National Mentor (NMH) 10-Q 2006 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2006

OR

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

For the transition period from             to

Commission file number: 333-129179

NATIONAL MENTOR HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Delaware	31-17570886
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)
313 Congress Street, 6th Floor
Boston, Massachusetts 02210	(617) 790-4800
(Address of Principal Executive Offices,	(Registrant’s Telephone Number,
including Zip Code)	Including Area Code)

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

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

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x

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

As of May 15, 2006, there were issued and outstanding 10,136,984.867 shares of the registrant’s common stock, $.01 par value.

Index
National Mentor Holdings, Inc.

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets—March 31, 2006 and September 30, 2005		3
	Condensed Consolidated Statements of Income—Three and Six months ended March 31, 2006 and 2005		4
	Condensed Consolidated Statements of Cash Flows—Six months ended March 31, 2006 and 2005		5
	Notes to Condensed Consolidated Financial Statements—March 31, 2006		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		22
Item 4.	Controls and Procedures		22
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings		23
Item 1A	Risk Factors		23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 3.	Defaults Upon Senior Securities		30
Item 4.	Submission of Matters to a Vote of Security Holders		30
Item 5.	Other Information		30
Item 6.	Exhibits		30

2

PART I.FINANCIAL INFORMATION

ITEM 1.Financial Statements

National Mentor Holdings, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)

	March 31 2006		September 30 2005
Assets
Current assets:
Cash and cash equivalents	$	29,575	$	29,307
Accounts receivable, net	88,147		83,528
Deferred tax assets, net	3,677		3,829
Prepaid expenses and other current assets	16,823		12,574
Total current assets	138,222		129,238
Property and equipment, net	114,990		114,166
Intangible assets, net	104,444		104,571
Goodwill	94,193		91,263
Other assets	3,817		10,200
Total assets	$	455,666	$	449,438
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable	$	15,039	$	14,812
Accrued payroll and related costs	40,555		33,678
Other accrued liabilities	20,104		19,957
Current portion of long-term debt	6,397		11,601
Total current liabilities	82,095		80,048
Other long-term liabilities	2,878		3,048
Deferred tax liabilities, net	10,896		10,602
Long-term debt	317,125		319,430
Total liabilities	412,994		413,128
Commitments and contingencies
Shareholders’ equity:
Common stock	101		102
Additional paid-in-capital	42,365		42,023
Note receivable from officer	—		(49		)
Retained earnings (accumulated deficit)	206		(5,766		)
Total shareholders’ equity	42,672		36,310
Total liabilities and shareholders’ equity	$	455,666	$	449,438

See accompanying notes.

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National Mentor Holdings, Inc.
Condensed Consolidated Statements of Income
(In thousands)
(Unaudited)

	Three Months Ended						Six Months Ended
	March 31						March 31
	2006			2005			2006			2005
Net revenues	$	191,464		$	171,299		$	375,805		$	340,127
Cost of revenues	145,894			130,256			285,007			257,993
Gross profit	45,570			41,043			90,798			82,134
Operating expenses:
General and administrative	25,542			23,124			51,462			45,406
Depreciation and amortization	5,633			5,271			11,079			10,621
Transaction costs	599			—			599			—
Total operating expenses	31,774			28,395			63,140			56,027
Income from operations	13,796			12,648			27,658			26,107
Other income (expense):
Management fee of related party	(72		)	(77		)	(135		)	(139		)
Other income (expense), net	(54		)	43			(58		)	32
Interest income	216			33			449			219
Interest expense	(7,855		)	(6,749		)	(14,964		)	(16,367		)
Income before provision for income taxes	6,031			5,898			12,950			9,852
Provision for income taxes	2,584			2,536			5,491			4,236
Net income	$	3,447		$	3,362		$	7,459		$	5,616

See accompanying notes.

4

National Mentor Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

	Six months ended March 31
	2006			2005
Operating activities
Net income	$	7,459		$	5,616
Adjustments to reconcile net income to cash provided by operating activities:
Accounts receivable allowances	2,644			3,835
Depreciation and amortization of property and equipment	6,405			6,283
Amortization of other intangible assets	4,674			4,338
Amortization of deferred debt financing costs	1,403			1,805
Amortization of excess tax goodwill	142			—
Stock based compensation	342			56
Gain on disposal of business	—			(80		)
Loss on disposal of property and equipment	97			117
Changes in operating assets and liabilities:
Accounts receivable	(7,263		)	(1,714		)
Other assets	1,303			(1,673		)
Accounts payable	227			(898		)
Accrued payroll and related costs	6,528			(1,265		)
Other accrued liabilities	147			(9,261		)
Deferred taxes	446			3,418
Other long-term liabilities	(170		)	(3,855		)
Net cash provided by operating activities	24,384			6,722
Investing activities
Cash paid for acquisitions, net of cash received	(8,839		)	(537		)
Purchases of property and equipment	(6,214		)	(6,211		)
Cash proceeds from sale of property and equipment	343			643
Net cash used in investing activities	(14,710		)	(6,105		)
Financing activities
Repayments of long-term debt	(7,509		)	(219,276		)
Redemption of preferred stock	—			(118,453		)
Proceeds from officer notes	—			539
Proceeds from issuance of long-term debt	—			338,000
Repurchase and retirement of common stock	(1,488		)	—
Payments of deferred financing costs	(409		)	(8,924		)
Net cash used in financing activities	(9,406		)	(8,114		)
Net increase (decrease) in cash and cash equivalents	268			(7,497		)
Cash and cash equivalents at beginning of period	29,307			24,416
Cash and cash equivalents at end of period	$	29,575		$	16,919

See accompanying notes.

5

National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Amounts in thousands, except share and per share amounts)
March 31, 2006
(Unaudited)

1.   Basis of Presentation

National Mentor Holdings, Inc., through its wholly owned subsidiaries (collectively, the “Company”), is a national provider of home and community-based services to (i) individuals with mental retardation and/or developmental disabilities; (ii) at-risk children and youth with emotional, behavioral or medically complex needs and their families; and (iii) persons with acquired brain injury.

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary to present fairly the financial position at March 31, 2006 and the results of operations and cash flows for the interim period have been included. Operating results for the six month period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending September 30, 2006.

