UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

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

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

NATIONAL MENTOR HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

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

Securities Registered Pursuant to Section 12(b) of the Act:
None.

Securities Registered Pursuant to Section 12(g) of the Act:
None.

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

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No þ

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

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

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

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

The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of March 31, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, was zero.

As of December 22, 2009, there were 100 shares of the registrant’s common stock, $0.01 par value, issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: None.

 

 

TABLE OF CONTENTS

PART I
Item 1. Business			4
Item 1A. Risk Factors			10
Item 1B. Unresolved Staff Comments			19
Item 2. Properties			19
Item 3. Legal Proceedings			19
Item 4. Submission of Matters to a Vote of Security Holders			19
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			20
Item 6. Selected Financial Data			22
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 7A. Quantitative and Qualitative Disclosures about Market Risk			32
Item 8. Financial Statements and Supplementary Data			32
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			32
Item 9A. Controls and Procedures			33
Item 9A(T). Controls and Procedures			33
Item 9B. Other Information			35
PART III
Item 10. Directors, Executive Officers and Corporate Governance			35
Item 11. Executive Compensation			38
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			50
Item 13. Certain Relationships and Related Transactions, and Director Independence			51
Item 14. Principal Accounting Fees and Services			54
PART IV
Item 15. Exhibits and Financial Statement Schedules			55
Signatures			56
Exhibit 10.9
Exhibit 10.10
Exhibit 10.11
Exhibit 10.12
Exhibit 10.13
Exhibit 10.16
Exhibit 10.17
Exhibit 10.19
Exhibit 10.21
Exhibit 21
Exhibit 31.1
Exhibit 31.2
Exhibit 32

FORWARD-LOOKING STATEMENTS

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

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

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

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changes in Medicaid funding or changes in budgetary priorities by state and local governments;

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our significant amount of debt, our ability to meet our debt service obligations and our ability to incur additional debt;

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current credit and financial market conditions;

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legal proceedings;

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the size of our self-insurance accruals and changes in the insurance market that affect our ability to obtain coverage at reasonable rates;

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our ability to control operating costs and collect accounts receivable;

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our ability to maintain, expand and renew existing services contracts and to obtain additional contracts;

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our ability to attract and retain experienced personnel, including members of our senior management team;

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our ability to acquire new licenses or to maintain our status as a licensed service provider in certain jurisdictions;

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government regulations and our ability to comply with such regulations or the interpretations thereof;

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our ability to establish and maintain relationships with government agencies and advocacy groups;

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increased or more effective competition;

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changes in reimbursement rates, policies or payment practices by our payors;

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changes in interest rates;

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successful integration of acquired businesses; and

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possible conflict between the interests of our majority equity holder and those of the holders of our notes.

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

PART I

Item 1. Business

Company Overview

We are a leading provider of home and community-based human services to adults and children with intellectual and/or developmental disabilities, acquired brain injury and other catastrophic injuries and illnesses; and to youth with emotional, behavioral and medically complex challenges. Since our founding in 1980, we have grown to provide services to approximately 24,000 clients in 35 states.

We design customized service plans to meet the unique needs of our clients in home- and community-based settings. Most of our services involve residential support, typically in small group home or host home settings, designed to improve our clients’ quality of life and to promote client independence and participation in community life. Our services include day programs, vocational services, case management, early intervention, family-based services, post-acute treatment and neurorehabilitation services, among others. Our customized services offer our clients, as well as the payors for these services, an attractive, cost-effective alternative to human services provided in large, institutional settings.

Our services are offered through a variety of models, including (i) small group homes, most of which house six people or fewer, (ii) host homes, or the “Mentor” model, in which a client lives in the home of a trained Mentor, (iii) in-home settings, in which we support clients’ independence with 24-hour services in their own homes, (iv) non-residential settings, consisting primarily of day programs and periodic services in various settings and (v) educational settings, in which we offer in-school, after-school and alternative educational services.

As of September 30, 2009, we provided our services through approximately 16,600 full-time equivalent employees, as well as approximately 4,400 independently contracted host home caregivers, or Mentors. We derive more than 90% of our revenue from state and local government payors. We generated net revenues of approximately $979.4 million, $941.4 million and $887.7 million during fiscal 2009, 2008 and 2007, respectively.

Description of Services by Segment

We previously operated our business in one reportable segment, Human Services, and one Other category. During the fourth quarter of fiscal 2009, we began managing the majority of our services to individuals with acquired brain injuries and other catastrophic injuries and illnesses differently. As a result, we changed the composition of our reportable segments to reflect two reportable segments, Human Services and Post Acute Specialty Rehabilitation Services.

Human Services

We are a leading provider of home and community-based human services to adults and children with intellectual and/or developmental disabilities and to youth with emotional, behavioral and medically complex challenges.

The largest part of our Human Services segment is the delivery of services to adults and children with intellectual and/or developmental disabilities (“I/DD”). Our I/DD programs include residential support, day habilitation, vocational services, case management and personal care. We provide services to these clients through small group homes, Intermediate Care Facilities for the Mentally Retarded (“ICFs-MR”), host homes, in-home settings and non-residential settings. As of September 30, 2009, we provided I/DD services to approximately 13,000 clients in 27 states. For fiscal 2009, our I/DD services generated net revenues of $671.6 million, representing approximately 69% of our net revenues. We receive substantially all our revenues for I/DD services from state and local governmental payors.

Our Human Services segment also includes the delivery of services to youth with emotional, behavioral and medically complex challenges, or at risk youth (“ARY”). Our ARY programs include therapeutic foster care, family reunification, family preservation, early intervention, alternative schools and adoption services. Our individualized approach allows us to work with an ever-changing client population that is diverse demographically as well as in type and severity of condition. We provide services to these clients through host homes, group homes, educational settings and non-residential settings. As of September 30, 2009, we provided ARY services to approximately 10,600 children, adolescents and their families in 21 states. For fiscal 2009, our ARY services generated net revenues of $217.3 million, representing approximately 22% of our net revenues. We receive substantially all our revenues for ARY services from state and local governmental payors.

Post Acute Specialty Rehabilitation Services

Our Post Acute Specialty Rehabilitation Services Segment delivers health care and community-based human services to individuals with acquired brain injuries (“ABI”) and other catastrophic injuries and illnesses. Our ABI services range from post-acute care to assisted independent living and include neurobehavioral rehabilitation, neurorehabilitation, adolescent integration, outpatient and day treatment, and pre-vocational services. Our goal is to provide a continuum of care that allows our clients to achieve the highest level of function possible while enhancing their quality of life. We provide services to these clients primarily through small group homes, in-home settings and non-residential settings. We also provide residential services to catastrophically injured pediatric and adult populations, including some individuals with intensive medical needs, who are slow to recover and are in need of longer-term services. These services are delivered in the community in small- to medium-sized facilities with specialized licensure. As of September 30, 2009, our Post Acute Specialty Rehabilitation Services operations provided services in 14 states and served approximately 500 clients nationally. For fiscal 2009, our Post Acute Specialty Rehabilitation Services operations generated net revenues of $90.5 million, representing approximately 9% of our net revenues. For fiscal 2009, we received approximately 40% of our Post Acute Specialty Rehabilitation Services revenue from state and local governmental payors and approximately 60% from non-public payors.

For additional information, see “Note 18. Segment Information” to the consolidated financial statements.

Industry Overview

The human services industry provides services to people with a range of disabilities and special needs, including adults and children with intellectual and/or developmental disabilities, acquired brain injury and other catastrophic injuries and illnesses; and to youth with emotional, behavioral and medically complex challenges. The market for these services remains highly fragmented, with service providers consisting of not-for-profit organizations, small- or medium-sized proprietary entities and publicly owned entities. Our primary population group, adults and children with intellectual and/or developmental disabilities, is funded primarily through Medicaid, a joint federal and state health insurance program under which eligible state expenditures are matched with federal funding. In addition, funds are also provided by other federal, state and local governmental programs and, to a lesser extent, private payors.

Intellectual and/or Developmental Disabilities

As of 2006, the most recent year for which data is available, approximately 1.6% of the U.S. population, or 4.7 million people, were considered to have I/DD, which is a severe, chronic developmental disability attributable to a mental or physical impairment. These individuals live in supervised residential settings, including institutions, with family caregivers or on their own. In 2006, approximately 536,000 individuals with I/DD received care within a supervised residential setting, representing only 11% of the I/DD population. Approximately 60% of the I/DD population, or approximately 2.8 million individuals, remained in the care of their family and approximately 29%, or 1.4 million individuals, lived independently.

Over the past two decades, the delivery of services to the I/DD population in supervised residential settings has grown significantly and, at the same time, there has been a major shift from institutional settings to home and community-based settings, both in part due to the Americans with Disabilities Act (“ADA”) and the U.S. Supreme Court Olmstead decision in 1999. The U.S. Supreme Court held in its Olmstead decision that under the ADA, states are required to place persons with intellectual disabilities in community settings rather than in institutions when such placement is deemed appropriate by medical professionals, the transfer from institutional care to a less restricted setting is not opposed by the affected individual and the placement can be accommodated taking into account the resources available to the state and the needs of other individuals with intellectual disabilities. We believe that community settings provide a higher quality and, in many cases, lower cost alternative to care provided in state institutions.

Public spending on I/DD services grew from an estimated $30.0 billion in 1998 to an estimated $43.8 billion in 2006, a growth rate of 4.8% per year. Of this $43.8 billion, the majority (approximately 81%) was spent to provide services in non-institutional settings of less than sixteen beds, our target market.

The Home and Community-Based Services (“HCBS”) Waiver program, a Medicaid program where the federal government has waived the requirement that services be delivered in institutional settings, is the primary funding vehicle for home and community-based services. The HCBS Waiver program was instituted as an alternative to the ICF-MR program, described below, authorizing federal reimbursement for a wide variety of community supports and services, including life-skills training, respite care, other family support, case management, supported employment and supported living. In this program, the provider responds to the client’s identified needs and typically is paid on a fee-for-service basis. In 2006, the HCBS waiver program provided approximately $11.1 billion in federal funding to approximately 489,000 individuals.

The Federal ICF-MR Program was established in 1971 when legislation was enacted to provide for federal financial participation for ICF-MR as an optional Medicaid service. This congressional authorization allows states to receive federal matching funds for institutional services that are funded with state or local government dollars. To qualify for Medicaid reimbursement, ICFs-MR must be certified and comply with federal standards in eight areas: management, client protections, facility staffing, active treatment services, client behavior and facility practices, health care services, physical environment and dietetic services.

The ICF-MR program is used by states to support I/DD housing programs in both smaller (up to 16 residents) and larger (16 residents or more) institutional settings. Individuals who live in ICFs-MR receive active treatment. In 2006, the ICF-MR program provided approximately $1.9 billion in federal funding to approximately 42,000 individuals living in public and private ICF-MR settings of up to 16 residents.

We believe that the following factors will continue to benefit the sector, and in particular home- and community-based programs:

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Increasing life expectancy of the I/DD population—The life expectancy of individuals with I/DD increased from 59 years in the 1970s to 66 years in the 1990s and we expect this trend to continue.

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Approximately 2.8 million individuals with I/DD are cared for by a family member, and 25% of their caregivers are age 60 or older. As the caregivers grow older and are not able to provide continuous care, we expect the demand for I/DD services to expand.

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Active Litigation and Advocacy—Individuals with I/DD are supported by active and well-organized advocacy groups. Using legislation prompted by the Olmstead decision, as well as lawsuits filed on behalf of those on waiting lists for services, policy makers, civil rights lawyers, social workers and advocacy groups are forcing states to provide to individuals with I/DD the option to live and receive services in home and community-based settings. In 2007, 66,000 individuals were on formal state waiting lists to receive residential services funded through the HCBS Waiver program, and there are at least 20 active lawsuits advocating for community integration and the reduction of HCBS waiting lists.

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Continued Closure of State Institutions—Although most of the shift from institutions to home and community-based settings has already occurred, the closure of additional state institutions is expected. There were approximately 36,000 individuals in large state institutions in 2007. State governments are still actively working to close many state institutions that remain open, with several institutions identified for downsizing or closure in the coming years. We currently provide services to individuals with I/DD in many of the states that are downsizing, including California, Georgia and Illinois.

At-Risk Youth and Their Families

In 2005, approximately 3.6 million children were reported to child protection authorities as possible victims of abuse and neglect. Approximately 900,000 of these children were confirmed to be maltreated, with only 60% of the children receiving services and support from child welfare systems. Forty percent, or almost 360,000 children, received no services or supports. As a result of abuse or neglect, 317,000 children were removed from their families and placed in foster care during 2005. More than 510,000 children were in foster care at year end, with 46%, or 236,000 children, placed in non-relative foster family homes and only 18% referred to institutions or group homes.

In recent years, the delivery of services to at-risk youth has emphasized support services intended to strengthen families, and keep children from entering foster care. Despite this effort geared toward family preservation, the number of children entering foster care has climbed modestly, from 295,000 in 2002 to 317,000 in 2006.

Similar to I/DD programs, there has been an increased emphasis on home and community-based alternatives for the ARY population. More states are shifting funds to private providers of these services in an attempt to purchase more cost-effective, evidence-based care.

ARY services are funded from a variety of sources, including Title IV-E of the Social Security Act, or The Adoption Assistance and Child Welfare Act of 1980, Medicaid and state and local government appropriations. As of 2006, the most recent year for which data is available, government spending on child welfare programs totaled $22.2 billion, including $4.7 billion in federal payments to states for foster care programs.

Post Acute Specialty Rehabilitation Services

The Post Acute Specialty Rehabilitation Services market includes adults and children with acquired brain injury or other catastrophic injuries and illnesses. The largest portion of our services is provided to adults and children with acquired brain injury.

