries, including us, and all of its operations are conducted through us and our subsidiaries. As a result, NMH Holdings will be dependent upon dividends and other payments from us to generate the funds necessary to meet its outstanding debt service and other obligations, including its obligations on the notes to be held by us. NMH Holdings has paid all of the interest payments to date on the notes entirely in PIK Interest (defined below) which increased the principal amount by $35.1 million. NMH Holdings currently expects to elect to pay entirely by increasing the principal amount of the NMH Holdings notes or issuing new notes ("PIK Interest") through June 15, 2012.

Subject to restrictions in the indentures governing our senior subordinated notes and the NMH Holdings notes and the credit agreement governing our senior secured credit facilities, we may be able to incur more debt in the future, which may intensify the risks described in this risk factor. All of the borrowings under the senior secured credit facilities are secured by substantially all of the assets of the

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Company and its subsidiaries. The NMH Holdings notes are structurally subordinated to the senior subordinated notes and the senior secured credit facilities.

In addition to our high level of indebtedness, we have significant rental obligations under our operating leases for our group homes, other service facilities and administrative offices. For the six months ended March 31, 2009, our aggregate rental payments for these leases, including taxes and operating expenses, was approximately $20.2 million. These obligations could further increase the risks described above.

Covenants in our debt agreements restrict our business in many ways.

The senior secured credit facilities, the indenture governing the senior subordinated notes and the indenture governing the NMH Holdings notes contain various covenants that limit our ability and/or our subsidiaries' ability to, among other things:

•: incur additional debt or issue certain preferred shares;
•: pay dividends on or make distributions in respect of capital stock or make other restricted payments;
•: make certain investments;
•: sell certain assets;
•: create liens on certain assets to secure debt;
•: enter into agreements that restrict dividends from subsidiaries;
•: consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and
•: enter into certain transactions with our affiliates.

The senior secured credit facilities also contain restrictive covenants and require the Company and its subsidiaries to maintain specified financial ratios and satisfy other financial condition tests. Our ability to meet those financial ratios and tests may be affected by events beyond our control, and we cannot assure you that we will meet those tests. The breach of any of these covenants or financial ratios could result in a default under the senior secured credit facilities and the lenders could elect to declare all amounts borrowed thereunder, together with accrued interest, to be due and payable and could proceed against the collateral securing that indebtedness.

The nature of our operations could subject us to substantial claims, some of which may not be fully insured against or reserved for.

We are in the human services business and, therefore, we have been and continue to be subject to claims alleging that we, our Mentors or our employees failed to provide proper care for a client, as well as claims by our clients, our Mentors, our employees or community members against us for negligence, intentional misconduct or violation of applicable law. Included in our recent claims are claims alleging personal injury, assault, battery, abuse, wrongful death and other charges. Regulatory agencies may initiate administrative proceedings alleging that our programs, employees or agents violate statutes and regulations and seek to impose monetary penalties on us. We could be required to incur significant costs to respond to regulatory investigations or defend against civil lawsuits and, if we do not prevail, we could be required to pay substantial amounts of money in damages, settlement amounts or penalties arising from these legal proceedings. We currently insure through our captive subsidiary amounts of up to $1.0 million per claim and up to $2.0 million in the aggregate. Above these limits, we have limited additional third-party coverage. Awards for punitive damages may be excluded from our insurance policies either contractually or by operation of state law.

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We also are subject to potential lawsuits under the False Claims Act or other federal and state whistleblower statutes designed to combat fraud and abuse in the health care industry. These lawsuits can involve significant monetary awards and bounties to private plaintiffs who successfully bring these suits. Finally, we are also subject to employee-related claims under state and federal law, including claims for discrimination, wrongful discharge or retaliation; claims for wage and hour violations under the Fair Labor Standards Act or state wage and hour laws; and novel intentional tort claims.

A litigation award excluded by, or in excess of, our third-party insurance limits and self-insurance reserves could have a material adverse impact on our operations and cash flow and could adversely impact our ability to continue to purchase appropriate liability insurance. Even if we are successful in our defense, civil lawsuits or regulatory proceedings could also irreparably damage our reputation.

Because a substantial portion of NMH Holdings and our indebtedness bears interest at rates that fluctuate with changes in certain prevailing short-term interest rates, we are vulnerable to interest rate increases.