2.   Long-Term Debt

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

	March 31		September 30
	2006		2005
Senior Term B Loan, principal and interest due in quarterly installments through September 30, 2011; variable interest rate (7.2% at March 31, 2006)	$	164,871	$	171,945
Senior Revolver, due November 4, 2010; quarterly cash interest payments at a variable interest rate	—		—
Senior Subordinated Notes, due November 4, 2012; semi-annual cash interest payments beginning June 1, 2005 (coupon rate of 95¤8%)	150,000		150,000
Term loan mortgage, principal and interest due in monthly installments through May 20, 2010; variable interest rate (9.25% at March 31, 2006)	5,651		6,086
Note Payable to Seller (Magellan Health Services, Inc.), due March 8, 2007; semiannual cash interest payments at 12% beginning September 2001	3,000		3,000
	$	323,522	$	331,031
Less current portion	6,397		11,601
Long-term debt	$	317,125	$	319,430

Any amounts outstanding under the senior revolver are due six years from the date of the senior credit agreement. The $175.0 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 one-half of a calculated amount if the Company generates certain levels of cash flow. For the year ended September 30, 2005, one-half of the calculated amount equaled $5,804. This amount is reflected in the current portion of long-term debt in the September 30, 2005 consolidated balance sheet and was paid in December 2005.

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2.Long-Term Debt (Continued)

The interest rate on the term B loan is equal to LIBOR plus 2.50% or Prime plus 1.50%. The interest rate on the term B loan outstanding at March 31, 2006 is based on LIBOR plus 2.50%. The interest rates for any senior revolving credit facility borrowings are equal to either LIBOR plus 3.25% or Prime plus 2.25%. Cash paid for interest amounted to approximately $14,413 and $21,415 for the six months ended March 31, 2006 and 2005, respectively.

The senior credit facility agreement and the bond indenture contain both affirmative and negative covenants, including limitations on the Company’s ability to incur additional debt, sell material assets, retire, redeem or otherwise reacquire capital stock, acquire the capital stock or assets of another business, pay dividends, and require the Company to meet or exceed certain financial ratios. The Company was in compliance with all covenants at March 31, 2006.

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 secured by substantially all of the assets of the Company.

In conjunction with the registration of the exchange offer for the senior subordinated notes in the first quarter, the Company incurred deferred financing costs of approximately $409 as of March 31, 2006. These costs are being amortized under the effective interest rate method over the expected term of the senior subordinated notes. As of March 31, 2006, the balance sheet included $7,369 in other current assets for deferred financing costs related to the senior credit facilities and senior subordinated notes. As of September 30, 2005, the balance sheet included $1,325 in other current assets and $7,053 as an other long-term asset. The Company charged approximately $1,403 and $1,805 to interest expense for the six months ended March 31, 2006 and 2005, respectively, related to the amortization of deferred financing costs. Included in this charge for the six months ended March 31, 2006 is approximately $720 due to the accelerated amortization of deferred financing costs in conjunction with the potential refinancing described in Note 8.

3.   Acquisitions

On January 31, 2006, the Company acquired the Florida operations of American Habilitation Services, Inc. (AHS Florida). AHS Florida provides residential group home, day program and ICF-MR services to individuals with mental retardation and/or developmental disabilities. In accordance with the agreement, the gross purchase price for the acquisition including transaction costs was approximately $12.9 million in cash. In conjunction with the acquisition, the Company sold approximately $4.5 million in real estate to Pinebrook Properties, LLC, resulting in a net purchase price of $8.4 million. The Company accounted for the acquisition under the purchase method of accounting in accordance with SFAS No. 141, Business Combinations. Accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based upon their respective fair values.  The excess of the purchase price over the estimated fair market value of net tangible assets was allocated to specifically identified intangible assets, with the residual being allocated to goodwill. Management determined the respective fair values of intangible assets utilizing the discounted cash flow method  for agency contracts and the avoided cost method for the licenses and permits.

The aggregate purchase price for the acquisitions was allocated as follows:

Other assets, current and long term	$	154
Property and equipment	1,366
Identifiable intangible assets	4,425
Goodwill	2,850
Accounts payable and accrued expenses	(349		)
	$	8,446

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4.   Stock-Based Compensation

On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS 123 (R)), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and amends SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative to financial statement recognition.

Under SFAS 123(R), entities that used the minimum-value method, as the Company had, to measure compensation cost for stock options under SFAS 123 for financial statement recognition or pro forma disclosure purposes are required to use the prospective method. Under the prospective method, entities continue to account for nonvested awards outstanding at the date of adoption of SFAS 123(R) in the same manner as they had been accounted for prior to adoption for financial statement recognition purposes. All awards granted, modified or settled after the date of adoption are accounted for using the measurement, recognition and attribution provisions of SFAS 123(R).

Effective October 1, 2005, the Company adopted the fair value recognition provisions of SFAS 123(R) using the prospective method. Therefore, the Company continues to account for nonvested awards outstanding at the date of adoption in the same manner it accounted for them prior to adoption. The Company uses the Black-Scholes option valuation to determine the fair value of share-based payments granted after October 1, 2005. At March 31, 2006, the Company has one stock-based employee compensation plan. In November 2001, the Board of Directors approved a stock option plan, which provides for the grant to our directors, officers and key employees of options to purchase shares of common stock. Options awarded under the stock option plan are exercisable into shares of common stock. The total number of shares of common stock as to which options may be granted may not exceed 1,292,952 shares of common stock.

Stock-based compensation cost of approximately $15 and $50 is reflected in pre-tax income for the three months ended March 31, 2006 and 2005, respectively, and $40 and $56 is reflected in pre-tax income for the six months ended March 31, 2006 and 2005, respectively. This compensation cost is related to options granted in 2002 and 2004 under the plan that had an exercise price less than the fair value of the underlying common stock on the date of grant. Due to the potential transaction described in Note 8, at the time of the merger, all unvested stock options will become vested in accordance with the change in control provision of the original stock option agreements. No additional compensation will be recognized until the time of the merger.

During the three and six months ended March 31, 2006, the Company recorded $249 and $302 of stock-based compensation expense as a result of the adoption of SFAS 123(R). The following table illustrates the effect on net income if the fair value based method had been applied to the three and six months ended March 31, 2005.