Acquired brain injury is an important public health problem in the United States. Because the cognitive challenges resulting from brain injuries are often not visible, and because awareness about ABI among the general public is limited, it is frequently referred to as a “silent epidemic.”

In the coming years experts predict a significant unmet need for programmatic and residential options for those who suffer from brain injuries. Currently, 5.3 million people in the U.S. are living with a permanent disability as a result of an ABI. In addition, more than 1.4 million new ABI cases occur each year, with 85,000 resulting in permanent disability.

Both the public and non-public sectors currently finance post acute services for individuals with ABI. Public funding for post acute services for individuals with ABI are provided under state ABI waiver programs that provide access to Medicaid funds for ABI specific care. In recent years, the number of states with ABI waiver programs has been increasing. In 2007, 24 states offered ABI waiver programs, up from 17 states in 1997. In addition, we believe that there has been a push by payors to move from high-cost institution-based settings to lower-cost community-based residential, outpatient and day treatment programs. Significant advocacy efforts are advancing at the federal and state levels to require insurers to pay for rehabilitative treatment for those who suffer a brain injury.

Non-public payors include private insurance companies, workers’ compensation funds and private individuals.

Competitive strengths

We believe that the following competitive strengths have allowed us to achieve and maintain our position as a leading provider of home and community-based services to our target population groups:

National Platform with Diverse Payor and Program Mix. We serve clients in 35 states, which are home to approximately 87% of the United States population, although we do not operate in all regions within those states. We believe that we deliver a level of quality and responsiveness that smaller local service providers are not always able to offer and which has helped us forge strong relationships with state and local agencies. Our extensive history of serving children and adults with a range of challenges and needs has led to the development of operational expertise in quality assurance, customer satisfaction survey implementation and analysis, outcomes measurement and risk management.

Our national platform has also enabled us to implement best practices across our organization and leverage economies of scale in various direct and indirect costs. In addition, our national platform, reputation and knowledge enable us to respond quickly and efficiently to new opportunities. As a result, we have expanded our markets and entered a number of new service areas, including ABI, early childhood autism programs, early intervention programs and non-residential therapeutic schools. Finally, the more than 30 different types of programs that we offer, coupled with our diverse base of state and county payors, stabilize our revenue base and mitigate the impact of changes in public policy, rates or reimbursement policies in any particular state, county or program.

Client-Oriented Care Model. We have the expertise to design customized service plans to meet the unique needs of our clients in community-based settings. We specialize in adapting our service offerings to a wide range of intensities of care and other client requirements, as well as in providing cost-effective services that are accountable to clients, their families and payors. For example, our program for foster children with complex medical conditions includes individual plans of care that address each child’s medical condition, as well as his or her physical and emotional needs. These children are cared for in a Mentor host home with the support of medical professionals, which we believe is better for the development of children and often a less expensive alternative for payors than hospital settings.

Stable Revenue and Strong Cash Flow. The extended length of care for individuals with I/DD, which is the largest part of our Human Services segment, provides us with a stable, recurring base of revenue. Clients with I/DD live in our homes for an average of approximately eight years, and the increased life expectancy of the I/DD population, as described above, is extending the average length of stay in our homes. Life expectancy and the services available for individuals with ABI have also increased as a result of improved medical resources and technology, providing additional stability to our revenue base. Furthermore, our business model has historically required capital expenditures of approximately 2-3% of net revenues per year and has modest working capital needs.

Flexible Cost Structure. We believe that our fixed costs are lower than those of large institutional care providers, enabling us to respond quickly to market developments and regulatory changes. A substantial portion of our caregivers are hourly employees or independently contracted clinicians and Mentors, which allows us to quickly respond to changes in our staffing needs. Our group homes consist of a mix of owned and leased residential real estate. We believe that the structure of our real estate portfolio allows us to respond quickly to changes in our service levels.

Experienced and Committed Management Team and Equity Sponsor. Our management team, having served previously as policy makers, fiscal managers and service providers, has extensive public and private sector experience in human services. Our senior management team has been with us for an average of thirteen years and averages approximately twenty-one years in the human services industry. Members of our management team have helped us to grow our net revenues from $191.3 million in fiscal 1999 to $979.4 million in fiscal 2009 through organic growth and acquisitions. Members of management have helped to integrate 42 acquisitions in the past ten years. The Company’s executive officers have invested approximately $4.2 million in Preferred Units and Class A Units in NMH Investment LLC (“NMH Investment”). In addition, our equity sponsor, Vestar Capital Partners (“Vestar”) has considerable experience making investments in a wide variety of industries, including healthcare.

Our strategy

We believe home and community-based human services that increase client independence and participation in community life while reducing payor costs will continue to grow in market share. We intend to continue to capitalize on these trends, both in existing markets and in new markets where we believe significant opportunities exist. The primary aspects of our strategy include the following:

Continue to Strengthen our Third-Party Payor Relationships. Much of our organic growth in recent years has resulted from the strength of our relationships with state and local government agencies. Our relationships with these payors have enabled us to gain contract referrals and to cross-sell new services into existing markets. We continue to strengthen these relationships by providing quality assurance, reporting and billing programs designed to serve the needs of third-party payors. We seek to position ourselves as the provider of choice to state and local governments and other third-party payors by finding solutions to their most challenging human service delivery problems.

Grow our Census and Expand our Services in New and Existing Markets. We believe that our future growth will depend on our ability to expand existing service contracts and to win new contracts. Our organic expansion activities consist of both new program starts in existing markets and geographical expansion in new markets.

Our new program starts typically require us to fund operating losses for a period of approximately 18-24 months. If a new program start does not become profitable during such period, we may terminate it. During the 12 months ended September 30, 2009, losses on new program starts for programs started within the last 18 months that generated operating losses were $3.7 million.

We also “cross-sell” new services in existing markets. Depending on the nature of the program and the state or local government involved, we will seek new programs through either unsolicited proposals to government agencies or by responding to a request, generally known as a request for proposal, from a public sector agency. We believe that our broad range of services, relationships with third-party payors, reputation for quality care and infrastructure give us the ability to expand the number of clients we serve in a cost-effective manner. We have successfully entered new service lines, including ABI, and program areas, including early childhood autism programs, early intervention and non-residential therapeutic schools. As we continue to strengthen existing services, we will use our clinical skills, personnel and experience to provide new, related services.

Selectively Pursue Acquisitions. We have selectively supplemented our organic growth through acquisitions which have allowed us to penetrate new geographies, leverage our systems, operating costs and best practices, and pursue cross-selling opportunities. We monitor the market nationally for human service businesses that we can purchase at an attractive price and efficiently integrate with our existing operations. We believe we are often seen as a preferred acquiror in these situations due to our experience, relationships, infrastructure and reputation for quality. We intend to continue to pursue acquisitions that are philosophically compatible and can be readily integrated into our existing operations. During fiscal 2009, we acquired four businesses for total consideration of $22.7 million. For additional information on the acquisitions made during fiscal 2009, see note 5 to our consolidated financial statements included elsewhere in this report.

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

Customers and contracts

Our customers, which pay us to provide services to our clients, are governmental agencies, not-for-profit organizations and non-public payors. Our I/DD and ARY services are delivered pursuant to contracts with various governmental agencies, such as departments of mental retardation, juvenile justice and child welfare, for the provision of services. Such contracts may be issued at the county or state level, depending upon the structure of the service system of the state in question. Contracts may cover a range of individuals such as all children referred for host home services in a county or a particular set of individuals who will share group living arrangements. Contracts are sometimes issued for specific individuals, where rates are individually determined based on need. Although our contracts generally have a stated term of one year and generally may be terminated without cause on 60 days’ notice, the contracts are typically renewed annually if we have complied with licensing, certification, program standards and other regulatory requirements. As provider of record, we contractually obligate ourselves to adhere to the applicable federal and state regulations regarding the provision of services, the maintenance of records and submission of claims for reimbursement under Medicaid.

During fiscal 2009 and 2008, revenue from our contracts with state and local governmental payors in the states of Minnesota, California, Florida, West Virginia and Indiana, our five largest revenue-generating states, comprised 42% of our net revenue. Revenue from our contracts with state and local governmental payors in the state of Minnesota, our largest state, accounted for 16% of our net revenue for both fiscal 2009 and 2008.

We have entered into service agreements with Alliance Health and Human Services, Inc. (“Alliance”), an independent, not-for-profit organization, to provide ARY services for states and local governments that prefer or choose not to enter into contracts with for-profit corporations to provide those services. In these cases, Alliance has licenses or contracts with state or local agencies, and we have entered into service agreements with Alliance in Illinois, Ohio and Pennsylvania to provide certain treatment services in local programs for ARY. Approximately 3% of our revenues for fiscal 2009 and 2008 were derived from contracts with Alliance.

Certain Transactions

On June 29, 2006, NMH MergerSub, Inc., a wholly owned subsidiary of NMH Investment, merged with and into the Company, and the Company was the surviving corporation (the “Merger”). Vestar, certain affiliates of Vestar, members of management and certain directors own NMH Investment, and therefore own the Company. In connection with the Merger, we entered into new senior secured credit facilities consisting of a $335.0 million seven-year senior secured term loan facility, a $125.0 million six-year senior secured revolving credit facility, and a $20.0 million seven-year senior secured synthetic letter of credit facility. We also issued $180.0 million of notes, which are guaranteed by our subsidiaries, except for our captive insurance subsidiary and our non-profit subsidiaries. For additional information on this transaction, see note 10 to our consolidated financial statements included elsewhere in this report.

On July 5, 2007, NMH Holdings, Inc. (“NMH Holdings”), our indirect parent company, issued $175.0 million aggregate principal amount of senior floating rate toggle notes. These notes are unsecured and are not guaranteed by the Company or any of its affiliates. NMH Holdings used the proceeds from this offering to pay a dividend to its parent NMH Investment, which was used by NMH Investment to pay a return of capital with respect to its preferred units and to pay fees and expenses related to the offering.

Our Sponsor

Vestar owns approximately 92.5% of our equity and is a leading international private equity firm. Since the firm’s founding in 1988, the Vestar funds have completed over sixty-five investments in companies with a total value of over $30.0 billion. Vestar’s investment in National Mentor Holdings, Inc. was funded by Vestar Capital Partners V, L.P., a $3.7 billion fund which closed in 2005, and an affiliate.

See “Item 13. Certain Relationships and Related Party Transactions, and Director Independence” and “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for additional information.

Item 1A. Risk Factors

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

We derive substantially all of our revenues from contracts with state and local governments. These governmental payors fund a significant portion of their payments to us through Medicaid, a joint federal/state health insurance program through which state expenditures are matched by federal funds ranging from, for federal fiscal year 2010, 65% to more than 82% of total costs, a number based largely on a state’s per capita income. Our revenues, therefore, are determined by the level of federal, state and local governmental spending for the services we provide. Budgetary pressures, particularly during recessionary periods, as well as other economic, industry, political and other factors, could cause the federal and state governments to limit spending, which could significantly reduce our revenues, margins and profitability and adversely affect our growth strategy. Governmental agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If a government agency does not receive an appropriation sufficient to cover its contractual obligations with us, it may terminate a contract or defer or reduce our reimbursement. In addition, there is risk that previously appropriated funds could be reduced through subsequent legislation. Many states in which we operate are experiencing unprecedented budgetary pressures and have implemented or are considering initiating service reductions, rate freezes and/or rate reductions, including the state of Minnesota, where 16% of our revenues are derived, which, in July 2009, enacted a 2.58% rate cut. Similarly, programmatic changes such as conversions to managed care with related contract demands regarding billing and services, unbundling of services, governmental efforts to increase consumer autonomy and reduce provider oversight, coverage and other changes under state Medicaid plans, may cause unanticipated costs and risks to our service delivery. The loss or reduction of or changes to reimbursement under our contracts could have a material adverse effect on our business, financial condition and operating results.

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

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

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

We have a significant amount of indebtedness. As of September 30, 2009, we had total indebtedness of approximately $510.0 million, no borrowings under our senior revolver and $119.0 million of availability under our senior revolver. The senior secured credit facilities also include a $20.0 million synthetic letter of credit facility, all of which has been fully utilized. The availability under our senior revolver was reduced from $125.0 million as $6.0 million of letters of credit in excess of $20.0 million under our synthetic letters of credit facility were outstanding under the senior credit agreement.

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

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it may limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, debt service requirements, acquisitions, and general corporate or other purposes;

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a substantial portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness and will not be available for other purposes, including our operations, future business opportunities and capital expenditures;

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the debt service requirements of our indebtedness could make it more difficult for us to satisfy our financial obligations;

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a portion of our variable interest rate borrowings under the senior secured credit facilities has not been hedged, exposing us to the risk of increased interest rates;

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it may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt and a lower degree of leverage; and

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we may be vulnerable if the current downturn in general economic conditions continues or if there is a downturn in our business, or we may be unable to carry out activities that are important to our growth.

In addition to our indebtedness noted above, our indirect parent company, NMH Holdings had $204.4 million aggregate principal amount of senior floating rate toggle notes due 2014 (the “NMH Holdings notes”) outstanding as of September 30, 2009 (including the $12.3 million of which was held by us). NMH Holdings is a holding company with no direct operations. Its principal assets are the direct and indirect equity interests it holds in its subsidiaries, including us, and all of its operations are conducted through us and our subsidiaries. As a result, NMH Holdings will be dependent upon dividends and other payments from us to generate the funds necessary to meet its outstanding debt service and other obligations, including its obligations on the notes held by us. NMH Holdings has paid all of the interest payments to date on the notes entirely in PIK Interest (defined below) which increased the principal amount by $43.3 million, including the PIK Interest issued to us. NMH Holdings currently expects to elect to make interest payments entirely by increasing the NMH Holdings notes or issuing new notes (“PIK Interest”) through June 15, 2012.