A substantial portion of our indebtedness, including borrowings under the senior revolver, the portion of our borrowings under the senior secured term loan facility for which the Company has not hedged its interest rate exposure under interest rate swap agreements, and the indebtedness of NMH Holdings under the NMH Holdings notes, bears interest at rates that fluctuate with changes in certain short-term prevailing interest rates. If interest rates increase, our and NMH Holdings' debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same.

As of March 31, 2009, we had approximately $17.9 million of floating rate debt outstanding after giving effect to interest rate swaps. As of March 31, 2009, NMH Holdings had $193.8 million of floating rate debt outstanding, net of discount, excluding the debt of its subsidiaries. A 1% increase in the interest rate on our floating rate debt would have increased cash interest expense of the floating rate debt by approximately $0.2 million, and a 1% increase in the interest rate on the NMH Holdings notes would have increased NMH Holdings' interest expense on those notes by approximately $1.9 million. If interest rates increase dramatically, NMH Holdings and the Company and its subsidiaries could be unable to service their debt.

The counterparties to our derivative financial instruments are substantial multi-national financial institutions. Although we consider the risk of counterparty nonperformance to be low, we cannot assure you that our counterparties will not default. If a counterparty defaulted, the effect on our results of operations could be material.

The nature of services that we provide could subject us to significant workers' compensation related liability, some of which may not be fully reserved for.

We use a combination of insurance and self-insurance plans to provide for potential liability for workers' compensation claims. Because of our high ratio of employees per client, and because of the inherent physical risk associated with the interaction of employees with I/DD, ARY and ABI clients, the potential for incidents giving rise to workers' compensation liability is relatively high.

We estimate liabilities associated with workers' compensation risk and establish reserves each quarter based on internal valuations, third-party actuarial advice, historical loss development factors and other assumptions believed to be reasonable under the circumstances. Our results of operations could be adversely impacted if actual future occurrences and claims exceed our assumptions and historical trends.

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If any of the state and local government agencies with which we have contracts determines that we have not complied with our contracts or violated any applicable laws or regulations, our revenues may decrease, we may be subject to fines or penalties and we may be required to restructure our billing and collection methods.

We derive virtually all of our revenues from state and local government agencies, and a substantial portion of these revenues is state-funded with federal Medicaid matching dollars. As a result of our participation in these government-funded programs, we are routinely subject to governmental reviews, audits and investigations to verify our compliance with applicable laws and regulations. As a result of these reviews, audits and investigations, these governmental payors may be entitled to, in their discretion:

•: require us to refund amounts we have previously been paid;
•: terminate or modify our existing contracts;
•: suspend or prevent us from receiving new contracts or extending existing contracts;
•: impose referral holds on us;
•: impose fines, penalties or other sanctions on us; and
•: reduce the amount we are paid under our existing contracts.

As a result of past reviews and audits of our operations, we have been subject to some of these actions from time to time. While we do not currently believe that our existing audit proceedings will have a material adverse effect on our financial condition or significantly harm our reputation, we cannot assure you that similar actions in the future will not do so. In addition, such proceedings could have a material adverse impact on our results of operations in a future reporting period.

In some states, we operate on a cost reimbursement model in which revenues are recognized at the time costs are incurred. In these states, payors audit our historical costs on a regular basis, and if it is determined that our historical costs are insufficient to justify our rates, our rates may be reduced, or we may be required to retroactively return fees paid to us. In some cases we have experienced negative audit adjustments which are based on subjective judgments of reasonableness, necessity or allocation of costs in our services provided to clients. These adjustments are generally required to be negotiated as part of the overall audit resolution and may result in paybacks to payors and adjustments of the rates. We cannot assure you that our rates will be maintained, or that we will be able to keep all payments made to us, until an audit of the relevant period is complete. Moreover, if we are required to restructure our billing and collection methods, these changes could be disruptive to our operations and costly to implement.

If we fail to establish and maintain relationships with state and local government agencies, we may not be able to successfully procure or retain government-sponsored contracts, which could negatively impact our revenues.

To facilitate our ability to procure or retain government-sponsored contracts, we rely in part on establishing and maintaining relationships with officials of various government agencies. These relationships enable us to maintain and renew existing contracts and obtain new contracts and referrals. The effectiveness of our relationships may be reduced or eliminated with changes in the personnel holding various government offices or staff positions. We also may lose key personnel who have these relationships and such personnel are generally not subject to non-compete or non-solicitation covenants. Any failure to establish, maintain or manage relationships with government and agency personnel may hinder our ability to procure or retain government-sponsored contracts.

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Negative publicity or changes in public perception of our services may adversely affect our ability to obtain new contracts and renew existing ones.