	Three months Ended			Six months Ended
	March 31 2005			March 31, 2005
Net income, as reported	$	3,362		$	5,616
Add: Stock-based employee compensation included in reported net income, net of related tax effects	29			32
Deduct: Total stock-based employee compensation expense determined under fair value method of all awards, net of related tax effects	(80		)	(142		)
Net income, pro forma	$	3,311		$	5,506

8

The fair value of options granted during the six months ended March 31, 2006 and March 31, 2005 were calculated using the following assumptions:

	Six Months Ended
	March 31 2006	March 31, 2005
Weighted-average exercise price	$22.50	$11.00
Risk-free interest rate	4.4%	4.4%
Expected dividend yield	—	—
Expected life	6.25 years	10 years
Expected volatility	64.9%	—
Weighted-average fair value of options granted	$14.38	$2.65

The risk-free interest rate represents the discount rate of an equivalent bond yield at the date of the option grants. In projecting expected stock price volatility the Company considered historical data of equity instruments of comparable companies. The Company estimated the expected life of stock options using the short-cut method. In calculating the weighted-average fair value of options granted, the Company estimated stock option forfeitures based on historical experience. Expected forfeitures are calculated based on an average forfeiture rate over the past four years of 4.6%. The historical trend of forfeitures is deemed reasonable to use in determining expected forfeitures. Upon adoption of FAS 123R on October 1, 2005, the Company uses the straight line method to recognize expense for options granted.

A summary of the activity under the Company’s stock option plan for the six months ended March 31, 2006 is presented below:

				Weighted Average	Aggregate
	Options		Weighted Average	Remaining Contractual	Intrinsic
	Outstanding		Exercise Price	Term in Years	Value
Outstanding at September 30, 2005	847,000		$ 7.08
Granted	294,500		22.50
Exercised	—		—
Forfeited	(36,250	)	7.52
Outstanding at December 31, 2005	1,105,250		$11.18	8.55	$12,515
Excerciable at December 31, 2005	350,563		$ 5.79	7.54	$  5,860
Options vested or expected to vest at December 31, 2005 (1)	1,062,902		11.11	8.53	$12,102
Outstanding at December 31, 2005	1,105,250		$11.18
Granted	—		—
Exercised	—		—
Forfeited	(8,000	)	8.50
Outstanding at March 31, 2006	1,097,250		$11.20	8.30	$26,448
Excerciable at March 31, 2006	363,063		$ 5.83	7.31	$10,701
Options vested or expected to vest at March 31, 2006 (1)	1,063,477		11.11	8.29	$25,724

(1)  In addition to the vested options, the Company expects a portion of the unvested options to vest at some point in the future. Options expected to vest is calculated by applying an estimated forfeiture rate to the unvested options.

As of March 31, 2006, there was $3.7 million of total unrecognized compensation cost related to unvested share-based awards. That cost is expected to be recognized over a period of 3.5 years or in accordance with the change in control provisions of the original stock option agreements.

Included in the options above are 942,000 options which the Company granted prior to October 1, 2005 and therefore, continues to account for these options under APB 25 and are fair-valued using the minimum-value method. Of these options, 139,250 were forfeited resulting in 802,750 options outstanding at March 31, 2006.

9

5.   Intangible Assets

Intangible assets, resulting from the Company’s acquisition of certain businesses accounted for under the purchase method, consist of identifiable assets, including agency contracts, trade names, noncompete/nonsolicit clauses, an intellectual property model, licenses and permits and relationships with contracted caregivers. Identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. Various trade names are classified as indefinite-lived intangible assets due to the length of time the trade names have been in existence and the planned use of the trade names for the foreseeable future.

Intangible assets consist of the following as of March 31, 2006:

Description	Estimated Useful Life	Gross Carrying Value		Accumulated Amortization		Intangible Assets, net
Agency contracts	5—13 years	$	100,534	$	22,152	$	78,382
Non-compete/non-solicit	4—5 years	350		258		92
Relationship with contracted caregivers	3 years	6,184		6,040		144
Trade names	10 years	526		162		364
Trade names	Indefinite life	19,192		—		19,192
Licenses and permits	10 years	8,265		2,364		5,901
Intellectual property models	10 years	550		181		369
		$	135,601	$	31,157	$	104,444

Amortization expense was $2,391 and $2,187 for the three months ended March 31, 2006 and 2005, respectively, and $4,674 and $4,338 for the six months ended March 31, 2006 and 2005, respectively.

The estimated remaining amortization expense related to intangible assets with finite lives for each of the five succeeding years and thereafter is as follows:

Year ending September 30,
2006	$	4,851
2007	9,615
2008	9,299
2009	9,150
2010	9,140
Thereafter	43,197
	$	85,252

6.   Segment Information

The Company provides home and community-based human services for individuals with mental retardation and other developmental disabilities, at-risk youth and their families and persons with acquired brain injury. The Company operates its business in three operating divisions: an Eastern Division, a Central Division and a Western Division. For the reasons discussed below, the Company’s operating divisions are aggregated to represent one reportable segment, human services, under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131). Accordingly, the accompanying consolidated financial statements reflect the operating results of the Company’s reportable segment. The aggregate of the Company’s Eastern, Central and Western operating divisions meets the definition of a segment in SFAS 131 as each of the three divisions engages in business activities that earn revenues and incur expenses, its operating results are regularly reviewed by management (comprising the Company’s chief operating decision-maker) to assess its performance and make decisions about resources to be allocated to the respective division, and discrete financial information is available in the form of detailed statements of income. The Company’s three service lines, which comprise mental retardation and other developmental disabilities, at-risk youth and persons with acquired brain injury do not represent operating segments per SFAS 131 as management does not internally evaluate the operating performance or review the results of the service lines to assess performance or make decisions about allocating resources. Discrete financial information is not available by service line at the level necessary for management to assess performance or make resource allocation decisions.

10

The Company’s Eastern, Central and Western operating divisions are combined into one reportable segment in accordance with the criteria outlined in SFAS 131. The aggregation of the three operating divisions is consistent with the objective and basic principles of SFAS 131 because it provides the users of the financial statements with the same information that management uses to internally evaluate the business. Each of the Company’s operating divisions provide the same types of services discussed above to similar customer groups, principally individuals. All of the operating divisions have similar economic characteristics, such as similar long-term gross margins. All of the operating divisions follow the same operating procedures and methods in managing their operations, as services are provided in a similar manner. In addition, each operating division operates in a similar regulatory environment, as each operating division has common objectives and regulatory and supervisory responsibilities (e.g., licensing, certification, program standards, regulatory requirements).

7.   Reserves for Self-Insurance and Other Commitments and Contingencies

The Company maintains professional and general liability, workers’ compensation, automobile liability and health insurance with 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. General and professional liability has a self-insured retention of $1.0 million per claim and $2.0 million in the aggregate. Above these limits the Company carries additional coverage. 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 coverage above the retention. The Company purchases both aggregate and specific stop loss insurance as protection against extraordinary claims liability for health insurance claims. Stop loss insurance covers any claims in the aggregate that exceed 120% of expected claims liability as well as any individual claims that exceed $250,000. Expected claims liability is determined by an outside consultant broker based on historical claims experience.