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

In addition to our high level of indebtedness, we have significant rental obligations under our operating leases for our group homes, other service facilities and administrative offices. For the fiscal year ended September 30, 2009, our aggregate rental payments for these leases, including taxes and operating expenses, was approximately $40.8 million. These obligations could further increase the risks described above.

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

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

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

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

Although our employees are generally not unionized, sixteen of our employees were represented by a labor union until September 30, 2009, when our only unionized program closed. Future unionization activities may result in an increase of our labor and other costs. The Employee Free Choice Act (“EFCA”) of 2009 (H.R. 1409) seeks to amend the National Labor Relations Act to make it easier for workers to be represented by labor unions. If the EFCA or a variation of this legislation becomes law, it could result in increased unionization activities. We may not be able to negotiate labor agreements on satisfactory terms with any future labor unions. If employees covered by a collective bargaining agreement were to engage in a strike, work stoppage or other slowdown, we could experience a disruption of our operations and/or higher ongoing labor costs, which could adversely affect our business, financial condition and results of operations.

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

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

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incur additional debt or issue certain preferred shares;

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pay dividends on or make distributions in respect of capital stock or make other restricted payments;

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make certain investments;

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sell certain assets;

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create liens on certain assets to secure debt;

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enter into agreements that restrict dividends from subsidiaries;

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consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

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enter into certain transactions with our affiliates.

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

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

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

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

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

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

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

As of September 30, 2009, we had approximately $19.1 million of floating rate debt outstanding after giving effect to interest rate swaps. As of September 30, 2009, NMH Holdings had $202.9 million of floating rate debt outstanding, net of discount, excluding the debt of its subsidiaries. A 1% increase in the interest rate on our floating rate debt would have increased cash interest expense of the floating rate debt by approximately $0.2 million, and a 1% increase in the interest rate on the NMH Holdings notes would increase NMH Holdings’ interest expense on those notes by approximately $2.0 million. If interest rates increase dramatically, NMH Holdings and the Company and its subsidiaries could be unable to service their debt.

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

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

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

We estimate liabilities associated with workers’ compensation risk and establish reserves each quarter based on internal valuations, third-party actuarial advice, historical loss development factors and other assumptions believed to be reasonable under the circumstances. As reported in Item 7 of this Annual Report on Form 10-K for the fiscal year ended September 30, 2009, in fiscal 2009 we recorded an increased charge for workers’ compensation expense compared to fiscal 2008. Our results of operations have been adversely impacted and may be adversely impacted in the future if actual occurrences and claims exceed our assumptions and historical trends.

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

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

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require us to refund amounts we have previously been paid;

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terminate or modify our existing contracts;

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suspend or prevent us from receiving new contracts or extending existing contracts;

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impose referral holds on us;

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impose fines, penalties or other sanctions on us; and

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reduce the amount we are paid under our existing contracts.

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

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

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

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

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

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

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

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

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

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we may be unable to maintain and renew the contracts of the acquired business;

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unforeseen difficulties may arise in integrating the acquired operations, including information systems and accounting controls;

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we may not achieve operating efficiencies, synergies, economies of scale and cost reductions as expected;

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the business we acquire may not continue to generate income at the same historical levels on which we based our acquisition decision;

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management may be distracted from overseeing existing operations by the need to integrate the acquired business;

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we may acquire or assume unexpected liabilities or there may be other unanticipated costs;

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we may encounter unanticipated regulatory risk;

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we may experience problems entering new markets or service lines in which we have limited or no experience;

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we may fail to retain and assimilate key employees of the acquired business;

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we may finance the acquisition by incurring additional debt and further increase our leverage ratios; and

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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.

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

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

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the failure by our employees or Mentors to properly care for clients;

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the failure to submit proper documentation to the applicable government agency, including documentation supporting reimbursements for costs;

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the failure by our programs to abide by the applicable regulations relating to the provision of human services; or

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the failure of our facilities to comply with the applicable building, health and safety codes and ordinances.

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

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

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

Expenses incurred under governmental agency contracts for any of our services, as well as management contracts with providers of record for such agencies, are subject to review by agencies administering the contracts and services. Representatives of those agencies visit our group homes to verify compliance with state and local regulations governing our home operations. A negative outcome from any of these examinations could increase government scrutiny, increase compliance costs or hinder our ability to obtain or retain contracts. Any of these events could have a material adverse effect on our business, financial condition and operating results.

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

In connection with our internal controls assessment required by the Sarbanes-Oxley Act of 2002 and as reported in Item 9A(T) of this Annual Report on Form 10-K for the fiscal year ended September 30, 2009, we identified material weaknesses in our internal control over financial reporting. Management concluded that as of September 30, 2009, our internal control over financial reporting was not effective and, as a result, our disclosure controls and procedures were not effective. Descriptions of the material weaknesses are included in Item 9A(T) of this Annual Report on Form 10-K. We also reported material weaknesses in our last assessment, for the fiscal year ended September 30, 2008, including a material weakness in controls to verify the existence of our fixed asset balances. In connection with this material weakness, we identified errors during the quarter ended June 30, 2009 which resulted in an adjustment to reduce property and equipment by $1.8 million. While we have taken action and continue to take actions to remediate our identified material weaknesses, our new policies and procedures, when implemented, may not be effective in remedying all of the deficiencies in our internal control over financial reporting. The decentralized nature of our operations and the manual nature of many of our controls make compliance with the requirements of Section 404 and remediation of our material weaknesses especially challenging. The implementation of our new billing and accounts receivable system has affected a number of processes that impact our internal control over financial reporting, and we may identify additional material weaknesses or significant deficiencies in connection with this implementation. A failure to remedy our material weaknesses in internal control over financial reporting could result in material misstatements in our financial statements and could impede an upgrade to our credit rating, even if our creditworthiness otherwise improves. Moreover, any future disclosures of additional material weaknesses, or errors as a result of those weaknesses, may result in a negative reaction in the financial markets if there is a loss of confidence in the reliability of our financial reporting.

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

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

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

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

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

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

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

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

Approximately 3% of our net revenues for the fiscal year ended September 30, 2009 were derived from contracts with affiliates of Alliance, an independent not-for-profit organization that has licenses and contracts from several state and local agencies to provide ARY services.

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

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

The government reimbursement process is time-consuming and complex, and there can be delays before we receive payment. Government reimbursement, group home credentialing and Medicaid recipient eligibility and service authorization procedures are often complicated and burdensome, and delays can result from, among other things, securing documentation and coordinating necessary eligibility paperwork between agencies. These reimbursement and procedural issues occasionally cause us to have to resubmit claims several times before payment is remitted. If there is a billing error, the process to resolve the error may be time-consuming and costly. To the extent that complexity associated with billing for our services causes delays in our cash collections, we assume the financial risk of increased carrying costs associated with the aging of our accounts receivable as well as increased potential for write-offs. We can provide no assurance that we will be able to collect payment for claims at our current levels in future periods. The risks associated with third-party payors and the inability to monitor and manage accounts receivable successfully could have a material adverse effect on our liquidity, cash flows and operating results.

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

For the fiscal year ended September 30, 2009, approximately 16% of our revenues were generated from contracts with government agencies in the state of Minnesota. Accordingly, any reduction in Minnesota’s budgetary appropriations for our services, whether as a result of fiscal constraints due to recession, changes in policy or otherwise, could result in a reduction in our fees and possibly the loss of contracts. Minnesota recently enacted a rate cut of 2.58%, which took effect July 1, 2009, and we cannot assure you that we will not receive further rate reductions in the future. The concentration of our operations in Minnesota also makes us particularly susceptible to many of the other risks described above occurring in this state, including:

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the failure to maintain and renew our licenses;

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the failure to maintain important relationships with officials of government agencies; and

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any negative publicity regarding our operations.

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

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

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

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

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

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

Our primary clients are individuals with developmental disabilities, brain injuries, or emotionally, behaviorally or medically complex challenges, many of whom may be more vulnerable than the general public in a public health catastrophe. For example, in a flu pandemic, such as the 2009 H1N1 pandemic, we could suffer significant losses to our client population and, at a high cost, be required to hire replacement staff and Mentors for workers who drop out of the workforce in very tight labor markets. Accordingly, certain public health catastrophes such as a flu pandemic could have a material adverse effect on our financial condition and results of operations.

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

Vestar controls our business affairs and policies. Circumstances may occur in which the interests of Vestar could be in conflict with the interests of our debt holders. In addition, Vestar may have an interest in pursuing acquisitions, divestitures or other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to our debt holders. Vestar is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Vestar may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as investment funds associated with or designated by Vestar continue to own a significant amount of our equity interests, even if such amount is less than 50%, Vestar will continue to be able to significantly influence or effectively control our decisions.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

Our principal executive office is located at 313 Congress Street, Boston, Massachusetts 02210. We operate a number of facilities and administrative offices throughout the United States. As of September 30, 2009, we provided services in 405 owned facilities and 905 leased facilities, as well as in homes owned by our Mentors. We also own two offices and lease 280 offices. We believe that our properties are adequate for our business as presently conducted and we believe we can meet requirements for additional space by extending leases that expire or by finding alternative space.

Item 3. Legal Proceedings

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

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

See “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information.

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

Not applicable.

PART II

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

Market Information

We are an indirect wholly owned subsidiary of NMH Investment. Accordingly, there is no public trading market for our common stock.

Stockholders

There was one owner of record of our common stock as of December 1, 2009.

Dividends

During the second quarter of fiscal 2009, we paid a dividend of $7.0 million to NMH Holdings, LLC (“Parent”), which used the proceeds of the dividend to make distributions to NMH Holdings. NMH Holdings used the proceeds of the distribution to repurchase approximately $13.9 million in aggregate principal amount of the NMH Holdings notes.

During the fourth quarter of fiscal 2009, we paid a dividend of $1.05 million to Parent, which used the proceeds of the dividend to make a distribution to NMH Holdings, which in turn used the proceeds of the distribution to pay a dividend of $1.05 million to NMH Investment. NMH Investment used the proceeds of the dividend to make a contribution to its wholly owned subsidiary ESB Holdings, LLC, which is an affiliate. ESB Holdings, in turn, used the proceeds to reimburse us for certain expenses we had incurred on its behalf in connection with exploring a strategic initiative.

We do not plan to pay any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on then-existing conditions, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors our board of directors deems relevant. In addition, our current financing arrangements limit the cash dividends we may pay in the foreseeable future.

Equity Compensation Plan Information

The following table lists the number of securities of NMH Investment available for issuance as of December 1, 2009 under the NMH Investment, LLC Amended and Restated 2006 Unit Plan, as amended. For a description of the plan, please see note 19 to the consolidated financial statements included elsewhere in this report.

										Number of Securities Remaining
										Available for Future Issuance
		Number of Securities to be				Weighted-Average				under Equity Compensation
		Issued Upon Exercise of				Exercise Price of				Plans (excluding Securities
		Outstanding Options				Outstanding Options				Reflected in Column (a))
Plan Category		(a)				(b)				(c)
Equity compensation plans approved										Preferred Units: 8,427.66
by security holders										A Units: 92,126.61
										B Units: 12,201.44
										C Units: 12,800.58
										D Units: 23,176.43
			N/A				N/A			E Units: 3,187.00
Equity compensation plans not approved by security holders			N/A				N/A			N/A
TOTAL			—				—			Preferred Units: 8,427.66
										A Units: 92,126.61
										B Units: 12,201.44
										C Units: 12,800.58
										D Units: 23,176.43
										E Units: 3,187.00

Unregistered Sales of Equity Securities

No equity securities of the Company were sold during fiscal 2009; however, the Company’s indirect parent, NMH Investment, did sell equity securities during this period.

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

Dates		Title of Securities		Amount				Purchasers		Consideration
January 8, 2009		Class A Common Units			6,200.00			One director and one executive officer		$	62,000.00
		Class B Common Units			4,990.33					$	249.52
		Class C Common Units			5,236.60					$	157.10
		Class D Common Units			5,547.68					$	55.48
		Class E Common Units			3,188.00					$	159.40
March 27, 2009		Class B Common Units			1,732.50			Certain employees		$	86.63
		Class C Common Units			1,818.00					$	54.54
		Class D Common Units			1,926.00					$	19.26
April 7, 2009		Class A Common Units			12,500.00			One employee		$	125,000.00
		Class B Common Units			5,513.56					$	275.68
		Class C Common Units			5,788.72					$	173.66
		Class D Common Units			6,136.19					$	61.36

Repurchases of Equity Securities

No equity securities of the Company were repurchased during the fourth quarter of fiscal 2009; however, NMH Investment did repurchase equity securities during this period.

The following table sets forth information in connection with repurchases made by NMH Investment of its common equity units during the quarterly period ended September 30, 2009:

														(d) Maximum Number (or
										(c) Total Number of				Approximate Dollar Value)
										Units Purchased as				of Shares (or Units) that
		(a) Class and								Part of Publicly				May Yet be Purchased
		Total Number of				(b) Average Price				Announced Plans				Under the Plans or
		Units Purchased				Paid per Unit				or Programs				Programs
Month #1 (July 1, 2009 through		1,443.75 B Units				$	0.05				—				N/A
July 31, 2009)		1,515.00 C Units				$	0.03				—				N/A
		1,605.00 D Units				$	0.01				—				N/A
Month #2 (August 1, 2009 through		500.00 A Units				$	10.00				—				N/A
August 31, 2009)		2,983.75 B Units				$	0.05				—				N/A
		3,131.00 C Units				$	0.03				—				N/A
		3,317.00 D Units				$	0.01				—				N/A
Month #3 (September 1, 2009 through		3,000.00 A Units				$	10.00				—				N/A
September 30, 2009)		4,427.50 B Units				$	0.05				—				N/A
		4,646.00 C Units				$	0.03				—				N/A
		4,922.00 D Units				$	0.01				—				N/A

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

Item 6. Selected Financial Data

We have derived the selected historical consolidated financial data as of and for the years ended September 30, 2007, 2008 and 2009 from the historical consolidated financial statements of the Company and the related notes included elsewhere in this Annual Report on Form 10-K.