Our success in obtaining new contracts and renewals of our existing contracts depends upon maintaining our reputation as a quality service provider among governmental authorities, advocacy groups, families of our clients and the public. Negative publicity, changes in public perception and government investigations with respect to our operations could damage our reputation and hinder our ability to retain contracts and obtain new contracts, and could reduce referrals, increase government scrutiny and compliance costs, or generally discourage clients from using our services. Any of these events could have a material adverse effect on our business, financial condition and operating results.

We face substantial competition in attracting and retaining experienced personnel, and we may be unable to maintain or grow our business if we cannot attract and retain qualified employees.

Our success depends to a significant degree on our ability to attract and retain qualified and experienced human service professionals who possess the skills and experience necessary to deliver quality services to our clients and manage our operations. We face competition for certain categories of our employees, particularly service provider employees, based on the wages, benefits and other working conditions we offer. Contractual requirements and client needs determine the number, education and experience levels of human service professionals we hire. Our ability to attract and retain employees with the requisite credentials, experience and skills depends on several factors, including, but not limited to, our ability to offer competitive wages, benefits and professional growth opportunities. The inability to attract and retain experienced personnel could have a material adverse effect on our business.

We may not realize the anticipated benefits of any future acquisitions and we may experience difficulties in integrating these acquisitions.

As part of our growth strategy, we intend to make selective acquisitions. Growing our business through acquisitions involves risks because with any acquisition there is the possibility that:

•: we may be unable to maintain and renew the contracts of the acquired business;
•: unforeseen difficulties may arise in integrating the acquired operations, including information systems and accounting controls;
•: we may not achieve operating efficiencies, synergies, economies of scale and cost reductions as expected;
•: the business we acquire may not continue to generate income at the same historical levels on which we based our acquisition decision;
•: management may be distracted from overseeing existing operations by the need to integrate the acquired business;
•: we may acquire or assume unexpected liabilities or there may be other unanticipated costs;
•: we may encounter unanticipated regulatory risk;
•: we may experience problems entering new markets or service lines in which we have limited or no experience;
•: we may fail to retain and assimilate key employees of the acquired business;
•: we may finance the acquisition by incurring additional debt and further increase our leverage ratios; and
•: the culture of the acquired business may not match well with our culture.

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As a result of these risks, there can be no assurance that any future acquisition will be successful or that it will not have a material adverse effect on our financial condition and results of operations.

A loss of our status as a licensed service provider in any jurisdiction could result in the termination of existing services and our inability to market our services in that jurisdiction.

We operate in numerous jurisdictions and are required to maintain licenses and certifications in order to conduct our operations in each of them. Each state and local government has its own regulations, which can be complicated, and each of our service lines can be regulated differently within a particular jurisdiction. As a result, maintaining the necessary licenses and certifications to conduct our operations can be cumbersome. Our licenses and certifications could be suspended, revoked or terminated for a number of reasons, including:

•: the failure by our employees or Mentors to properly care for clients;
•: the failure to submit proper documentation to the government agency, including documentation supporting reimbursements for costs;
•: the failure by our programs to abide by the applicable regulations relating to the provision of human services; or
•: the failure of our facilities to comply with the applicable building, health and safety codes and ordinances.

From time to time, some of our licenses or certifications are temporarily placed on probationary status or suspended. If we lost our status as a licensed provider of human services in any jurisdiction or any other required certification, we would be unable to market our services in that jurisdiction, and the contracts under which we provide services in that jurisdiction would be subject to termination. Moreover, such an event could constitute a violation of provisions of contracts in other jurisdictions, resulting in other contract, license or certification terminations. Any of these events could have a material adverse effect on our operations.

We are subject to extensive governmental regulations, which require significant compliance expenditures, and a failure to comply with these regulations could adversely affect our business.

We must comply with comprehensive government regulation of our business, including statutes, regulations and policies governing the licensing of our facilities, the maintenance and management of our work place for our employees, the quality of our service, the revenues we receive for our services, and reimbursement for the cost of our services. Compliance with these laws, regulations and policies is expensive, and if we fail to comply with these laws, regulations and policies, we could lose contracts and the related revenues, thereby harming our financial results. State and federal regulatory agencies have broad discretionary powers over the administration and enforcement of laws and regulations that govern our operations. A material violation of a law or regulation could subject us to fines and penalties and in some circumstances could disqualify some or all of the facilities and programs under our control from future participation in Medicaid or other government programs. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), which requires the establishment of privacy standards for health care information storage, retrieval and dissemination as well as electronic transmission and security standards, could result in potential penalties in certain of our businesses if we fail to comply with these privacy and security standards.

