##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington D.C 20549
 
 Form 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Numbers 333-97293 and 333-116927
 EXTENDICARE HEALTH SERVICES, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    111 West Michigan Street
    
    98-0066268(State or other jurisdiction of
    
    Milwaukee, WI 53203
    
    (I.R.S. Employerincorporation or organization)
    
    (Address of principal executive office
    
    Identification Number)including zip code)
 (414) 908-8000
  þ o
  Large Accelerated File o
    
    Accelerated File o
    
    Non-accelerated filer þ
  o þ




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##### 



EXTENDICARE HEALTH SERVICES, INC.
 INDEX
 PagePart I
    
    Financial Information:Item 1
    
    Financial Statements:Condensed Consolidated Statements of Income for the Three Months and Six Months Ended June 30, 2006 and 2005
    
    
    3Condensed Consolidated Balance Sheets, June 30, 2006 and December 31, 2005
    
    
    4Condensed Consolidated Statements of Shareholders Equity for the Six Months Ended June 30, 2006
    
    
    5Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    8Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    67Item 4
    
    Controls and Procedures
    
    
    68Part II
    
    Other Information:Item 1
    
    Legal Proceedings
    
    
    69Item 1A
    
    Risk Factors
    
    
    69Item 6
    
    Exhibits
    
    
    69Signatures
    
    
    70Exhibit Index
    
    
    71Section 302 CertificationSection 302 CertificationSection 1350 Written Statement
  2




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##### Table of Contents



PART I
FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In thousands)
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005REVENUES:Nursing and assisted living facilities
    
    $
    303,998
    
    
    $
    297,837
    
    
    $
    602,225
    
    
    $
    577,252Outpatient therapy
    
    
    2,978
    
    
    
    2,903
    
    
    
    5,711
    
    
    
    5,630Other
    
    
    4,759
    
    
    
    4,294
    
    
    
    9,875
    
    
    
    8,961311,735
    
    
    
    305,034
    
    
    
    617,811
    
    
    
    591,843COSTS AND EXPENSES (INCOME):Operating
    
    
    250,642
    
    
    
    235,968
    
    
    
    497,445
    
    
    
    468,208General and administrative
    
    
    11,089
    
    
    
    9,773
    
    
    
    23,443
    
    
    
    19,382Lease costs
    
    
    5,708
    
    
    
    5,681
    
    
    
    11,407
    
    
    
    10,190Depreciation and amortization
    
    
    12,062
    
    
    
    11,797
    
    
    
    23,948
    
    
    
    21,665Accretion of retirement obligations (Note 2)
    
    
    215
    
    
    
    
    
    
    
    429
    
    
    
    Interest expense, net (Note 8)
    
    
    11,385
    
    
    
    9,913
    
    
    
    22,084
    
    
    
    18,097Valuation adjustment on interest rate caps (Note 9)
    
    
    (324
    )
    
    
    939
    
    
    
    (413
    )
    
    
    2,237Loss (Gain) on disposal of assets (Note 11)
    
    
    2,636
    
    
    
    (630
    )
    
    
    2,555
    
    
    
    (1,078
    )Loss on refinancing and retirement of debt (Note 8)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    275293,413
    
    
    
    273,441
    
    
    
    580,898
    
    
    
    538,976INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES
    
    
    18,322
    
    
    
    31,593
    
    
    
    36,913
    
    
    
    52,867Income tax expense (Note 4 (b))
    
    
    9,689
    
    
    
    12,295
    
    
    
    16,478
    
    
    
    20,680NET INCOME FROM CONTINUING OPERATIONS
    
    
    8,633
    
    
    
    19,298
    
    
    
    20,435
    
    
    
    32,187Loss from discontinued operations before income
taxes (Note 12)
    
    
    (1,943
    )
    
    
    (6,613
    )
    
    
    (4,965
    )
    
    
    (7,993
    )Income tax benefit on discontinued operations
(Note 12)
    
    
    (801
    )
    
    
    (2,614
    )
    
    
    (2,050
    )
    
    
    (3,159
    )NET LOSS FROM DISCONTINUED OPERATIONS
    
    
    (1,142
    )
    
    
    (3,999
    )
    
    
    (2,915
    )
    
    
    (4,834
    )NET INCOME
    
    $
    7,491
    
    
    $
    15,299
    
    
    $
    17,520
    
    
    $
    27,353
  3




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 JUNE 30, 2006 AND DECEMBER 31, 2005
(In thousands except share data)
 June 30,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent Assets :Cash and cash equivalents
    
    $
    7,531
    
    
    $
    13,347Short-term investments
    
    
    2,371
    
    
    
    5,722Accounts receivable, less allowances of $15,586 and
$13,813 respectively
    
    
    138,681
    
    
    
    120,982Supplies, inventories and other current assets
    
    
    19,040
    
    
    
    23,173Income taxes receivable
    
    
    1,083
    
    
    
    557Deferred state income taxes
    
    
    5,027
    
    
    
    4,660Due from shareholder and affiliates (Note 10):Federal income taxes receivable
    
    
    8,970
    
    
    
    10,450Deferred federal income taxes
    
    
    16,471
    
    
    
    15,787Total current assets
    
    
    199,174
    
    
    
    194,678Property and equipment, net
    
    
    767,410
    
    
    