Beginning November 1, 2005, the first $1.0 million per claim and $2.0 million in the aggregate of professional and general liability risk has been transferred to and funded into the Company’s wholly owned subsidiary captive insurance company. The accounts of the captive insurance company are fully consolidated with those of the other operations of the Company in the accompanying financial statements.

The Company issued approximately $24.0 million in standby letters of credit as of March 31, 2006 related to the Company’s workers’ compensation insurance coverage. These letters of credit are secured by the senior revolver in the event the letters of credit are drawn upon.

From time to time, the Company is involved in litigation in the operation of its business. The Company reserves for costs related to contingencies when a loss is probable and the amount is reasonably estimable. While the Company believes its provision for legal contingencies is adequate, the outcome of the legal proceedings is difficult to predict and the Company may settle legal claims or be subject to judgments for amounts that differ from its estimates.

8.   Other Significant Events

On March 22, 2006, the Company entered into an agreement and plan of merger (the “Merger Agreement”) with NMH Holdings, LLC (“Purchaser”) and NMH Mergersub, Inc., a wholly-owned subsidiary of Purchaser (“PurchaserSub”). Purchaser is owned by NMH Investments, LLC, the sole member of which is Vestar Capital Partners V, L.P. The Merger Agreement has been approved by the Company’s stockholders and the merger is currently expected to close in June of 2006.

The Merger Agreement contemplates that PurchaserSub will be merged with and into the Company, and each outstanding share of common stock of the Company will be converted into the right to receive cash. At the effective time of the merger, each outstanding option to purchase the Company’s common stock will be converted into the right to receive cash, less the amount of the applicable exercise price.

11

Consummation of the merger is subject to various customary conditions, including the expiration or termination of the required waiting period under the Hart Scott Rodino Antitrust Improvements Act, the absence of certain legal impediments to the consummation of the merger, the performance in all material respects of the Company’s and Purchaser’s obligations under the Merger Agreement and the representations and warranties being true and correct except as would not reasonably be expected to have a material adverse effect.

Purchaser has obtained equity and debt financing commitments for the transactions contemplated by the Merger Agreement which are subject to customary conditions.

As a result of the planned merger, the principal items relating to the merger that are expected to affect the Company’s financial statements include the following:

·The Company expects to refinance its existing Senior Secured Term B Loan and Senior Secured Revolving Credit Facility.

·The Company expects to commence a tender offer and consent solitication with respect to the outstanding 9 5/8 % Senior Subordinated Notes due 2012 of the Company’s wholly-owned subsidiary, National Mentor Inc. An offer to purchase and related materials regarding the tender offer and consent solitication will be furnished to the holders at the appropriate time.

·Remaining unamortized deferred financing costs of approximately $7.2 million related to the Company’s existing bank debt and 9 5/8% Senior Subordinated Notes are expected to be expensed on an accelerated basis through the date of closing.

·The new debt financing in an estimated amount of $515.0 million is expected to be incurred consisting of a new senior secured credit facility as well as a new issue of subordinated notes.

·Unvested stock options will become vested at the date of the merger in accordance with the provisions of the stock option agreements. The Company will incur compensation expense related to stock options exercised in connection with the merger. The difference between the fair value of the underlying stock and the related stock option exercise price is estimated at $26.6 million.

·Merger related costs of $599 have been incurred as of March 31, 2006. The Company expects to incur additional transaction costs.

9.   Pending Acquisition

The Company entered into a purchase agreement for approximately $21.0 million, excluding earnest provisions, to acquire the assets of a leading provider of cost effective, highly sophisticated sub-acute services for catastrophically ill or injured patients in non-institutional, residential settings. This acquired company specializes in rehabilitative nursing care for adult and pediatric patients who have traumatic brain or spinal cord injuries, pulmonary or neuromuscular disorders or congenital anomalies. The Company expects this acquisition to close in the third quarter.

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

The following discussion provides an assessment of our results of operations, liquidity and capital resources and should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this document.

Overview

Founded in 1980, we are a leading provider of home and community-based services to individuals with mental retardation and other developmental disabilities, at-risk youth and persons with acquired brain injury. As of March 31, 2006, we provided our services to approximately 21,000 clients in 32 states through approximately 15,500 full-time equivalent employees. Most of our services involve residential support, typically in single-family or small group home settings, designed 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 government agencies, as well as smaller amounts from private-sector insurers, mostly in our acquired brain injury business. For the three and six months ended March 31, 2006, we generated $191.5 million and $375.8 million of net revenues, respectively.

The largest part of our business is the delivery of services to individuals with mental retardation or a developmental disability (MR/DD). The MR/DD services we provide include residential support, vocational services, day habilitation and case management. We also provide a variety of services to children with severe emotional, developmental and behavioral disorders, medical complexities and youth under the auspices of the juvenile justice system, all of whom we refer to as at-risk youth (ARY). Our ARY services include family-based services designed to support family preservation and family reunification, as well as case management, adoption assistance and education services. The remaining services we provide are post-acute services to individuals with acquired brain injury (ABI). These services include neurorehabilitation, neurobehavioral rehabilitation and assisted living services.

Our service lines do not represent operating segments per SFAS 131 as management does not internally evaluate the operating performance or review the results of the service lines to assess performance or make decisions about allocating resources. Also, discrete financial information is not available by service line at the level necessary for management to assess the performance or make resource allocation decisions.

We operate our business as one human services reporting segment organized into three divisions, an Eastern Division, a Central Division and a Western Division.

Our fiscal year ends September 30. We refer to the fiscal year ended September 20, 2006 as “fiscal 2006”.

On March 22, 2006, National Mentor Holdings, Inc. (the “Company”) entered into an agreement and plan of merger (the “Merger Agreement”) with NMH Holdings, LLC (“Purchaser”) and NMH Mergersub, Inc., a wholly-owned subsidiary of Purchaser. Purchaser is owned by NMH Investments, LLC, the sole member of which is Vestar Capital Partners V, L.P. The Merger Agreement has been approved by the Company’s stockholders and the merger is currently expected to close in June of 2006. A copy of the Merger Agreement is attached as Exhibit 2.1 to this quarterly report on Form 10-Q.