Expenses incurred under governmental agency contracts for any of our services, as well as management contracts with providers of record for such agencies, are subject to review by agencies administering the contracts and services. Representatives of those agencies visit our group homes to verify compliance with state and local regulations governing our home operations. A negative outcome from any of these examinations could increase government scrutiny, increase compliance costs or

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hinder our ability to obtain or retain contracts. Any of these events could have a material adverse effect on our business, financial condition and operating results.

We have identified material weaknesses in our internal control over financial reporting.

In connection with our internal controls assessment required by the Sarbanes-Oxley Act of 2002 and as reported in Item 9AT of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008, we identified material weaknesses in our internal control over financial reporting. Management concluded that as of September 30, 2008, our internal control over financial reporting was not effective and, as a result, our disclosure controls and procedures were not effective. Descriptions of the material weaknesses are included in Item 4T of this quarterly report on Form 10-Q. While we have taken action and continue to take actions to remediate our identified material weaknesses, our new policies and procedures, when implemented, may not be effective in remedying all of the deficiencies in our internal control over financial reporting. The decentralized nature of our operations, and the manual nature of many of our controls, make compliance with the requirements of Section 404 and remediation of our material weaknesses especially challenging. We expect that the implementation of our new billing and accounts receivable system will affect a number of processes that impact our internal control over financial reporting; however we may identify additional material weaknesses or significant deficiencies in connection with this implementation. A failure to remedy our material weaknesses in internal control over financial reporting could result in material misstatements in our financial statements. Moreover, our conclusion that our internal control over financial reporting and disclosure controls and procedures are not effective, and any future disclosures of additional material weaknesses, may result in a negative reaction in the financial markets if there is a loss of confidence in the reliability of our financial reporting.

We have extensive work remaining to remedy the material weaknesses in our internal control over financial reporting, and until our remediation efforts are completed, management will continue to devote significant time and attention to these efforts. We will continue to incur costs associated with implementing additional processes, including fees for additional auditor services and consulting services, and may be required to incur additional costs in improving our internal controls and hiring additional personnel, which could negatively affect our financial condition and operating results.

The high level of competition in our industry could adversely affect our contract and revenue base.

We compete with a wide variety of competitors, ranging from small, local agencies to a few large, national organizations. Competitive factors may favor other providers and reduce our ability to obtain contracts, which would hinder our growth. Not-for-profit organizations are active in all states and range from small agencies serving a limited area with specific programs to multi-state organizations. Smaller local organizations may have a better understanding of the local conditions and may be better able to gain political and public acceptance. Not-for-profit providers may be affiliated with advocacy groups, health organizations or religious organizations that have substantial influence with legislators and government agencies. Increased competition may result in pricing pressures, loss of or failure to gain market share or loss of clients or payors, any of which could harm our business.

We rely on third parties to refer clients to our facilities and programs.

We receive substantially all of our clients from third-party referrals and are governed by the federal anti-kickback/non-self referral statute. Our reputation and prior experience with agency staff, care workers and others in positions to make referrals to us are important for building and maintaining our operations. Any event that harms our reputation or creates negative experiences with such third parties could impact our ability to receive referrals and grow our client base.

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Home and community-based human services may become less popular among our targeted client populations and/or state and local governments, which would adversely affect our results of operations.

Our growth depends on the continuation of trends in our industry toward providing services to individuals in smaller, community-based settings and increasing the percentage of individuals served by non-governmental providers. The continuation of these trends and our future success are subject to a variety of political, economic, social and legal pressures, all of which are beyond our control. A reversal in the downsizing and privatization trends could reduce the demand for our services, which could adversely affect our revenues and profitability.

Regulations that require ARY services to be provided through not-for-profit organizations could harm our revenues or gross margin.

Approximately 3% of our net revenues for the six months ended March 31, 2009 were derived from contracts with affiliates of Alliance Health and Human Services, Inc., or "Alliance," an independent not-for-profit organization that has licenses and contracts from several state and local agencies to provide ARY services.