We have derived the selected historical consolidated financial data as of and for the year ended September 30, 2005 and as of and for the periods from October 1, 2005 through June 29, 2006 and from June 30, 2006 through September 30, 2006 from the historical consolidated financial statements of the Company and the related notes not included or incorporated by reference in this Annual Report on Form 10-K.

The selected information below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical consolidated financial statements and notes included elsewhere in this report.

		Predecessor(1)(4)								Successor(4)
						Period From				Period From
						October 1				June 30
		Year Ended				Through				Through				Year Ended
		September 30,				June 29,				September 30,				September 30,
(dollars in thousands)		2005				2006				2006				2007				2008				2009
Statements of Operations Data:
Net revenues		$	674,881			$	564,840			$	203,367			$	887,668			$	941,371			$	979,397
Cost of revenues			509,550				427,530				155,633				670,983				714,980				745,576
Gross profit			165,331				137,310				47,734				216,685				226,391				233,821
General and administrative expenses			90,665				76,230				29,031				118,264				130,941				133,585
Stock option settlement			—				26,880				—				—				—				—
Depreciation and amortization			21,405				17,274				11,621				51,481				51,244				57,770
Transaction costs			—				9,136				—				—				—				—
Income from operations			53,261				7,790				7,082				46,940				44,206				42,466
Management fee to related party			(270	)			(198	)			(227	)			(892	)			(1,349	)			(1,146	)
Other (expense) income, net			(186	)			808				(60	)			(404	)			(873	)			(788	)
Interest income			661				646				256				1,060				684				193
Interest income from related party			—				—				—				—				—				1,202
Interest expense			(30,636	)			(52,311	)			(13,269	)			(50,687	)			(48,947	)			(48,254	)
Income (loss) from continuing operations before income taxes			22,830				(43,265	)			(6,218	)			(3,983	)			(6,279	)			(6,327	)
Provision (benefit) for income taxes			9,734				(11,396	)			(2,346	)			(859	)			(250	)			(2,051	)
Income (loss) from continuing operations			13,096				(31,869	)			(3,872	)			(3,124	)			(6,029	)			(4,276	)
Income (loss) from discontinued operations, net of tax			902				83				208				632				(1,206	)			(1,180	)
Net income (loss)		$	13,998			$	(31,786	)		$	(3,664	)		$	(2,492	)		$	(7,235	)		$	(5,456	)
Balance Sheet Data (at end of period):
Cash and cash equivalents		$	24,707							$	26,511			$	29,373			$	38,908			$	23,650
Working capital(2)			49,190								55,423				57,297				55,878				47,836
Total assets			449,438								1,000,665				1,012,628				1,016,433				995,610
Long-term debt(3)			319,430								517,001				512,300				509,984				502,443
Shareholder’s equity			36,310								248,868				246,031				237,128				223,728

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

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

Overview

Founded in 1980, we are a leading provider of home and community-based human services to adults and children with intellectual and/or developmental disabilities (“I/DD”), acquired brain injury and other catastrophic injuries and illnesses (“ABI”); and to youth with emotional, behavioral and medically complex challenges, or at risk youth (“ARY”). As of September 30, 2009, we provided our services to approximately 24,000 clients in 35 states through approximately 16,600 full-time equivalent employees. Most of our services involve residential support, typically in small group homes, ICFs-MR or host home settings, designed to improve our clients’ quality of life and to promote client independence and participation in community life. Our non-residential services consist primarily of day programs and periodic services in various settings. We derive most of our revenues from state and county governmental payors, as well as smaller amounts from non-public payors, mostly in our ABI services.

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

We previously operated our business in one reportable segment, Human Services, and one Other category. During the fourth quarter of fiscal 2009, we began managing the majority of our services to individuals with acquired brain injuries and other catastrophic injuries and illnesses differently. As a result, we changed the composition of our reportable segments to reflect two reportable segments, Human Services and Post Acute Specialty Rehabilitation Services.

The Human Services segment provides home and community-based human services to adults and children with intellectual and/or developmental disabilities and to youth with emotional, behavioral and medically complex challenges. The Post Acute Specialty Rehabilitation Services segment provides a mix of health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses.

Factors Affecting our Operating Results

Demand for Home and Community-Based Human Services

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

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

Political and economic trends can also affect our operations. In particular, state budgetary pressures, like those currently facing state governments, may influence the overall level of payments for our services, the number of clients and the preferred settings for many of the services we provide. In recent months our government payors in several states have implemented provider rate reductions, including in the states of Arizona, California and Minnesota where we have significant market presence. We cannot be certain whether there will be further rate reductions in the coming months as state governments respond to deteriorating revenue collections.

Historically, pressure from client advocacy groups for the populations we serve has generally helped our business, as these groups generally seek to pressure governments to fund residential services that use our small group home or host home models, rather than large, institutional models. In addition, our ARY service line has historically been positively affected by the trend toward privatization of services. Furthermore, we believe that successful lobbying by these groups has preserved I/DD and ARY services and, therefore, our revenue base, from significant cutbacks as compared with certain other human services. In addition, a number of states have developed community-based waiver programs to support long-term care services for survivors of a traumatic brain injury.

Expansion

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

Organic Growth

We believe that our future growth will depend heavily on our ability to expand existing service contracts and to win new contracts. Our organic expansion activities consist of both new program starts in existing markets and geographical expansion in new markets. Our new program starts typically require us to fund operating losses for a period of approximately 18-24 months. If a new program start does not become profitable during such period, we may terminate it. During the 12 months ended September 30, 2009, losses on new program starts for programs started within the last 18 months that generated operating losses were $3.7 million.

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

Acquisitions

As of September 30, 2009, we have completed 29 acquisitions since 2004, including several acquisitions of rights to government contracts or fixed assets from small providers, which we integrate with our existing operations. We have pursued larger strategic acquisitions in markets with significant opportunities.

Divestitures

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

Net revenues

Revenues are reported net of allowances for unauthorized sales, estimated sales adjustments by business units and changes in the allowance for doubtful accounts. Revenues are also reported net of any state provider taxes or gross receipts taxes levied on services we provide. For the year ended September 30, 2009, we derived more than 90% of our net revenue from state and local government payors. The payment terms and rates of these contracts vary widely by jurisdiction and service type, and may be based on per person per diems, rates established by the jurisdiction, cost-based reimbursement, hourly rates and/or units of service. We bill most of our residential services on a per diem basis, and we bill most of our non-residential services on an hourly basis. Some of our revenues are billed pursuant to cost-based reimbursement contracts, under which the billed rate is tied to the underlying costs. Lower than expected cost levels may require us to return previously received payments after cost reports are filed. In addition, our revenues may be affected by adjustments to our billed rates as well as write-offs of previously billed amounts. Revenues in the future may be affected by changes in rate-setting structures, methodologies or interpretations that may be proposed in states where we operate or by the federal government which provides matching funds. We cannot determine the impact of such changes or the effect of any possible governmental actions.

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

Expenses

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

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

Occupancy costs represent a significant portion of our operating costs. As of September 30, 2009, we owned 405 facilities and two offices, and we leased 905 facilities and 280 offices. We incur no facility costs for services provided in the home of a Mentor.

Expenses incurred in connection with liability insurance and third-party claims for professional and general liability totaled approximately 0.6%, 0.4% and 0.3% of our net revenues for the years ended September 30, 2009, 2008 and 2007, respectively. We have incurred professional and general liability claims and insurance expense for professional and general liability of $5.5 million, $3.5 million and $2.8 million for the years ended September 30, 2009, 2008 and 2007, respectively. We currently insure through our captive subsidiary professional and general liability claims for amounts of up to $1.0 million per claim and up to $2.0 million in the aggregate. Above these limits, we have limited additional third-party coverage. We also insure through our captive subsidiary employment practices liability claims of up to $240,000 per claim and up to $1.0 million in the aggregate.

Our ability to maintain our margin in the future is dependent upon obtaining increases in rates and/or controlling our expenses. In fiscal 2008 and 2009, we invested in our infrastructure initiatives and business process improvements, which had a negative impact on our margin. As we continue to invest in our infrastructure initiatives and business process improvements our margin will continue to be negatively impacted.

Results of Operations

The following table sets forth the percentages of net revenues that certain items of operating data constitute for the periods indicated:

						Post Acute Specialty
For the Year Ended September 30,		Human Services				Rehabilitation Services				Corporate				Consolidated
(in thousands)
2009
Net revenue		$	888,901			$	90,496			$	—			$	979,397
Income (loss) from operations			74,239				10,768				(42,541	)			42,466
Operating margin			8.4	%			11.9	%			—				4.3	%
2008
Net revenue			861,431				79,940				—				941,371
Income (loss) from operations			76,669				10,526				(42,989	)			44,206
Operating margin			8.9	%			13.2	%			—				4.7	%
2007
Net revenue			813,185				74,483				—				887,668
Income (loss) from operations			71,299				12,546				(36,905	)			46,940
Operating margin			8.8	%			16.8	%			—				5.3	%

Fiscal Year Ended September 30, 2009 Compared to Fiscal Year Ended September 30, 2008

Consolidated

Consolidated revenue for fiscal 2009 increased by $38.0 million, or 4.0%, compared to revenue for fiscal 2008. The increase in revenue was primarily related to organic growth of $25.4 million, including growth related to new programs that began operations during fiscal 2008 and 2009. Revenue increased approximately $22.0 million as a result of acquisitions that closed during fiscal 2008 and 2009. Revenue growth was partially offset by a reduction in revenue of approximately $9.4 million from businesses we divested in fiscal 2008 and 2009.

Consolidated income from operations decreased from $44.2 million for fiscal 2008 to $42.5 million for fiscal 2009 while operating margins decreased from 4.7% for fiscal 2008 to 4.3% for fiscal 2009. Operating margin was negatively impacted by an increase in labor costs, primarily due to a $5.5 million increase in workers’ compensation insurance costs, an increase in depreciation and amortization expense of $6.5 million and an increased investment in growth initiatives. The decrease in our operating margin was offset by our on-going cost containment efforts, including a decrease in our overtime costs of $1.7 million.

During fiscal 2009, we recorded a $1.8 million increase to depreciation expense which resulted from disposals of assets that we believe relate to a period or periods prior to 2009. We also reduced the estimated useful life on furniture and fixtures and client home furnishings which resulted in additional depreciation expense of $1.6 million. In addition, depreciation expense increased $1.7 million from fiscal 2008 due to the depreciation on the new billing system.

Loss from discontinued operations, net of tax remained constant at $1.2 million for fiscal 2008 and fiscal 2009. Loss from discontinued operations for fiscal 2009 included $1.4 million of net loss related to the sales of REM Utah and REM Health. Loss from discontinued operations for fiscal 2008 primarily included $1.3 million of net loss related to the sale of our business operations in the state of Oklahoma and the sale of Integrity Home Health Care.

Human Services

Human Services revenue for fiscal 2009 increased by $27.5 million, or 3.2% compared to fiscal 2008. The increase was due to organic growth of $16.9 million, which included growth related to new programs that began operations during fiscal 2008 and 2009. In addition, acquisitions contributed additional revenue growth of $20.0 million. Human Services revenue growth was partially offset by a reduction in revenue of approximately $9.4 million from businesses we divested in fiscal 2008 and 2009.

Operating margin decreased from 8.9% during fiscal 2008 to 8.4% during fiscal 2009. Operating margin was negatively impacted by an increase in labor costs, primarily due to a $4.9 million increase in workers’ compensation insurance costs, as well as an increase in depreciation and amortization expense. The decrease in our operating margin was partially offset by our on-going cost containment efforts, including a decrease in our overtime costs of $1.8 million.

During fiscal 2009, depreciation and amortization expense increased approximately $4.0 million, the majority of which relates to the charges recorded for the disposals of assets that we believe relate to a period or periods prior to 2009 and for the reduction in the estimated useful life on furniture and fixtures and client home furnishings.

Post Acute Specialty Rehabilitation Services

Post Acute Specialty Rehabilitation Services revenue for fiscal 2009 increased by $10.6 million, or 13.2%, compared to fiscal 2008. This increase was primarily due to organic growth of $8.6 million, which included growth related to new programs that began operations during fiscal 2008 and 2009. In addition, acquisitions contributed additional revenue growth of $2.0 million.

Operating margin decreased from 13.2% for fiscal 2008 to 11.9% for fiscal 2009 due to increased investment in growth initiatives.

Corporate

Corporate represents corporate general and administrative expenses. Total corporate expense decreased by approximately $0.5 million from fiscal 2008 to $42.5 million for fiscal 2009. Corporate expense decreased as a result of the $1.05 million of reimbursement received from ESB Holdings, LLC during fiscal 2009. ESB Holdings used the proceeds of a contribution from NMH Investment to reimburse us for certain expenses we had incurred on its behalf in connection with exploring a strategic initiative. In addition, fiscal 2009 corporate expense included a decrease of $0.9 million of stock based compensation expense. Offsetting the decrease in corporate expense was an increase in depreciation expense of approximately $1.7 million from fiscal 2008 primarily due to depreciation on the new billing system.