Factors Affecting our Operating Results

Demand for Home and Community-Based Human Services

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

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Demographic trends have a particular impact on our MR/DD business. Increases in the life expectancy of MR/DD individuals, we believe, have resulted in steady increases in the demand for MR/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 MR/DD population in need of services and, therefore, the amount of residential and non-residential MR/DD programs offered by governments in our markets. In addition, the “baby boom echo” in the early 1990s suggests a similar positive impact on the size of the ARY populations in our markets.

Political trends can also affect our operations. In particular, budgetary restraints and lobbying from client advocacy groups can influence the overall level of funding and the preferred settings for many of the services we provide. For example, pressure from 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. Furthermore, we believe that successful lobbying by these groups has preserved MR/DD and ARY services, and therefore our revenue base, from significant cutbacks as compared with certain other human services. Historically, many state and county governments have also been direct providers of many of our services, generally in institutions. As a result, our operations often depend not only on the success of our care model, but on governments’ general willingness to outsource these services to for-profit entities such as us, sometimes for the first time.

New Program Starts

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 or geographical expansion in new markets. Much of our growth in existing markets comes in the form of “cross-selling” new services into existing geographic markets. Depending on the nature of the program and the state or county 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.

Acquisitions

As of March 31, 2006, we have completed 35 acquisitions since 1997, 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 strategic acquisitions in markets with significant opportunities. We have also acquired businesses or contracts only insofar as the regulatory environment and our level of expertise would allow us to establish a strong market presence quickly.

Rates and Reimbursement

We derive a majority of our revenues from states, counties or regional government agencies. The payment terms of these contracts vary by jurisdiction and service type, and may be based on flat rates, cost-based reimbursement, per person per diems, 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. For the second quarter, we derived approximately 15% of our revenues pursuant to cost-based reimbursement contracts, under which the billed rate is tied to the underlying costs plus a margin. Insufficient cost levels may require us to return previously received payments after cost reports are filed, although these amounts have historically been insignificant. 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.

Our government payors fund most of their payments to us through Medicaid waiver programs, under which $1 of state funding is matched by federal funding of between $1 and $4. These federal matching funds programs enhance the long-term stability of our revenues, as they provide a strong incentive for state and counties to preserve existing programs, even in periods of budgetary restraint.

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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. As of March 31, 2006, our consolidated days sales outstanding was 42.8 days as compared with 44.9 on September 30, 2005.

Labor and Other Costs

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

We incur no facilities costs for services provided in the home of a Mentor. Additionally since nearly all of our leased group homes are operated under short-term leases, our ability to reduce these fixed occupancy costs is more flexible than larger institutions. As of March 31, 2006, we owned 420 facilities and one office, and we leased 671 facilities and 249 offices.

Expenses incurred in connection with regulatory compliance, liability insurance and third-party claims totaled less than 1.0% and 0.6% of our cost of revenues for the three months ended March 31, 2006 and 2005, respectively, and less than 1.2% and 0.8% for the six months ended March 31, 2006 and 2005, respectively. We have incurred professional liability claims and insurance expense of $0.9 million and $0.4 million for the three months ended March 31, 2006 and 2005, respectively, and $2.2 million and $1.2 million for the six months ended March 31, 2006 and 2005, respectively. We currently self-insure for amounts of up to $1.0 million per claim and $2.0 million in the aggregate. We have additional coverage above these limits.

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Results of Operations

The following table sets forth the components of net income as a percentage of net revenues:

	Three Months				Six Months
	Ended March 31				Ended March 31
	2006		2005		2006		2005
Statement of operations data:
Net revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of revenues	76.2	%	76.0	%	75.8	%	75.9	%
General and administrative expenses	13.3	%	13.5	%	13.7	%	13.3	%
Transaction costs	0.3	%	0.0	%	0.2	%	0.0	%
Depreciation and amortization	2.9	%	3.1	%	2.9	%	3.1	%
Income from operations	7.2	%	7.4	%	7.4	%	7.7	%
Other income (expense)	0.1	%	0.0	%	0.1	%	0.0	%
Interest income	0.1	%	0.0	%	0.1	%	0.1	%
Interest expense	4.1	%	3.9	%	4.0	%	4.8	%
Income before provision for income taxes	3.1	%	3.4	%	3.4	%	2.9	%
Provision for income taxes	1.3	%	1.5	%	1.5	%	1.2	%
Net income	1.8	%	2.0	%	2.0	%	1.7	%

Three months ended March 31, 2006 compared to three months ended March 31, 2005

Net revenues

Net revenues increased by $20.2 million, or 11.8%, from $171.3 million for the three months ended March 31, 2005 to $191.5 million for the three months ended March 31, 2006. Approximately $10.9 million of the increase is as a result of revenue earned from several acquisitions that closed after March 31, 2005. In addition, approximately $1.1 million of the increase is as a result of revenue earned from new programs started after March 31, 2005. The remaining increase was due to census growth in our existing service lines and a 2.26% rate increase in Minnesota, our largest state, which became effective in the first quarter of fiscal 2006.

Cost of revenues

Cost of revenues increased by $15.7 million, or 12.0%, from $130.3 million for the three months ended March 31, 2005 to $146.0 million for the three months ended March 31, 2006. The majority of the $15.7 million increase is due to increases in labor costs. The increase in labor costs consisted of a $9.9 million increase in direct care wages, a $2.0 million increase in payroll taxes and fringe benefits. The increase in wages is mostly attributable to increases in our workforce to provide services for additional clients served. In addition, there was an increase of $1.9 million in rent and other occupancy expenses due to additional homes leased after March 31, 2005.

General and administrative expenses

General and administrative expenses increased by $2.4 million, or 10.5%, from $23.1 million for the three months ended March 31, 2005 to $25.5 million for the three months ended March 31, 2006. Administrative wages increased $1.1 million due to an increase in the number of employees, salary increases, as well as $0.3 million in stock-based compensation expense, which resulted from the adoption of SFAS 123(R) in fiscal 2006. In addition, during the three months ended March 31, 2006, an analysis of our professional and general liability claims resulted in an increase in our reserve of $0.5 million.

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Transaction costs

Transaction costs were $0.6 million in 2006. These costs primarily consist of professional fees paid related to the Company’s pending merger with a subsidiary of Vestar Capital Partners, V, L.P. pursuant to the Merger Agreement.