Historically, some state governments have interpreted federal law to preclude them from receiving federal reimbursement under Title IV-E of the Social Security Act for ARY services provided under a contract with a proprietary organization. However, in 2005 the Fair Access Foster Care Act of 2005 was signed into law, thereby allowing states to seek reimbursement from the federal government for ARY services provided by proprietary organizations. In some jurisdictions that interpreted the prior federal law to preclude them from seeking reimbursement for ARY services provided under a contract with a proprietary provider, or in others that prefer to contract with not-for-profit providers, we provide ARY services as a subcontractor of Alliance. We do not control Alliance, and none of our employees or agents has a role in the management of Alliance. Although Edward Murphy, our President and Chief Executive Officer, was an officer and director of Alliance immediately prior to becoming our President in September 2004, Mr. Murphy has no role in the management of Alliance. Our ARY business could be harmed if Alliance chooses to discontinue all or a portion of its service agreements with us. Our ARY business could also be harmed if the state or local governments that prefer that ARY services be provided by not-for-profit organizations determine that they do not want the service performed indirectly by for-profit companies like us on behalf of not-for-profit organizations. We cannot assure you that our contracts with Alliance will continue, and if these contracts are terminated without our consent, it could have an adverse effect on our business, financial condition and operating results. Alliance and its subsidiaries are organized as non-profit corporations and are recognized as tax-exempt under section 501(c)(3) of the Internal Revenue Code. As such, Alliance is subject to the public charity regulations of the states in which it operates and to the federal regulations governing tax-exempt entities. If Alliance fails to comply with the laws and regulations of the states in which it operates or with the federal regulations, it could be subject to penalties and sanctions, including the loss of tax-exempt status, which could preclude it from continuing to contract with certain state and local governments. Our business could be harmed if Alliance lost its contracts and was therefore unable to continue to contract with us.

Government reimbursement procedures are time-consuming and complex, and failure to comply with these procedures could adversely affect our liquidity, cash flows and operating results.

The government reimbursement process is time-consuming and complex, and there can be delays before we receive payment. Government reimbursement, group home credentialing and Medicaid recipient eligibility and service authorization procedures are often complicated and burdensome, and delays can result from, among other things, securing documentation and coordinating necessary eligibility paperwork between agencies. These reimbursement and procedural issues occasionally cause us to have to resubmit claims several times before payment is remitted. If there is a billing error, the

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process to resolve the error may be time-consuming and costly. To the extent that complexity associated with billing for our services causes delays in our cash collections, we assume the financial risk of increased carrying costs associated with the aging of our accounts receivable as well as increased potential for write-offs. We can provide no assurance that we will be able to collect payment for claims at our current levels in future periods. The risks associated with third-party payors and the inability to monitor and manage accounts receivable successfully could have a material adverse effect on our liquidity, cash flows and operating results.

We conduct a significant percentage of our operations in Minnesota and, as a result, we are particularly susceptible to any reduction in budget appropriations for our services or any other adverse developments in that state.

For the six months ended March 31, 2009, approximately 16% of our revenues were generated from contracts with government agencies in the state of Minnesota. Accordingly, any reduction in Minnesota's budgetary appropriations for our services, whether as a result of fiscal constraints due to recession, changes in policy or otherwise, could result in a reduction in our fees and possibly the loss of contracts. In the past, our operations in Minnesota have been subject to rate reductions and we cannot assure you that we will not receive rate reductions in the future. The concentration of our operations in Minnesota also makes us particularly susceptible to many of the other risks described above occurring in this state, including:

•: the failure to maintain and renew our licenses;
•: the failure to maintain important relationships with officials of government agencies; and
•: any negative publicity regarding our operations.

Any of these adverse developments occurring in Minnesota could result in a reduction in revenue or a loss of contracts, which could have a material adverse effect on our results of operations, financial position and cash flows.

We depend upon the continued services of certain members of our senior management team, without whom our business operations could be significantly disrupted.

Our success depends, in part, on the continued contributions of our executive officers and other key employees. Our management team has significant industry experience and would be difficult to replace. If we lose or suffer an extended interruption in the service of one or more of our senior officers, our financial condition and operating results could be adversely affected. The market for qualified individuals is highly competitive and we may not be able to attract and retain qualified personnel to replace or succeed members of our senior management or other key employees, should the need arise.

Our success depends on our ability to manage growing and changing operations.

Since 1998, our business has grown significantly in size and complexity. This growth has placed, and is expected to continue to place, significant demands on our management, systems, internal controls and financial and physical resources. Our operations are highly decentralized, with many billing, accounting, collection and payment functions being performed at the local level. This requires us to expend significant resources implementing and monitoring compliance at the local level. In addition, we expect that we will need to further develop our financial and managerial controls and reporting systems to accommodate future growth. This will require us to incur expenses for hiring additional qualified personnel, retaining professionals to assist in developing the appropriate control systems and expanding our information technology infrastructure. The nature of our business is such

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that qualified management personnel can be difficult to find. Our inability to manage growth effectively could have a material adverse effect on our results of operations, financial position and cash flows.