Fiscal Year Ended September 30, 2008 Compared to Fiscal Year Ended September 30, 2007

Consolidated

Consolidated revenue for fiscal 2008 increased by $53.7 million, or 6.0% compared to revenue for fiscal 2007. The increase in revenue was primarily related to organic growth of $50.4 million, including growth related to new programs that began operations during fiscal 2007 and 2008. Revenue increased approximately $3.9 million as a result of acquisitions that closed during fiscal 2007 and 2008. Revenue growth was partially offset by a reduction in revenue of approximately $0.6 million from businesses we divested in fiscal 2007 and 2008.

Consolidated income from operations for fiscal 2008 was $44.2 million, compared to $46.9 million for fiscal 2007. Consolidated operating margin decreased from 5.3% for fiscal 2007 to 4.7% for fiscal 2008. The decrease in margin was primarily the result of a change in reimbursement policy affecting our business in North Carolina, an increase in investments in growth initiatives and business process improvements and an additional $1.4 million of stock based compensation expense recorded in fiscal 2008.

Other expense, net for fiscal 2008 increased by approximately $0.5 million, or 110%, to $0.9 million. Other expense included losses on disposal of property, equipment and real estate, as well as, market declines of investments held pursuant to the Company’s nonqualified deferred compensation plan.

Interest expense for fiscal 2008 decreased $1.7 million, or 3.4%, to $48.9 million. As a percentage of net revenues, interest expense decreased from 5.7% for fiscal 2007 to 5.2% for fiscal 2008. The decrease in interest expense is due to a decrease in the average debt balance as well as a 0.3% decrease in the weighted average interest rate from fiscal 2007 to fiscal 2008.

Loss from discontinued operations, net of tax for fiscal 2008 was $1.2 million, compared to income from discontinued operations, net of tax of $0.6 million for fiscal 2007. Loss from discontinued operations for fiscal 2008 primarily included $1.3 million of net loss related to the sale of our business operations in the state of Oklahoma and the sale of Integrity Home Health Care. Income from discontinued operations for fiscal 2007 primarily included net income of $0.6 million related to REM Health.

Human Services

Human Services revenue for fiscal 2008 increased by $48.2 million, or 5.9% compared to fiscal 2007. The increase was due mostly to organic growth of $45.0 million, which included growth related to new programs that began operations during fiscal 2007 and 2008. In addition, acquisitions contributed additional revenue growth of $3.8 million. Human Services revenue growth was partially offset by a reduction in revenue of approximately $0.6 million from businesses we divested in fiscal 2007 and 2008.

Operating margin increased from 8.8% during fiscal 2007 to 8.9% during fiscal 2008 despite the negative impact that the change in reimbursement policy had on our business in North Carolina. Operating margin was positively impacted by a $1.4 million decrease in depreciation and amortization expense. In fiscal 2007, the Company recorded a pre tax impairment charge of $1.1 million related to the write-down of agency contracts and the write-off of intellectual property.

Post Acute Specialty Rehabilitation Services

Post Acute Specialty Rehabilitation Services revenue increased by $5.5 million, or 7.3%, compared to fiscal 2007 due to organic growth, which included growth related to new programs that began operations during fiscal 2007 and 2008.

Operating margin decreased from 16.8% for fiscal 2007 to 13.2% for fiscal 2008 primarily due to increased investments in growth initiatives.

Corporate

Corporate represents corporate general and administrative expenses. Total corporate expense increased by approximately $6.1 million from fiscal 2007 to $43.0 million for fiscal 2008 primarily due to increased investments in growth initiatives and business process improvements. Corporate in fiscal 2008 included an additional $1.4 million of stock based compensation expense.

Liquidity and Capital Resources

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

Operating activities

Cash flows provided by operating activities for fiscal 2009 were $59.0 million compared to $53.6 million and $52.8 million for fiscal 2008 and 2007, respectively. The increase from fiscal 2008 to fiscal 2009 was primarily due to an increase in operating income. Our days sales outstanding increased approximately half a day from 45.8 days at September 30, 2008 to 46.2 days at September 30, 2009.

Investing activities

Net cash used in investing activities, primarily consisting of cash paid for acquisitions and purchases of property and equipment, was $62.3 million for fiscal 2009 compared to $39.0 million and $43.2 million for fiscal 2008 and 2007, respectively. Fiscal 2009 included cash deployed for four acquisitions, as well as an earnout payment for CareMerdian, which we acquired in fiscal 2006. In addition, fiscal 2009 included the purchase of $11.5 million of the NMH Holdings notes for $6.6 million. For additional information about this purchase, please see note 13 to the consolidated financial statements included elsewhere in this report.

Cash paid for acquisitions for fiscal 2009 was $33.6 million, which primarily included the earnout payment of $12.0 million associated with the CareMeridian acquisition, the acquisition of Institute for Family Centered Services, Inc. for approximately $11.5 million and the acquisition of Lakeview Healthcare Systems, Inc. for approximately $10.1 million. Cash paid for acquisitions for fiscal 2008 was $14.9 million, which primarily included the acquisition of Transitional Services, Inc. for approximately $9.3 million and the earnout payment of $5.5 million associated with the CareMeridian acquisition. Cash paid for acquisitions for fiscal 2007 was $25.1 million, primarily reflecting the acquisition of six companies engaged in the behavioral health and human services.

Cash paid for property and equipment for fiscal 2009 was $27.4 million, or 2.8% of net revenues, and included $4.4 million related to the purchase of real estate and approximately $2.7 million related to the implementation of a new billing system. Cash paid for property and equipment was $26.1 million, or 2.8% of net revenues, for fiscal 2008 and $19.7 million, or 2.2% of net revenues, for fiscal 2007.

Financing activities

Net cash used in financing activities was $11.9 million for fiscal 2009 compared to $5.0 million and $6.7 million for fiscal 2008 and 2007, respectively. Fiscal 2009 included two dividend payments to Parent for approximately $8.0 million.

During fiscal 2009, we paid a dividend of $7.0 million to Parent, which used the proceeds of the dividend to make distributions to NMH Holdings. NMH Holdings used the proceeds of the distribution to repurchase approximately $13.9 million of the NMH Holdings notes.

Also during fiscal 2009, we paid a dividend of $1.05 million to Parent, which used the proceeds of the dividend to make a distribution to NMH Holdings, which in turn used the proceeds of the distribution to pay a dividend of $1.05 million to NMH Investment. NMH Investment used the proceeds of the dividend to make a contribution to its wholly owned subsidiary ESB Holdings, LLC, which is an affiliate. ESB Holdings, in turn, used the proceeds to reimburse us for certain expenses we had incurred on its behalf in connection with exploring a strategic initiative.

Our financing activities also included the repayment of long-term debt of $3.7 million, $4.0 million and $4.5 million for fiscal 2009, 2008 and 2007, respectively. In addition to our scheduled term B payments, in fiscal 2007, we paid $750 thousand to repurchase the remaining 9⁵/₈% senior subordinated notes due 2012.

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

As mentioned above, our principal sources of funds are cash flows from operating activities and available borrowings under the $125.0 million senior revolver. As of September 30, 2009, the availability on the senior revolver was reduced by $6.0 million to $119.0 million as letters of credit in excess of $20.0 million under our synthetic letters of credit facility were outstanding. For a description of the senior credit facilities, see note 10 in the consolidated financial statements. We believe that these funds will provide sufficient liquidity and capital resources to meet our near term and future financial obligations, including scheduled principal and interest payments, as well as to provide funds for working capital, capital expenditures and other needs for the foreseeable future. No assurance can be given, however, that this will be the case.

Contractual Commitments Summary

The following table summarizes our contractual obligations and commitments as of September 30, 2009:

						Less than												More than
(in thousands)		Total				1 year				1-3 years				3-5 years				5 years
Long-term debt obligations(1)		$	508,178			$	7,415			$	6,700			$	494,063			$	—
Operating lease obligations(2)			140,755				34,553				49,760				27,920				28,522
Capital lease obligations			1,798				118				129				141				1,410
Standby letters of credit			26,049				26,049				—				—				—
Total obligations and commitments		$	676,780				68,135				56,589				522,124				29,932

Inflation

We do not believe that general inflation in the U.S. economy has had a material impact on our financial position or results of operations.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet transactions or interests.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of financial statements in conformity with GAAP requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and the impact of those events cannot be determined with certainty, the actual results may differ from our estimates. These differences could be material to the financial statements.

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

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

Revenue Recognition

Revenues are reported net of any state provider taxes or gross receipts taxes levied on services we provide. Revenues are also reported net of allowances for unauthorized sales and estimated sales adjustments by business units. Sales adjustments are estimated based on an analysis of historical sales adjustments and recent developments in the payment trends in each business unit. Revenue is recognized when evidence of an arrangement exists, the service has been provided, the price is fixed or determinable and collectibility is reasonably assured.

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

Accounts Receivable

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

Accruals for Self-Insurance

We maintain employment practices liability, professional and general liability, workers’ compensation, automobile liability and health insurance with policies that include self-insured retentions. We record expenses related to claims on an incurred basis, which includes estimates of fully developed losses for both reported and unreported claims. The accruals for the health and workers’ compensation, automobile and professional and general liability programs are based on analyses performed internally by management and may take into account reports by independent third parties. Accruals relating to prior periods are periodically reevaluated and increased or decreased based on new information. Changes in estimates are charged or credited to the statement of operations in a period subsequent to the change in estimate.

Goodwill and Indefinite-lived Intangible Assets

We review costs of purchased businesses in excess of net assets acquired (goodwill), and indefinite-life intangible assets for impairment at least annually, unless significant changes in circumstances indicate a potential impairment may have occurred sooner.

We are required to test goodwill on a reporting unit basis, which is the same level as our operating segments. We use a fair value approach to test goodwill for impairment and potential impairment is noted for a reporting unit if its carrying value exceeds the fair value of the reporting unit. For those reporting units that have potential goodwill impairment, we determine the implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, an impairment loss is recorded.

The impairment test for indefinite-life intangible assets requires the determination of the fair value of the intangible asset. If the fair value of the indefinite-life intangible asset is less than its carrying value, an impairment loss is recognized in an amount equal to the difference. Fair values are established using discounted cash flow and comparative market multiple methods. We conduct our annual impairment test on July 1 of each year. 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 indefinite-life intangible assets. If updated calculations indicate that the fair value of goodwill or any indefinite-life intangibles is less than the carrying value of the asset, an impairment charge is recorded in the statement of operations in the period of the change in estimate.

Impairment of Long-Lived Assets

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 using the asset and liability method. 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.

We also recognize the benefits of tax positions when certain criteria are satisfied. We follow the more likely than not recognition threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return.

Stock-Based Compensation

NMH Investment adopted an equity-based compensation plan, and issued units of limited liability company interests pursuant to such plan. The units are limited liability company interests and are available for issuance to our employees and members of the Board of Directors for incentive purposes. For purposes of determining the compensation expense associated with these grants, management valued the business enterprise using a variety of widely accepted valuation techniques which considered a number of factors such as our financial performance, the values of comparable companies and the lack of marketability of our equity. We then used the option pricing method to determine the fair value of these units at the time of grant using valuation assumptions consisting of the expected term in which the units will be realized; a risk-free interest rate equal to the U.S. federal treasury bond rate consistent with the term assumption; expected dividend yield, for which there is none; and expected volatility based on the historical data of equity instruments of comparable companies. The Class B and Class E units vest over a five-year service period. The Class C and Class D units vest over a three-year period based on service and on certain performance and/or investment return conditions being met or achieved. The estimated fair value of the units, less an assumed forfeiture rate, is recognized in expense on a straight-line basis over the requisite service/performance periods of the awards.

Derivative Financial Instruments

We report derivative financial instruments on the balance sheet at fair value and establish criteria for designation and effectiveness of hedging relationships. Changes in the fair value of derivatives are recorded each period in current operations or in shareholder’s equity as other comprehensive income (loss) depending upon whether the derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction.

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

Available-for-Sale Securities

Our investments in marketable debt securities have been classified as available-for-sale securities and, accordingly, are valued at fair value at the end of each reporting period. Unrealized gains and losses arising from such valuation are reported, net of applicable income taxes, in other comprehensive income (loss).

Legal Contingencies

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

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to changes in interest rates as a result of our outstanding variable rate debt. To reduce our interest rate exposure, we entered into interest rate swap agreements whereby we fixed the interest rate on approximately $221.2 million of our $335.0 million term B loan, effective as of August 31, 2006 and maturing on June 30, 2010 and fixed the interest rate on approximately $113.3 million of our remaining $335.0 million term B loan, effective as of August 31, 2007 and maturing on September 30, 2010. In total, as of September 30, 2009, we fixed the interest rate on approximately $309.1 million of our $324.1 term B loan.

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

		September 30, 2009								September 30, 2010
(in thousands)		Swap								Swap
Interest Swap effective date		Value				Rate				Value				Rate
August 31, 2006(1)		$	88,988				5.32	%		$	—				—
August 31, 2007(1)			220,117				4.89	%			—				—
Variable rate debt			15,008				—				320,763				—
Total term B loan		$	324,113				—			$	320,763				—

As a result of the interest rate swap agreements, the variable rate debt outstanding was effectively reduced from $328.2 million outstanding to $19.1 million outstanding as of September 30, 2009. The variable rate debt outstanding relates to the term B loan, which has an interest rate based on LIBOR plus 2.00% or Prime plus 1.00%, the senior revolver, which has an interest rate based on LIBOR plus 2.25% or Prime plus 1.25%, subject to reduction depending on our leverage ratio, and the term loan mortgage, which has an interest rate based on Prime plus 1.50%. A 1% increase in the interest rate on our floating rate debt would increase cash interest expense of the floating rate debt by approximately $0.2 million.

Item 8. Financial Statements and Supplementary Data

Our consolidated financial statements required by this Item are on pages F-1 through F-28 of this report.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

Item 9A. Controls and Procedures

Not applicable.