Interest expense

Interest expense increased $1.1 million from $6.7 million for the three months ended March 31, 2005 to $7.8 million for the three months ended March 31, 2006. This increase was primarily due to approximately $0.7 million in accelerated amortization of deferred financing costs related to the Company’s pending merger and related financing transactions described in Note 8 to the Company’s Unaudited Condensed Consolidated Financial Statements set forth in Part I of this quarterly report on Form 10-Q. Interest expense also increased due to an increase in LIBOR over the prior period.

Provision for income taxes

Provision for income taxes increased $0.1 million from $2.5 million for the three months ended March 31, 2005 to $2.6 million for the three months ended March 31, 2006. The effective tax rate remained consistent, as it only slightly decreased from 43.0% for the three months ended March 31, 2005 to 42.8% for the three months ended March 31, 2006. This decrease in the effective tax rate is due to changes in the legal entity structure of operating subsidiaries.

Six months ended March 31, 2006 compared to six months ended March 31, 2005

Net revenues

Net revenues increased by $35.7 million, or 10.5%, from $340.1 million for the six months ended March 31, 2005 to $375.8 million for the six months ended March 31, 2006. Approximately $16.7 million of the increase is as a result of revenue earned from several acquisitions that closed after March 31, 2005. In addition, approximately $1.9 million of the increase is as a result of revenue earned from new programs started after March 31, 2005. The remaining increase was due to census growth in our existing service lines and a 2.26% rate increase in Minnesota, our largest state, which became effective in the first quarter of fiscal 2006.

Cost of revenues

Cost of revenues increased by $27.0 million, or 10.5 %, from $258.0 million for the six months ended March 31, 2005 to $285.0 million for the six months ended March 31, 2006. The majority of the increase is due to a $19.1million increase in direct care wages, a $1.6 million increase in payroll taxes and fringe benefits, and a $0.6 million increase in payments to Mentors. The increase in wages is mostly attributable to increases in our workforce to provide services for additional clients served. Cost of revenues also increased due to a $3.6 million increase in rent and other occupancy expenses related to more homes leased after March 31, 2005.

General and administrative expenses

General and administrative expenses increased by $6.1 million, or 13.3 %, from $45.4 million for the six months ended March 31, 2005 to $51.5 million for the six months ended March 31, 2006. The majority of the increase is due to labor costs. The increase in labor costs consisted of a $2.5 million increase in administrative wages due to an increase in the number of employees, salary increases, as well as $0.3 million in stock-based compensation expense, which resulted from the adoption of SFAS 123(R) in fiscal 2006.  In addition, during the six months ended March 31, 2006, an analysis of our professional and general liability claims resulted in an increase in our reserve of $1.1 million. General and administrative expenses also increased due to an increase of $0.6 million in professional services primarily related to various corporate initiatives including our Sarbanes-Oxley compliance project, as well as information technology projects.

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Transaction costs

Transaction costs were $0.6 million in 2006. These costs primarily consist of professional and legal fees paid related to the Company’s pending merger with a subsidiary of Vestar Capital Partners V, L.P. pursuant to the Merger Agreement.

Interest expense

Interest expense decreased $1.4 million from $16.4 million for the six months ended March 31, 2005 to $15.0 million for the six months ended March 31, 2006. The decrease was primarily due to $2.8 million of one-time interest expense charges recorded in the six months ended March 31, 2005, resulting from a charge of $1.3 million related to the acceleration of amortization for deferred financing costs from the prior senior credit facility and $1.5 million related to a pre-payment fee on our prior senior credit facility. This decrease is offset by an increase of approximately $0.7 million recorded in the six months ended March 31, 2006 for the accelerated amortization of deferred financing costs related to the Company’s pending merger and related financing transactions described in Note 8 to the Company’s Unaudited Condensed Consolidated financial statements set forth in Part I of this quaterly report on Form 10-Q.

Provision for income taxes

Provision for income taxes increased $1.3 million from $4.2 million for the six months ended March 31, 2005 to $5.5 million for the six months ended March 31, 2006. Although the effective tax rate decreased from 43.0% for the six months ended March 31, 2005 to 42.4% for the six months ended March 31, 2006, provision for income taxes increased due to higher income before provision for income taxes. This decrease in the effective tax rate is due to changes in the legal entity structure of operating subsidiaries.

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 the aforementioned cash requirements.

Net cash provided by operating activities was $24.4 million and $6.7 million for the six months ended March 31, 2006 and 2005, respectively. Cash provided by operating activities for the six months ended March 31, 2005 included payments associated with the refinancing that occurred on November 4, 2004. Certain deferred compensation plans were terminated and funds were distributed in the amount of $4.3 million in the six months ended March 31, 2005. In addition, in connection with the repayment of the subordinated notes payable in fiscal 2005, accrued interest of $13.5 million was paid. Excluding these items related to the prior year refinancing, net cash provided by operating activities was $24.5 million for the six months ended March 31, 2005. The operating activities for the six months ended March 31, 2006 includes an increase in accrued payroll and related costs primarily due to an increase in the health insurance accrual of $5.3 million. The health insurance accrual increased as we did not prepay health claims into the Voluntary Employee Beneficiary Association (VEBA) at March 31, 2006 as we had done as of September 30, 2005. In addition, operating cash related to accounts receivable decreased in the six months ended March 31, 2006 primarily due to the build up of approximately $4.0 million in accounts receivable related to the AHS Florida acquisition that occurred at the end of January.

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Net cash used in investing activities was $14.7 million and $6.1 million for the six months ended March 31, 2006 and 2005, respectively. The primary investing components are cash paid for acquisitions, purchases of property and equipment and cash proceeds from the sale of property and equipment. Cash paid for acquisitions for the six months ended March 31, 2006 of $8.8 million includes the acquisition of four companies engaged in behavioral health and human services. The majority of the $8.8 million is due to the acquisition of AHS Florida for approximately $8.4 million in cash in January 2006. We spent $6.2 million in capital expenditures for both the six months ended March 31, 2006 and 2005. Capital expenditures for both periods are primarily related to building improvements, vehicles and computer equipment.