We may be more susceptible to the effects of a public health catastrophe than other businesses due to the vulnerable nature of our client population.

Our primary clients are individuals with developmental disabilities, brain injuries, or emotionally, behaviorally or medically complex challenges, many of whom may be more vulnerable than the general public in a public health catastrophe. For example, if a flu pandemic were to occur we could suffer significant losses to our client population and, at a high cost, be required to hire replacement staff and Mentors for workers who drop out of the workforce in very tight labor markets. Accordingly, certain public health catastrophes such as a flu pandemic could have a material adverse effect on our financial condition and results of operations.

We are controlled by our principal equityholder, which has the power to take unilateral action.

Vestar controls our business affairs and policies. Circumstances may occur in which the interests of Vestar could be in conflict with the interests of our debt holders. In addition, Vestar may have an interest in pursuing acquisitions, divestitures or other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to our debt holders. Vestar 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. Vestar 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 Vestar continue to own a significant amount of our equity interests, even if such amount is less than 50%, Vestar will continue to be able to significantly influence or effectively control our decisions.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

No equity securities of the Company were sold during the three months ended March 31, 2009.

The following table sets forth the number of units of common equity of NMH Investment issued during the quarter ended March 31, 2009 pursuant to the NMH Investment, LLC Amended and Restated 2006 Unit Plan, as amended. The units were issued under Rule 701 promulgated under the Securities Act of 1933.

Dates	Title of Securities		Purchasers	Consideration

January 8, 2009	Class A Common Units	6,200.00	One director and one executive officer	$	62,000.00
	Class B Common Units	4,990.33		$	249.52
	Class C Common Units	5,236.60		$	157.10
	Class D Common Units	5,547.68		$	55.48
	Class E Common Units	3,188.00		$	159.40
March 27, 2009	Class B Common Units	1,732.50	Certain employees	$	88.63
	Class C Common Units	1,818.00		$	54.54
	Class D Common Units	1,926.00		$	19.26

Repurchases of Equity Securities

No equity securities of the Company were repurchased during the three months ended March 31, 2009.

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The following table sets forth information in connection with repurchases made by NMH Investment of its common equity units during the quarterly period ended March 31, 2009:

		(b) Average Price Paid per Unit

Month #1 (January 1, 2009 through January 31, 2009)	25,250.00 A Units	$	10.00	—	N/A
	6,737.50 B Units	$	0.05	—	N/A
	7,070.00 C Units	$	0.03	—	N/A
	7,490.00 D Units	$	0.01	—	N/A
Month #2 (February 1, 2009 through February 28, 2009)	—		—	—	—
Month #3 (March 1, 2009 through March 31, 2009)	1,443.75 B Units	$	0.05	—	N/A
	1,515.00 C Units	$	0.03	—	N/A
	1,605.00 D Units	$	0.01	—	N/A

We did not repurchase any of our common stock as part of an equity repurchase program during the second quarter of fiscal 2009. NMH Investment purchased all of the units listed in the table from certain of our employees upon their departures.

Item 3. Defaults Upon Senior Securities

None.

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

None.

Item 5. Other Information

None.

Item 6. Exhibits

The Exhibit Index is incorporated herein by reference.

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SIGNATURES

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


	NATIONAL MENTOR HOLDINGS, INC.
May 14, 2009	By:	/s/ EDWARD M. MURPHY Edward M. Murphy
	Its:	President and Chief Executive Officer
May 14, 2009	By:	/s/ DENIS M. HOLLER Denis M. Holler
	Its:	Executive Vice President, Chief Financial Officer and Treasurer

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3.1	Amended and Restated Certificate of Incorporation of National Mentor Holdings, Inc.	Incorporated by reference to Exhibit 3.1 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended March 31, 2007 (the "March 2007 10-Q")
3.2	By-Laws of National Mentor Holdings, Inc.	Incorporated by reference to Exhibit 3.2 of the March 2007 10-Q
31.1	Certification of principal executive officer.	Filed herewith
31.2	Certification of principal financial officer.	Filed herewith
32	Certifications furnished pursuant to 18 U.S.C. Section 1350.	Filed herewith

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National Mentor (NMH) Inactive 10-Q2009 Q2 Quarterly report

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