Item 9A(T). Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC, and is accumulated and communicated to management, including the Chief Executive Officer, President and Chief Financial Officer, to allow for timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. As of September 30, 2009, the end of the period covered by this Annual Report on Form 10-K, our management, with the participation of our Chief Executive Officer, President and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on that evaluation, our Chief Executive Officer, President and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2009, in light of the material weaknesses described below.

(b) Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers, or persons performing similar functions, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Our management, with the participation of the Chief Executive Officer, President and Chief Financial Officer, evaluated the effectiveness of our internal control over financial reporting as of September 30, 2009, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In connection with this evaluation, management identified the material weaknesses described below and, therefore, concluded that our internal control over financial reporting was not effective as of the end of the period covered by this report. We have reported these material weaknesses to our Audit Committee and our independent registered public accounting firm. Management’s evaluation did not include assessing the internal controls of three businesses that were acquired by us in purchase business combination transactions during fiscal 2009, Institute for Family Centered Services, Inc., Lakeview Healthcare Systems, Inc. and Stepping Stones. The combined financial statements of these companies are included in our consolidated financial statements for the fiscal year ended September 30, 2009, and represented approximately 2.0% of our total assets as of September 30, 2009 and 1.1 % of our net revenues for the fiscal year ended September 30, 2009.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. To our knowledge, these material weaknesses have not resulted in any material misstatement of our financial statements. Our material weaknesses relate to our revenue and accounts receivable balances, as detailed below.

Revenue

During the quarter ended September 30, 2009, we continued implementation of our billing and accounts receivable system, which is now being used by the majority of our business. As a result of this system implementation, we have had to redesign certain of our billing processes and controls over revenue. Management anticipated that controls over revenue could deteriorate during this system implementation, potentially increasing our material weaknesses or significant deficiencies in the revenue area. Management has taken steps to strengthen internal controls over revenue, but additional remediation is required, as noted in the first, second and third material weaknesses identified below.

We did not maintain effective controls over the accuracy of revenue and accounts receivable balances and have identified the following material weaknesses as of September 30, 2009.

•

We have insufficient segregation of duties within our new billing and accounts receivable system and insufficient controls to ensure appropriate access to our new billing and accounts receivable system and data. This material weakness increases the risk that erroneous or unauthorized revenue transactions could occur and the risk that they would not be detected on a timely basis if they do occur. Management is currently designing processes and controls to limit system access to appropriate personnel and segregate incompatible duties.

•

We have insufficient controls over the accuracy and validity of the billing rates used to calculate revenues recorded in our consolidated financial statements. We previously addressed this material weakness within our legacy accounts receivable system. However, our new billing and accounts receivable system is not yet able to generate timely reports to identify changes to billing rates for periodic review. Therefore, as of September 30, 2009, we had no control to verify that changes to billing rates entered into the new system were valid and accurate. This control deficiency increases the risk of errors in the invoicing and recording of billings to payors.

•

During the fourth quarter, we completed implementation of our new billing and accounts receivable system, introducing the system and related controls in multiple locations relating to a substantial portion of our revenue. As of September 30, 2009, these controls had not been in place for an adequate period of time for us to determine whether they were operating effectively. Because we were unable to conduct our review and testing of revenue controls for the revenue associated with these new locations, we are unable to conclude that these controls are operating effectively, and there can be no assurance that there are not additional material weaknesses relating to revenue.

The following item was first disclosed in our Form 10-Q for the quarterly period ended December 31, 2007. It has not been fully remediated and continues to exist.

•

We have insufficient controls over revenue recognition and revenue reserves for unauthorized sales. We maintain a revenue recognition policy in accordance with U.S. generally accepted accounting principles. However, we lacked controls to ensure definitive, consistent and documented application of the revenue recognition criteria regarding varying local payor contract requirements, specifically with respect to payor service authorization requirements. During the quarter ended September 30, 2009, management undertook a process to remediate the control design by documenting, reviewing and approving local application of revenue recognition requirements and developing a process to assess contract terms in each state to ensure that revenue recognition criteria are being consistently and appropriately interpreted and applied. However, we continue to have insufficient controls to ensure that all unauthorized sales are identified and reserved appropriately in the consolidated financial statements. Generally, if we provide services without a current, valid authorization from the payor agency to provide those services, revenue associated with the unauthorized services may need to be either reserved until such authorization is received, or ultimately written off if authorization is not granted. Management expects our new billing and accounts receivable system, when remediated, to capture more complete and accurate data related to authorizations, which will improve our controls over identifying and reserving for unauthorized sales.

Fixed Assets

As of December 31, 2007, we identified a material weakness in our internal control over financial reporting related to insufficient controls to verify the existence of our fixed asset balances reflected on our consolidated balance sheet. This material weakness increased the risk of overstating our fixed asset balances. Based on our remediation efforts described below, which we believe have improved our internal control over financial reporting and reduced the likelihood of misstatements that would not be prevented or detected, we have concluded that this material weakness has been corrected as of September 30, 2009.

•

In order to remediate this material weakness, we conducted a physical count of a majority of our fixed asset balances and reviewed their net book value during the period ended September 30, 2009. We identified errors arising from unrecorded disposals in furniture and fixtures and client home furnishings, which resulted in an adjustment to reduce our property and equipment balance by $1.8 million as of June 30, 2009 and to incur related depreciation expense of $1.8 million during the quarter ended June 30, 2009. We also reduced the useful lives of furniture and fixtures and client home furnishings to better reflect their respective usage periods, depreciating the net book value of our fixed assets over a lesser number of years. As a result of this change we incurred additional depreciation expense of $1.6 million during the quarter ended June 30, 2009.

•

We plan to conduct periodic review and counts of a sample of our fixed assets, as determined by management, to support the existence of our fixed asset balances reflected on our consolidated balance sheets.

(c) Changes in Internal Control over Financial Reporting

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

Except for the changes implemented to remediate the material weaknesses noted above and the continued implementation of a new billing and accounts receivable system in a majority of our operations, during the most recent fiscal quarter, there were no significant changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Item 9B. Other Information

Not applicable.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The following table sets forth the name, age and position of each of our directors and executive officers as of December 4, 2009:

Name		Age				Position
Gregory T. Torres			60			Chairman and Director
Edward M. Murphy			62			Chief Executive Officer and Director
Bruce F. Nardella			52			President and Chief Operating Officer
Juliette E. Fay			57			Executive Vice President and Chief Development Officer
Denis M. Holler			55			Executive Vice President, Chief Financial Officer and Treasurer
Hugh R. Jones, III			44			Executive Vice President, Chief Administrative Officer and Assistant Secretary
Linda DeRenzo			50			Senior Vice President, General Counsel and Secretary
Kathleen P. Federico			50			Senior Vice President, Human Resources
John J. Green			50			Senior Vice President of Finance Operations and Assistant Treasurer
Robert A. Longo			47			Senior Vice President and Cambridge Operating Group President
David M. Petersen			61			Senior Vice President and Redwood Operating Group President
James L. Elrod, Jr.			55			Director
Pamela F. Lenehan			57			Director
Kevin A. Mundt			55			Director
Daniel S. O’Connell			55			Director
Guy Sansone			45			Director

Directors are elected at the annual meeting of our sole stockholder and hold office until the next annual meeting or a special meeting in lieu thereof, and until their successors are elected and qualified, or upon their earlier resignation or removal. There are no family relationships between any of the directors and executive officers listed in the table. There are no arrangements or understandings between any executive officer and any other person pursuant to which he or she was selected as an officer.

Gregory T. Torres has served as Chairman of the board of directors since September 2004. He was also the Company’s Chief Executive Officer from January 1996 to January 2005, as well as its President from January 1996 until September 2004. Mr. Torres joined MENTOR in 1980 as a member of its first board of directors. Prior to joining the company, Mr. Torres held prominent positions within the public sector, including chief of staff of the Massachusetts Senate Committee on Ways and Means and assistant secretary of human services. Since May 2007, Mr. Torres has been president and chief executive officer of the Massachusetts Institute for a New Commonwealth (“MassINC”), an independent, nonpartisan research and educational institute in Boston.

Edward M. Murphy has served as Chief Executive Officer since January 2005 and was elected to the Board of Directors in September 2004. He also served as our President from September 2004 until December 4, 2009. Mr. Murphy founded Alliance Health and Human Services in 1999 and served as the organization’s President and CEO until September 2004. Prior to founding Alliance, he was a Senior Vice President at Tucker Anthony and President and Chief Operating Officer of Olympus Healthcare Group. Mr. Murphy is a former Commissioner of the Massachusetts Department of Youth Services and the Massachusetts Department of Mental Health, and the former Executive Director of the Massachusetts Health and Educational Facilities Authority.

Bruce F. Nardella was appointed President and Chief Operating Officer on December 4, 2009, after being appointed Executive Vice President and Chief Operating Officer in May 2007. Mr. Nardella joined MENTOR in 1996 as a state director and in May 2003 he was named President of our Eastern Division. Prior to that, he was a deputy commissioner for the Massachusetts Department of Youth Services.

Juliette E. Fay has served as our Executive Vice President and Chief Development Officer since January 2006, managing national business development. Ms. Fay served as the Senior Vice President of National Business Development and Marketing from January 2002 to January 2006. Before joining MENTOR in 1998, Ms. Fay was the President and CEO of Charles River Health Management, a provider-based managed care company; the director of marketing and business development at the Massachusetts Health and Educational Facilities Authority; chief of staff for the Massachusetts Department of Mental Health; and the assistant commissioner for facility operations at the Massachusetts Department of Youth Services.

Denis M. Holler was appointed Executive Vice President, Chief Financial Officer and Treasurer in May 2007. Mr. Holler was named Senior Vice President of Finance in January 2002 and led the Company’s corporate finance functions through the 2006 purchase by Vestar Capital Partners V, L.P. In addition to overseeing all finance functions of the Company, he manages external relationships with our equity sponsor, banking partners and high-yield investors. Prior to joining MENTOR in October 2000 as Vice President of Financial Operations, Mr. Holler was Chief Financial Officer of the Fortress Corporation.

Hugh R. (Tripp) Jones, III was named Executive Vice President and Chief Administrative Officer in August 2008. Prior to that he served as our Senior Vice President and Chief Administrative Officer beginning in May 2004, and served as Senior Vice President of Public Strategy from February 2003 to May 2004. In his current role, Mr. Jones coordinates corporate and operating group functions with responsibility for human resources, information technology, legal and public strategy. Before joining MENTOR, he co-founded in 1995 and led MassINC. Mr. Jones is a former staff director of the Massachusetts Legislature’s Education Committee and chaired Governor Mitt Romney’s education transition team in 2002.

Linda DeRenzo has served as our Senior Vice President, General Counsel and Secretary since March 2006. Ms. DeRenzo serves as our chief legal officer and oversees the risk management, regulatory compliance, labor and employment and corporate legal functions. An 18-year business law veteran before joining the Company, Ms. DeRenzo represented high-growth companies and their financiers in a variety of industries including information technology, life sciences and health services. Prior to joining MENTOR, Ms. DeRenzo was a partner at Testa, Hurwitz & Thibeault, LLP in Boston from 1992 to 2004.

Kathleen P. Federico joined the Company in December 2008, as our Senior Vice President, Human Resources. From 2005 until joining MENTOR, Ms. Federico served as Senior Vice President, Sales and Human Resources, for World Travel Holdings in Woburn, Massachusetts, and was its Senior Vice President, Human Resources, from 2002 to 2005. Prior to that, she served as Vice President of Human Resources for KaBloom LLC, NE Restaurant Company and Sodexho Marriott Services. Ms. Federico was also Chief Operating Officer for Sheehan Associates, an employee benefits brokerage firm.

John J. Green served as our Senior Vice President of Field Finance from the May 2003 acquisition of REM until being named Senior Vice President of Finance Operations in June 2007. In this role, Mr. Green oversees field finance operations across our operations, and manages the procurement services, payroll services, real estate and leasing management services, reimbursement and field financial reporting and analysis. Mr. Green was previously Controller of REM, having joined REM in April 1986 as Assistant Controller. He is a certified public accountant with 27 years of experience both in public accounting and the human services industry.

Robert A. Longo served as our Senior Vice President and President of our Western Division from May 2003 until being named Cambridge Operating Group President in June 2007. Mr. Longo joined MENTOR in 1993, and has previously held the positions of children’s services program manager, state director and vice president, all managing various operations. Mr. Longo has served on the boards of numerous organizations focused on mental health and human services, including serving for three years on the board of the national Foster Family-Based Treatment Association.

David M. Petersen served as our Senior Vice President and President of our Central Division from May 2003 until being named Senior Vice President and Redwood Operating Group President in June 2007. Prior to joining MENTOR, Mr. Petersen worked for REM since 1972, having managed various operations in Minnesota, Montana, North Dakota and Wisconsin.

James L. Elrod, Jr. joined our board of directors in June 2006. Mr. Elrod is a Managing Director of Vestar Capital Partners, having joined Vestar in 1998. Previously, he was Executive Vice President, Finance and Operations for Physicians Health Service, a public managed care company. Prior to that, he was a Managing Director and Partner of Dillon, Read & Co. Inc. Mr. Elrod is currently a director of Essent Healthcare, Inc., Joerns Healthcare, LLC and Radiation Therapy Services, Inc.

Pamela F. Lenehan was elected to our board of directors in December 2008. Ms. Lenehan has served as President of Ridge Hill Consulting, a strategy and financial consulting firm, since 2002. Prior to this, Ms. Lenehan was self-employed as a private investor. From 2000 to 2001, she was vice president and chief financial officer of Convergent Networks. From 1995 to 2000, she was senior vice president of corporate development and treasurer of Oak Industries Inc. Prior to that, Ms. Lenehan was a Managing Director in Credit Suisse First Boston’s Investment Banking division and a vice president of Corporate Banking at Chase Manhattan Bank. Ms. Lenehan is currently a member of the boards of directors of Spartech Corporation and Monotype Imaging Holdings Inc.