Net cash used in financing activities for the six months ended March 31, 2006 and 2005 was $9.4 million and $8.1 million, respectively. The activity for the six months ended March 31, 2005 is primarily due to the refinancing transaction on November 4, 2004. In addition to the refinancing activities, we made scheduled debt maturity payments in accordance with our term loan facilities of $1.7million and $0.9 million for the six months ended March 31, 2006 and 2005, respectively. Also, we paid an additional $5.8 million of our outstanding term B loan in the six months ended March 31, 2006. This amount was calculated in accordance with a provision in the senior credit agreement requiring the prepayment of a portion of the outstanding term loan amount at any year-end equal to one-half of a calculated amount if we generate certain levels of cash flow. We also incurred and paid approximately $0.4 million in costs for the six months ended March 31, 2006 in connection with the exchange offer for the senior subordinated notes and $8.9 million in costs for the six months ended March 31, 2005 primarily related to the refinancing transaction. In addition, for the six months ended March 31, 2006, we paid approximately $1.5 million to repurchase 66,121.91 shares of common stock from a member of our management team who retired on October 1, 2005.

Our principal sources of funds are cash flows from operating activities and available borrowings under the senior credit facilities. We believe that these funds will provide sufficient liquidity and capital resources to meet the 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. The availability under the $80.0 million revolving facility is reduced by outstanding letters of credit totaling approximately $24.0 million. As of March 31, 2006, the availability under this facility was $56.0 million.

Commitments Summary

Information concerning our contractual obligations and commitments follows (in thousands):

Payments Due by Period
Twelve Months Ending March 31

	Total		2007		2008- 2009		2010- 2011		2012 and Thereafter
Long-term debt	$	323,522	$	6,397	$	4,142	$	84,314	$	228,669
Operating leases	81,615		25,564		31,867		16,770		7,414
Standby letters of credit	23,986		23,986		—		—		—
Total obligations and commitments	$	429,123	$	55,947	$	36,009	$	101,084	$	236,083

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 of America (GAAP). The preparation of financial statements in 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 will inevitably differ from our estimates. These differences could be material to the financial statements.

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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. Historically, our application of accounting policies has been appropriate, and actual results have not differed materially from those determined using necessary estimates.

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. We follow Staff Accounting Bulletin (SAB) 104, Revenue Recognition, 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 and types of costs being 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 record a liability for such excess payments. At the end of the contract period, any balance of excess payments is maintained as a liability for reimbursement 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. To date, we have not encountered any rate-setting changes of significance.

Accounts Receivables

Accounts receivable primarily consist of amounts due from government agencies, not-for-profit providers, and commercial insurance companies. An estimated allowance for doubtful accounts receivable 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 income statement in the period of the change in estimate.

Reserves for Self-Insurance

We self-insure a substantial portion of our health, workers compensation, auto and professional and general liability (“PL/GL”) programs. We record expenses related to claims on an incurred basis, which includes maintaining fully developed reserves for both reported and unreported claims. The reserves for the health and workers compensation, auto and PL/GL programs may be based on analysis performed internally by management or actuarially determined estimates by independent third parties. While we believe that the estimates of reserves are adequate, the ultimate liability may be greater or less than the aggregate amount of reserves recorded. Reserves relating to prior periods are continually reevaluated and increased or decreased based on new information. As such, these changes in estimates are recorded as charges or credits to the income statement in a subsequent period of the change in estimate.

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Goodwill and 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-lived 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-lived 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 1st, 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-lived intangibles is less than the carrying value of the asset, an impairment charge would be recorded in the income statement in the period of the change in estimate.

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. Under FAS 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.

Legal Contingencies

From time to time, we are involved in litigation 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 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.

Forward-Looking Statements

These statements relate to future events or our future financial performance. In some cases, forward-looking statements can be identified 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.

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, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. All written and oral forward-looking statements made in connection with this report which are 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.

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The information in this report is not a complete description of our business or the risks associated with an investment in the 95¤8% senior subordinated notes due 2012. 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 which could cause actual results to differ materially from those estimated by us include, but are not limited to, those factors or conditions described under “Risk Factors.”

ITEM 3.Quantitative and Qualitative Disclosures about Market Risk

Although we are exposed to changes in interest rates as a result of our outstanding variable rate debt, we do not currently utilize any derivative financial instruments related to our interest rate exposure. At March 31, 2006, we had variable rate debt outstanding of $170.5 million compared to $178.0 million outstanding at September 30, 2005. The variable rate debt outstanding relates to the term loan, which has an interest rate based on LIBOR plus 2.50% or Prime plus 1.50%, the revolver, which has an interest rate based on LIBOR plus 3.25% or Prime plus 2.25%, and 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, 2006, would increase interest expense approximately $1.7 million annually.

ITEM 4.Controls and Procedures

As of the end of the period covered by this report, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15 (e) and 15d-15 (e) promulgated under the Securities Exchange Act of 1934) was evaluated by our management, with the participation of our Chief Executive Officer and our Chief Financial Officer. Our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective, as of the end of the period covered by this report.

There were no changes in our internal control over financial reporting that occurred during our second fiscal quarter (the quarter ended March 31, 2006) 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

Information regarding legal proceedings is incorporated by reference from Note 7 to the condensed consolidated financial statements set forth in Part I of this quarterly report on Form 10-Q.

ITEM 1A.Risk Factors

Risks Related to Our Business

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

During the six months ended March 31, 2006, we derived a majority of our revenues from contracts with state and local governments. These government 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 percent to more than 77 percent 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, as well as economic, industry, political and other factors, could cause governments to limit spending, which could significantly reduce our revenues, margins and profitability and adversely affect our growth strategy. Federal, state and local government 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 have experienced budgetary pressures from time to time and, during these times, some of these states have initiated service reductions, rate freezes and/or rate reductions.

The nature of our operations could subject us to substantial litigation.

We are in the human services business and therefore we have been and continue to be subject to claims alleging we, our Mentors or our employees failed to provide proper care for a client, as well as claims for negligence or intentional misconduct, including 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 pay substantial amounts of money to respond to regulatory investigations or defend against civil lawsuits and, if we do not prevail, in damages, settlement amounts or penalties arising from these legal proceedings. An award 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. We also are subject to potential lawsuits under a federal whistleblower statute 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 including wrongful discharge or discrimination, a violation of equal employment law and novel intentional tort claims.

Many of our contracts with state and county government agencies are subject to audit and modification by the payors.

We derive virtually all of our revenues from state and local government agencies, and a substantial portion of these revenues are state-funded with federal Medicaid matching dollars. As a result of our participation in these government funded programs, we are often 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 government payors may, at their discretion, be entitled to:

·terminate or modify our existing contracts;

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·suspend or prevent us from receiving new contracts or extending existing contracts because of violations or suspected violations of procurement laws or regulations;

·impose referral holds on us;

·impose fines, penalties or other sanctions on us;

·reduce the amount we are paid under our existing contracts; and/or

·require us to refund amounts we have previously been paid.