Kevin A. Mundt joined our board of directors in March 2008. He is a Managing Director at Vestar Capital Partners, and is President of the Vestar Resources group. Before joining Vestar in 2004, Mr. Mundt spent 23 years as a strategy and operations consultant specializing in consumer products, retailing and multi-point distribution, as well as healthcare and industrial marketing. For 11 of those years, Mr. Mundt was a strategic adviser to Vestar, and served on the boards of several Vestar portfolio companies. He began his consulting career at Bain and Company, and went on from there to co-found Corporate Decisions, Inc. When that firm was acquired by Marsh and McLennan, Mr. Mundt became a Managing Director of Marsh and McLennan’s financial consulting arm, Mercer Oliver Wyman. Mr. Mundt is currently Chairman of the Board for Solo Cup Company and a Director at Fiorucci Foods, MediMedia and The Sun Products Corp.; companies in which Vestar or its affiliates have a significant equity interest.

Daniel S. O’Connell joined our Board of Directors in June 2006. Mr. O’Connell is the Chief Executive Officer and founder of Vestar Capital Partners, a private equity investment firm founded in 1988. Mr. O’Connell is currently a director of Birds Eye Foods, Inc., St. John Knits International, Inc., Solo Cup Company, Sunrise Medical, Inc., and The Sun Products Corp., companies in which Vestar or its affiliates have a significant equity interest. In addition, Mr. O’Connell is a Trustee Emeritus of Brown University, a member of the Investment Committee of the Brown Endowment, and is Vice Chairman of the Board of Cardinal Spellman High School, Bronx, N.Y.

Guy Sansone was elected to our Board of Directors on December 4, 2009. Mr. Sansone is a Managing Director at Alvarez & Marsal in New York and serves as head of its Healthcare Industry Group. Over the past 19 years, he has invested in and consulted as an executive to numerous companies, focusing on developing and evaluating strategic and operating alternatives designed to enhance value. While at Alvarez & Marsal, Mr. Sansone served as Chief Executive Officer and Chief Restructuring Officer at Saint Vincent Catholic Medical Centers in New York from October 2005 to August 2007 and as interim Chief Financial Officer of HealthSouth Corporation from March 2003 to October 2004, among other positions. He currently serves as Chief Restructuring Officer for Erickson Retirement Communities, which filed for bankruptcy protection in October 2009. Mr. Sansone was a director of Rotech Healthcare, Inc. from March 2002 to August 2005.

Code of Ethics

We have adopted a code of ethics that applies to our directors, officers and employees, including our principal executive officer and our principal financial and accounting officer. The MENTOR Network Code of Conduct is publicly available on our website at www.thementornetwork.com, via a link from our “Network of Quality” page under the tab,“Compliance”. If we make any substantive amendments to the Code, or grant any waiver from a provision of the Code to our principal executive officers, principal financial officer or principal accounting officer, we will disclose the nature of such amendment or waiver on our website or in a report on Form 8-K.

Audit Committee Financial Expert

The Board of Directors has determined that Ms. Lenehan, the chairman of the Company’s audit committee, is an audit committee financial expert. Our securities are not listed on any stock exchange, so we are not subject to listing standards requiring that we maintain an audit committee consisting of independent directors, but Ms. Lenehan would likely qualify as an independent director based on the definition of independent director set forth in Rule 5605(a)(2) of the Nasdaq Stock Market, LLC Listing Rules.

Item 11. Executive Compensation

Compensation Discussion and Analysis

General Overview. The Company is an indirect wholly owned subsidiary of NMH Investment. NMH Investment is beneficially owned by Vestar and certain affiliates, certain of our directors and members of our management team. Daniel O’Connell, James Elrod, Jr. and Kevin Mundt, each an employee of Vestar, are directors of the Company. Pamela F. Lenehan is a director and the Chairman of our Audit Committee. The Company’s Compensation Committee currently consists of Mr. Elrod. Guy Sansone was elected to the Board of Directors effective December 4, 2009, and will begin serving on the Compensation Committee and the Capital Allocation Committee in the second quarter of fiscal 2010.

In connection with the Merger on June 29, 2006, the Company entered into an amended and restated employment agreement with its Chief Executive Officer, Edward Murphy. It also entered into severance agreements with its other executive officers, including Denis Holler, the Company’s Executive Vice President and Chief Financial Officer, Bruce Nardella, the Company’s President and Chief Operating Officer, Juliette Fay, the Company’s Executive Vice President and Chief Development Officer, and Hugh R. Jones III, the Company’s Executive Vice President and Chief Administrative Officer. The compensation paid to the executive officers reflects negotiations at the time of the Merger, with adjustments for Messrs. Holler and Nardella upon their promotions during fiscal 2007, for Mr. Jones upon his promotion during fiscal 2008 and for Mr. Nardella upon his promotion on December 4, 2009. As of September 30, 2009, the Company’s executive officers have invested approximately $4.2 million in the Preferred Units and Class A Common Units of NMH Investment.

Following the Merger, in January 2007, certain members of the Company’s management, including the executive officers, were awarded grants of Class B, Class C and Class D Units in NMH Investment. Messrs. Holler and Nardella were awarded additional grants of Class B, Class C and Class D Units following their promotions in fiscal 2007. The Company’s executive officers were awarded additional grants of Class B, Class C and Class D Units in fiscal 2008, and Mr. Jones was awarded an additional grant of Class B, Class C and Class D Units following his promotion in fiscal 2008. Throughout this analysis, Messrs. Murphy, Holler, Nardella and Jones and Ms. Fay are referred to as the “named executive officers”.

Compensation Policies and Practices. The primary objectives of our executive compensation program are to:

•

attract and retain top executive talent;

•

achieve accountability for performance by linking annual cash and long-term equity incentive awards to achievement of measurable performance objectives; and

•

align executives’ incentives with equity value creation.

Our executive compensation programs are designed to encourage our executive officers to operate the business in a manner that enhances equity value. The primary objective of our compensation program is to align the interests of our executive officers with our equityholders’ short- and long-term interests. This is accomplished by awarding a substantial portion of our executives’ overall compensation based on our financial performance, specifically growth in earnings before interest, taxes, depreciation and amortization, or EBITDA (with certain adjustments). We also have provided a significant portion of our executive officers’ compensation through equity-based awards. Our compensation philosophy provides for a direct relationship between compensation and the achievement of our goals and seeks to include management in upside rewards.

We seek to achieve an overall compensation program that provides foundational elements such as base salary and benefits that are generally competitive with our industry, as well as an opportunity for variable incentive compensation that comprises a substantial portion of an executive officer’s annual compensation in order to drive the Company’s achievement of performance goals.

The Company’s executive compensation program is overseen by the Compensation Committee (the “Committee”) of the Company’s Board of Directors. The role of the Committee is, among other things, to review and approve salaries and other compensation of the executive officers of the Company, to review and recommend equity grants under NMH Investment’s equity plan, and to review and approve the annual cash incentive plan for all employees, including the executive officers.

Elements of Compensation. Each element of the executive compensation program works to fulfill one or more of the objectives of the program. The elements of our compensation program are as follows:

•

base salary;

•

annual cash bonus incentives;

•

long-term incentive compensation in the form of equity-based units;

•

deferred compensation;

•

severance and change-in-control benefits; and

•

other benefits.

Our base salary structure is designed to recognize the contributions of our senior management team. Our annual bonuses are designed to reward executive officers for achievement of annual objectives tied to growth in EBITDA (with certain adjustments). Our equity component of compensation, in the form of equity units in NMH Investment, is designed to reward equity value creation. During fiscal 2008, at the direction of the Committee and consistent with its philosophy to provide competitive total compensation, the Company engaged an outside consultant to perform a market analysis of the total compensation paid to our executive officers compared to executive officers in comparable organizations. The study was suspended prior to its completion, as a determination was made that it would be inappropriate to adjust executive compensation until such time as the Committee was expanded and in light of the deterioration in the general economic environment after the study was initiated. The Board is currently evaluating the size and membership of the Committee, and the Committee may re-initiate this study at such time as this evaluation is complete. Set forth below is a description of each element, including why we have chosen to pay the element, how we determine the amount to be paid and how each compensation element and our decisions regarding how the element fits into our overall compensation objectives.

Base Salary. Base salary provides executives with a fixed amount of compensation paid on a regular basis throughout the year. The Committee’s charter charges the Committee with reviewing and determining each executive’s base salary on an annual basis. The named executive officers’ base salaries were reviewed in connection with the closing of the Merger. In connection with the promotions of Messrs. Holler and Nardella in fiscal 2007, Mr. Holler’s salary increased from $220,000 to $275,000 and Mr. Nardella’s salary increased from $225,000 to $275,000, to reflect their increased duties. In connection with Mr. Jones’s promotion in fiscal 2008, his salary increased from $238,200 to $275,000, commensurate with the salary of the Company’s other executive vice presidents. Mr. Nardella’s salary increased from $275,000 to $302,500 effective with his election to president on December 4, 2009. The promotions and increases were reviewed and approved by the Committee. Factors considered in increasing these base salaries included the new level and scope of responsibilities and a comparison with the base pay of the Company’s other executive officers. The named executive officers’ base salaries were reviewed again in September 2008 and September 2009 as required by the Committee’s charter, and they were left unchanged.

Annual Incentive Compensation. In addition to base salary, each named executive officer participates in an annual cash incentive plan, which constitutes the variable, performance-based component of an executive’s cash compensation. The objective of this element of executive compensation is to drive individual performance and the achievement of organizational goals. The plan provides the executive officers with the opportunity to earn significant annual cash bonuses. The annual incentive plan for fiscal 2009 was structured to provide incentive compensation based upon the Company’s attainment of certain financial targets for the applicable fiscal year, which were approved by the Compensation Committee, and individual performance on quality. For fiscal 2009, the incentive compensation payout opportunity for Messrs. Holler, Nardella and Jones and Ms. Fay was 25 percent of base salary at the threshold performance level, 50 percent at target level and 75 percent at the maximum level. Mr. Murphy’s amended and restated employment agreement entitles him to 50 percent, 100 percent and 150 percent at the threshold, target and maximum levels, respectively. For fiscal 2010, Mr. Nardella’s incentive compensation payout opportunity will be 37.5 percent, 75 percent and 112.5 percent at the threshold, target and maximum levels, respectively.

The achievement of the payout targets is challenging. For the named executive officers to receive any payout, the Company must achieve a minimum threshold of 92.5% of its adjusted EBITDA and revenue goals. For the named executive officers to receive their maximum payout, the Company must achieve at least 107.5% of its adjusted EBITDA and revenue goals. Payouts for performance levels between threshold and maximum are calculated based upon pro-ration/interpolation. Under the terms of the plan, the incentive compensation is calculated by first determining potential incentive compensation based on the achievement of the goals for EBITDA (weighted 75%) and revenue (weighted 25%). This initial amount can be reduced by 10% for failure to achieve the free cash flow goal, and by up to 100% for the failure to meet individual quality goals. It can also be increased from a discretionary pool, if any, that arises when there are reductions under the Plan for failure to meet goals. In November 2008, the Committee approved the following financial targets for fiscal 2009: adjusted EBITDA of approximately $115 million, revenue of approximately $997 million and free cash flows of $24.5 million. The Committee chose these targets as profitability continues to be a major objective of the Company, while the focus on revenue is meant to incentivize management to expand the Company’s overall business and not just its EBITDA. Free cash flows are essential to repay debt and fund the Company’s growth and investment in infrastructure, and quality is central to our mission and vital to ensure that profitability is achieved only through delivery of safe and effective services.

This year, the Company fell short of meeting its financial goals, achieving only 92.8% of the adjusted EBITDA goal and 97.7% of the revenue goal. The Company achieved its goal for free cash flows. As a result, the named executive officers were eligible to receive 61% of the payout that was achievable had the targets been met.

Equity-Based Compensation. Long-term incentive compensation is provided in the form of non-voting equity units in the Company’s indirect parent company, NMH Investment, pursuant to the NMH Investment 2006 Unit Plan. The plan allows certain officers, employees, directors and consultants of the Company to participate in the long-term growth and financial success of the Company through acquisition of equity interests in NMH Investment, including Class B, Class C, Class D and Class E Common Units of NMH Investment. The purpose of the plan is to promote the Company’s long-term growth and profitability by aligning the interests of the Company’s management with the interests of the ultimate parent of the Company and by encouraging retention. A pool of units was set aside for all employees, including the named executive officers, as part of the Merger and granted during the second quarter of fiscal 2007. Messrs. Holler and Nardella received grants of B, C and D units during fiscal 2007 in recognition of their promotions. NMH Investment granted additional B, C and D units to the executive officers, including the named executive officers, during the fourth quarter of fiscal 2008, and Mr. Jones received an additional grant of B, C and D units in September 2008 in recognition of his promotion.

The B units time vest over 61 months. Assuming continued employment of the employee with the Company, 40 percent vest at the end of 37 months from the measurement date, and the remaining 60 percent vest monthly through the end of 61 months from the measurement date. Assuming continued employment, the C and D units time vest after three years, although the value of the C and D units depends on the achievement of certain financial targets for fiscal 2007, fiscal 2008 and fiscal 2009. Those financial targets are Targeted Adjusted EBITDA, Targeted Organic Adjusted EBITDA Growth Rate and Targeted Adjusted Net Debt (Maximum). Each of the financial targets must be met in a specified fiscal year for the holder to earn one-third of the class of units with respect to that year. As set forth in the table below, the targets with respect to the C units were achieved for fiscal 2007, 2008 and 2009, and the targets with respect to the D units were achieved for fiscal 2007.

										Targeted				Actual
										Organic				Organic				Targeted				Actual				Was each
		Targeted				Actual				Adjusted				Adjusted				Adjusted				Adjusted				of the
		Adjusted				Adjusted				EBITDA				EBITDA				Net Debt				Net Debt				financial
		EBITDA				EBITDA				Growth				Growth				(Maximum)				(Maximum)				targets		Vesting
		(in millions)				(in millions)				Rate				Rate				(in millions)				(in millions)				met?		result
Fiscal 2007
C units		$	92.2			$	106.1				3.0	%			8.9	%		$	495.9			$	491.8			Yes		1/3 C units
D units			105.0				106.1				5.0				8.9				515.2				491.8			Yes		1/3 D units
Fiscal 2008
C units			98.4				108.8				3.0				3.4				488.7				474.9			Yes		1/3 C units
D units			110.9				108.8				5.0				3.4				490.0				474.9			No		—
Fiscal 2009
C units			106.4				111.8				N/A				0.0				483.7				455.6			Yes		1/3 C units
D units			114.4				111.8				5.0				0.0				482.0				455.6			No		—

These financial targets were chosen for the C and D units because profitability, organic growth of the business and appropriate leverage are critical to the Company’s long-term profitability and equity value. They are designed to motivate management to achieve financial results that would enhance the valuation of the Company upon a sale of the Company or other liquidity event. The specific levels of the financial targets with respect to the C and D units were negotiated between management and Vestar and reflect their agreement about how any increase in equity value would be divided among Vestar and management upon a liquidity event. For fiscal 2009, given the deterioration of the general economic environment and the national recession, the Compensation Committee deemed it appropriate to waive the Targeted Organic Adjusted EBITDA Growth Rate with respect to the C units, and NMH Investment, LLC approved this recommendation.

In all cases, vesting depends upon continued employment. If an executive’s employment is terminated, NMH Investment may repurchase the executive’s units. The units will be purchased for the initial purchase price, or “cost”, fair market value or a combination of the two, depending on the circumstances of departure and based on the relevant measurement date, as set out in the table below. The relevant measurement date for all units held by the named executive officers is June 29, 2006, the date of the Merger, except for the units issued upon Mr. Holler’s and Mr. Nardella’s promotions, for which the relevant measurement date is May 22, 2007, and the units issued upon Mr. Jones’s promotion, for which the relevant measurement date is August 1, 2008.

		B units		B units		C and D units		C and D units		All units
Circumstances of departure		Termination without cause, or resignation for good reason		Resignation without good reason		Termination without cause, or resignation for good reason		Resignation without good reason		Termination for cause
1-12 months after relevant measurement date		Cost		Cost		Fair market value		Cost		Cost
13-36 months after relevant measurement date		Portion at fair market value increases ratably each month, from 20.00% to 59.10%		Cost		Fair market value		Cost		Cost
37-60 months after relevant measurement date		Portion at fair market value increases ratably each month, from 60.80% to 99.90%		Portion at fair market value increases ratably each month, from 40.00% to 99.94%		Fair market value		Fair market value		Cost
61 months or later after relevant measurement date		Fair market value		Fair market value		Fair market value		Fair market value		Cost

The plan is administered by the Compensation Committee which recommends awards to the management committee of NMH Investment. The management committee determines, among other things, specific participants in the plan as well as the amount and value of any units awarded. In recommending the equity grants for the executive officers, the Compensation Committee considered and adopted the recommendations of Mr. Murphy regarding allocations to the executive officers. Mr. Murphy’s recommendations were based on each executive officer’s position and level of responsibility relative to the other executive officers.

Deferred Compensation. Under the National Mentor Holdings, LLC Executive Deferred Compensation Plan, the named executive officers receive an allocation to their account based on a percentage of base salary, as follows: Mr. Murphy, 13%; and Messrs. Holler, Nardella and Jones and Ms. Fay, 11%. Effective with his election to president on December 4, 2009, Mr. Nardella receives an allocation of 12%. These allocations are made as of the end of the plan year, December 31, for service rendered during the prior fiscal year. However, the Company elected to suspend these allocations for the 2009 plan year in light of current economic conditions. The balances accrue interest at a rate set prior to the beginning of the plan year. The interest rate for plan years 2009, 2008 and 2007 was 6%. The plan is an unfunded, nonqualified deferred compensation arrangement, which provides deferred compensation to senior management. We may make discretionary contributions to the plan, although we did not do so in fiscal 2009, 2008 or 2007. A participant’s account balance is 100% vested and non-forfeitable and will be distributed to a participant following his or her retirement or termination from the Company, disability, death or at the Company’s direction under certain circumstances.

A 401(k) plan is available to eligible employees, including the named executive officers. Under the plan, we may make an annual discretionary matching contribution and/or profit-sharing contribution. To supplement the 401(k) plan, the National Mentor Holdings, LLC Executive Deferral Plan is available to highly compensated employees (as defined by Section 414(q) of the Internal Revenue Code), including the named executive officers. Participants may contribute up to 100 percent of salary and/or bonus earned during the plan year. This plan is a nonqualified deferred compensation arrangement and is coordinated with our 401(k) plan so as to maximize a participant’s contributions and the Company’s matching contributions to the 401(k) plan, with the residual remaining in the Executive Deferral Plan. Distributions are made upon a participant’s termination of employment, disability, death, retirement or at a time specified by the participant when he or she makes a deferral election. Participants can elect to have distributions made in a lump sum or in monthly installments over a five-year period. A specific-date election may be made only in a lump sum. We have established a grantor trust to accumulate assets to provide for the obligations under the plan. Any assets of the grantor trust are subject to the claims of our general creditors.

Severance and Change-in-Control Benefits. As part of the Merger, the Company entered into an amended and restated employment agreement with Mr. Murphy and entered into severance agreements with each of the other named executive officers. Each of these agreements provides for severance benefits to be paid to the named executive officer if the Company terminates his or her employment without “cause” or he or she resigns for “good reason”, each as defined in the applicable agreement. See “—Severance Agreements”.

If any of the named executive officers is terminated without cause, or he or she resigns for good reason, depending upon the timing of his or her departure, he or she would be entitled to receive a higher purchase price for his or her B, C and D units, compared with if he or she terminated employment voluntarily, as described above under “Equity-Based Compensation”. Under each executive officer’s management unit subscription agreement, NMH Investment has the right to repurchase the units at a blend of cost and fair market value, depending on the circumstances of the executive officer’s departure, including the date of departure. Fair market value is as determined in good faith by the management committee of NMH Investment (valuing the Company and its subsidiaries as a going concern, disregarding any discount for minority interest or marketability of the units).

In addition, upon a change in control of the Company any unvested B units will vest immediately, and any unvested C and D units may vest if certain investment return conditions are met. The Company believes that such accelerated vesting could align the interests of the named executive officers with the interests of the indirect parent of the Company in the event of a sale of the Company by encouraging the named executive officers to remain with the Company and enhancing their focus on the Company during a sale of the Company.

Other Benefits. The named executive officers are entitled to participate in group health and welfare benefits on the same basis as all regular, full-time employees. These benefits include medical, dental, vision care, flexible spending accounts, term life insurance, short-term and long-term disability insurance and an employee assistance program. In addition, all employees, including the executive officers, have the option of purchasing supplemental group term life insurance for themselves as well as coverage for their spouses and dependent children.

Compensation Committee Report

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management. Based on that review and discussion, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.

Respectfully submitted,

James L. Elrod, Jr.

Fiscal 2009 Summary Compensation Table

														Non-Equity				Nonqualified
														Incentive				Deferred
										Equity				Plan				Compensation				All Other
Name and Principal		Fiscal				Salary				Awards				Compensation				Earnings				Compensation				Total
Position		Year				($)(b)				($)(c)				($)(d)				($)(e)				($)(f)				($)
Edward M. Murphy			2009				350,000				70,329				213,755				1,511				19,523				654,758
President and Chief Executive Officer(a)			2008				350,000				123,624				205,719				466				53,615				733,424
			2007				350,000				60,918				155,275				1,865				53,459				621,517
Denis M. Holler			2009				275,000				65,810				83,975				784				14,376				439,944
Executive Vice President and			2008				275,000				111,602				84,352				323				36,610				507,887
Chief Financial Officer			2007				239,039				57,742				122,002				32,948				29,754				481,485

														Non-Equity				Nonqualified
														Incentive				Deferred
										Equity				Plan				Compensation				All Other
Name and Principal		Fiscal				Salary				Awards				Compensation				Earnings				Compensation				Total
Position		Year				($)(b)				($)(c)				($)(d)				($)(e)				($)(f)				($)
Juliette E. Fay			2009				275,000				62,587				83,9758				2,248				14,496				438,306
Executive Vice President and			2008				275,000				108,404				84,352				400				37,150				505,306
Chief Development Officer			2007				275,000				56,566				122,002				6,967				37,060				497,595
Bruce F. Nardella			2009				275,000				66,286				83,975				788				13,956				440,005
Executive Vice President and			2008				275,000				111,413				84,352				325				36,610				507,700
Chief Operating Officer(a)			2007				242,308				54,566				130,244				8,026				30,037				465,181
Hugh R. Jones III			2009				275,000				65,220				83,975				774				13,130				438,099
Executive Vice President and Chief Administrative Officer

						Company
		Contributions				match on
		to Executive				contributions
		Deferred				to 401(k) and												Group
		Compensation				Executive				Company								term life
		Plan				Deferral Plan				paid parking				Gross-ups				insurance
Edward M. Murphy			11,375				3,675				1,470				683				2,376
Denis M. Holler			7,563				3,675				1,470				683				1,040
Juliette E. Fay			7,563				3,675				1,470				683				1,161
Bruce F. Nardella			7,563				3,675				1,470				683				621
Hugh R. Jones III			7,563				3,675				876				407				665

Grants of Plan-Based Awards in Fiscal 2009

Estimated Possible Payouts Under Non-Equity Incentive Plan

Name		Threshold (a)($)				Target (a)($)				Maximum (a)($)
Edward M. Murphy			175,000				350,000				525,000
Denis M. Holler			68,750				137,500				206,250
Juliette E. Fay			68,750				137,500				206,250
Bruce F. Nardella			68,750				137,500				206,250
Hugh R. Jones III			68,750				137,500				206,250

Estimated Future Payouts Under Equity Incentive Plan

No grants of equity awards were made to the named executive officers during fiscal 2009.

Outstanding Equity Awards at Fiscal 2009 Year End

Shares and stock options are not included in this table because none were issued during the fiscal year and none were outstanding at fiscal year-end.

Equity Incentive Plan Awards

Payout Value

Number and Class

Payout Value

Number and Class

of Unearned

of Earned Units

of Earned Units

of Unearned Units

Units Not

Name

Not Vested (#)

Not Vested ($)(e)

Not Vested (#)(f)

Vested ($)(e)

Edward M. Murphy

664.13 Class B Units

(a)

33.21

696.90 Class C Units

(a)

20.91

8,698.65 Class D Units

(a)

86.99

17,397.31 Class D Units

(a)

173.97

6,737.50 Class B Units

(b)

336.88

7,070.00 Class C Units

(b)

212.10

2,496.67 Class D Units

(b)

24.97

4,993.33 Class D Units

(b)

49.93

Denis M. Holler

664.13 Class B Units

(a)

33.21

696.90 Class C Units

(a)

20.91

7,241.32 Class D Units

(a)

72.41

14,482.63 Class D Units

(a)

144.83

481.25 Class B Units

(c)

24.06

505.00 Class C Units

(c)

15.15

178.33 Class D Units

(c)

1.78

356.67 Class D Units

(c)

3.57

6,256.25 Class B Units

(b)

312.81

6,565.00 Class C Units

(b)

196.95

2,318.33 Class D Units

(b)

23.18

4,636.67 Class D Units

(b)

46.37

Juliette E. Fay

664.13 Class B Units

(a)

33.21

696.90 Class C Units

(a)

20.91

7,241.32 Class D Units

(a)

72.41

14,482.63 Class D Units

(a)

144.83

6,256.25 Class B Units

(b)

312.81

6,565.00 Class C Units

(b)

196.95

2,318.33 Class D Units

(b)

23.18

4,636.67 Class D Units

(b)

46.37

Equity Incentive Plan Awards

Payout Value

Number and Class

Payout Value

Number and Class

of Unearned

of Earned Units

of Earned Units

of Unearned Units

Units Not

Name

Not Vested(#)

Not Vested($)(e)

Not Vested(#)(f)

Vested($)(e)

Bruce F. Nardella

664.13 Class B Units

(a)

33.21

696.90 Class C Units

(a)

20.91

7,241.32 Class D Units

(a)

72.41

14,482.63 Class D Units

(a)

144.83

962.50 Class B Units

(c)

48.13

1,010.00 Class C Units

(c)

30.30

356.67 Class D Units

(c)

3.57

713.33 Class D Units

(c)

7.13

5,775.00 Class B Units

(b)

288.75

6,060.00 Class C Units

(b)

181.80

2,140.00 Class D Units

(b)

21.40

4,280.00 Class D Units

(b)

42.80

Hugh R. Jones III

664.13 Class B Units

(a)

33.21

696.90 Class C Units

(a)

20.91

4,618.11 Class D Units

(a)

46.18

9,236.22 Class D Units

(a)

92.36

5,775.00 Class B Units

(b)

288.75

6,060.00 Class C Units

(b)

181.80

2,140.00 Class D Units

(b)

21.40

4,280.00 Class D Units

(b)

42.80

481.25 Class B Units

(d)

24.06

505.00 Class C Units

(d)

15.15

2,801.54 Class D Units

(d)

28.02

5,603.08 Class D Units

(d)

56.03