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 any proceedings will have a material adverse effect on our results of operations or significantly harm our reputation, we cannot assure you that similar actions in the future will not do so.

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 we do not have enough costs 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 or necessity” of costs in our service 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. 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.

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 for persons with developmental disabilities and their families 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, obtain new contracts, 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.

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 county 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 some of 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 provisions of human services; or the failure of our facilities to abide by the applicable building, health and safety codes and ordinances. We have had some of our licenses or certifications temporarily suspended in the past. 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 terminations. Any of these events could have a material adverse effect on our operations.

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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 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 increase potential penalties in certain of our businesses if we fail to comply with these privacy and security standards. Furthermore, future regulation or legislation affecting our programs may require us to change our operations significantly or incur increased costs.

Expenses incurred under federal, state and local government 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 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.

Our variable cost structure is directly related to our labor costs, which may be adversely affected by labor shortages.

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 limited availability 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 changes in client service models, such as the trends toward supported living and managed care. Some of our operating units have incurred higher labor costs in certain markets from time to time because of difficulty in hiring 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 and outside clinical consultants. In part to help with the challenge of recruiting and retaining direct care employees, we offer these employees a full benefits package that includes paid time off, health insurance, dental insurance, vision coverage, life insurance and a 401(k) plan, and these costs are significant. Only 15% 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. For those contracts where we do not operate under a cost-reimbursement model, we may not be able to pass along these costs, including increased labor costs, to third parties through an increase in our rates, which could have a material adverse affect on our margins and profitability.

We face substantial competition in attracting and retaining experienced personnel, and we may be unable to 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 highly qualified and experienced social service professionals who possess the skills and experience necessary to deliver high quality services to our clients. These employees are in great demand and are likely to remain a limited resource for the foreseeable future. Contractual requirements and client needs determine the number, education and experience levels of social service professionals we hire. Our ability to attract and retain employees with the requisite 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.

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If we fail to establish and maintain relationships with officials of 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. These relationships also enable us to provide informal input and advice to the government agencies prior to the development of a “request for proposal” or program for privatization of social services and enhance our chances of procuring contracts with these payors. 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-solicit 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.

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. Moreover, 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.

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 large, national organizations, including publicly traded companies. 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.

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 MR/DD client Medicaid eligibility and service authorization procedures are often complicated and burdensome, and delays can result from, among other reasons, 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 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 increase potential for bad debts. We can provide no assurance that we will be able to maintain our current levels of collectibility 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.

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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 with MR/DD in smaller, community-based settings and increasing the percentage of individuals with MR/DD served by non-governmental providers. The continuation of these trends and our future success is subject to a variety of political, economic, social and legal pressures, virtually 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 5.5% of our revenues for the six months ended March 31, 2006 were derived from contracts with subsidiaries of Alliance Health and Human Services, Inc. or “Alliance,” an independent not-for-profit organization that has a license or contract from several state or 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 by organizations other than non-for-profit organizations. 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 have interpreted 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 further 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, it could have a material adverse effect on our business, financial condition and operating results. In addition, our relationship with Alliance could change if state or local governments change their policy regarding the awarding of contracts to non-profit or proprietary providers.

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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 regulations of the Internal Revenue Service governing tax-exempt entities. If Alliance fails to comply with the laws and regulations of the states in which it operates or with the rules of the Internal Revenue Service, 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 would be harmed if Alliance lost its contracts and was therefore unable to continue to contract with us.

Changes in federal, state and local reimbursement policies 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. If we do not receive or cannot negotiate increases in reimbursement rates at approximately the same time as our costs of providing services increase, 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 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 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 and 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.

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

We receive substantially all of our clients from third-party referrals. 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.

We conduct a significant percent 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 this state.

For the six months ending March 31, 2006, approximately 18% of our revenue was 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. 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.

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. In addition, we expect that we will need to further develop our financial and managerial controls and reporting systems to accommodate future growth. This could 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 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.

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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 integrating the acquired operations, including information systems and accounting controls;

·operating efficiencies, synergies, economies of scale and cost reductions may not be achieved 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 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 may become highly leveraged; and

·the culture of the acquired business may not match well with our culture.

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.

We are controlled by our principal equityholder, which has the power to take unilateral action and we are currently undergoing a change in control.

Madison Dearborn controls our business affairs and policies. Circumstances may occur in which the interests of Madison Dearborn could be in conflict with the interests of the holders of the 95¤8% senior subordinated notes due 2012. In addition, Madison Dearborn 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 holders of the notes. See “Item 12. Security Ownership of Principal Shareholders and Management” and “Item 13. Certain Relationships and Related Transactions” in our annual report on Form 10-K for the year ended September 30, 2005. We are currently undergoing a change in control transaction. See also Note 8 to the Company’s Unaudited Condensed Consolidated financial statements set forth in Part I of this quaterly report on Form 10-Q. A failure to consummate this transaction could have a material adverse effect on our financial condition and results of operations.

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

None.

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ITEM 3.       Defaults Upon Senior Securities

None.

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

Shortly after the execution of the Merger Agreement, dated as of March 22, 2006, by and among National Mentor Holdings, Inc., NMH Holdings, LLC and NHM Mergersub, Inc., a majority of the stockholders of National Mentor Holdings, Inc. adopted a written consent in lieu of a stockholders’ meeting approving the Merger Agreement.

ITEM 5.       Other Information

None.

ITEM 6.       Exhibits

(a) Exhibits

Exhibit No.	Description
2.1	Agreement and Plan of Merger, dated as of March 22, 2006, by and among National Mentor Holdings, Inc., a Delaware corporation, NMH Holdings, LLC, a Delaware limited liability company, and NMH Mergersub, Inc., a Delaware corporation.
3.1	Certificate of Incorporation of National MENTOR Holdings, Inc. (the “Company”) (incorporated by reference to the Company’s Registration Statement on Form S-4, Registration No. 333-129179, filed on October 21, 2005).
3.2	By-Laws of National MENTOR Holdings, Inc. (incorporated by reference to the Company’s Registration Statement on Form S-4, Registration No. 333-129179, filed on October 21, 2005).
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 on May 15, 2006.

NATIONAL MENTOR HOLDINGS, INC.
/s/	EDWARD M. MURPHY
By:	Edward M. Murphy
Its:	President and Chief Executive Officer
/s/	JOHN W. GILLESPIE
By:	John W. Gillespie
Its:	Executive Vice President, Chief Financial Officer and Treasurer

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