    750,075Goodwill and other intangible assets, net
    
    
    86,363
    
    
    
    85,476Other assets
    
    
    33,498
    
    
    
    28,563Total Assets
    
    $
    1,086,445
    
    
    $
    1,058,792LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Outstanding checks in excess of bank balance
    
    $
    
    
    
    $
    13,453Current maturities of long-term debt and capital lease
obligations (Note 8)
    
    
    4,250
    
    
    
    4,142Accounts payable
    
    
    30,027
    
    
    
    29,169Accrued liabilities
    
    
    125,590
    
    
    
    117,448Current portion of accrual for self-insured liabilities
    
    
    12,500
    
    
    
    12,500Current portion of amounts due to shareholder and
affiliates (Note 10)
    
    
    2,995
    
    
    
    2,975Total current liabilities
    
    
    175,362
    
    
    
    179,687Accrual for self-insured liabilities
    
    
    18,830
    
    
    
    21,691Long-term debt and capital lease obligations (Note 8)
    
    
    530,268
    
    
    
    515,084Deferred state income taxes
    
    
    58
    
    
    
    479Other long-term liabilities
    
    
    33,979
    
    
    
    32,652Due to shareholder and affiliates (Note 10):Deferred federal income taxes
    
    
    11,740
    
    
    
    9,815Other
    
    
    5,098
    
    
    
    5,940Total Liabilities
    
    
    775,335
    
    
    
    765,348Shareholders Equity:Common stock, $1 par value, 1,000 shares
authorized, 947 shares issued and outstanding
    
    
    1
    
    
    
    1Additional paid-in capital
    
    
    209,917
    
    
    
    209,771Retained earnings
    
    
    101,192
    
    
    
    83,672Total Shareholders Equity
    
    
    311,110
    
    
    
    293,444Total Liabilities and Shareholders Equity
    
    $
    1,086,445
    
    
    $
    1,058,792
  4




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
 FOR THE SIX MONTHS ENDED JUNE 30, 2006
(In thousands except share data)
 Common Stock
    
    
    Additional
    
    
    
    
    
    
    TotalPaid-In
    
    
    Retained
    
    
    Shareholder'sShares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    EquityBALANCES at DECEMBER 31, 2005
    
    
    947
    
    
    $
    1
    
    
    $
    209,771
    
    
    $
    83,672
    
    
    $
    293,444Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,520
    
    
    
    17,520Income tax benefit from
parent stock options
exercised
    
    
    
    
    
    
    
    
    
    
    146
    
    
    
    
    
    
    
    146BALANCES at JUNE 30, 2006
    
    
    947
    
    
    $
    1
    
    
    $
    209,917
    
    
    $
    101,192
    
    
    $
    311,110
  5




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In thousands)
 Six Months Ended
    
    
    Six Months EndedJune 30, 2006
    
    
    June 30, 2005OPERATING ACTIVITIES:Net income
    
    $
    17,520
    
    
    $
    27,353Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    24,072
    
    
    
    22,607Amortization of deferred financing costs
    
    
    1,033
    
    
    
    925Amortization of purchase accounting adjustments for leases and debt
    
    
    (262
    )
    
    
    (251
    )Amortization of purchase accounting adjustments for below market
resident leases
    
    
    (859
    )
    
    
    (1,165
    )Accretion of retirement obligations (Note 2)
    
    
    439
    
    
    
    Provision for self-insured liabilities
    
    
    4,680
    
    
    
    4,037Payment of self-insured liability claims
    
    
    (7,542
    )
    
    
    (7,209
    )Deferred income taxes
    
    
    453
    
    
    
    3,497Valuation adjustment on interest rate caps
    
    
    (413
    )
    
    
    2,237(Gain) loss on disposal of assets and impairment of long-lived assets
    
    
    4,157
    
    
    
    4,622Loss on refinancing and retirement of debt
    
    
    
    
    
    
    275Changes in assets and liabilities:Accounts receivable attributable to Indiana and Pennsylvania provider
tax
    
    
    1,761
    
    
    
    (17,618
    )Accounts receivable
    
    
    (19,461
    )
    
    
    (10,207
    )Other assets
    
    
    (3,897
    )
    
    
    573Supplies, inventories and other current assets
    
    
    4,197
    
    
    
    2,951Accounts payable
    
    
    858
    
    
    
    (4,153
    )Accrued liabilities attributable to Indiana and Pennsylvania
provider tax
    
    
    (1,896
    )
    
    
    10,904Accrued liabilities
    
    
    9,961
    
    
    
    5,632Income taxes payable/receivable
    
    
    (511
    )
    
    
    1,135Current due to shareholder and affiliates
    
    
    (1,541
    )
    
    
    5,204Cash provided by operating activities
    
    
    32,749
    
    
    
    51,349INVESTING ACTIVITIES:Payment for acquisition of ALC (Note 5)
    
    
    
    
    
    
    (144,316
    )Cash balances in ALC as of acquisition
    
    
    
    
    
    
    6,547Payments for other acquisitions (Note 6)
    
    
    (24,723
    )
    
    
    (8,218
    )Payments for new construction projects
    
    
    (5,837
    )
    
    
    (13,106
    )Payments for purchase of property and equipment
    
    
    (16,255
    )
    
    
    (11,437
    )Proceeds from sale of investments
    
    
    3,054
    
    
    
    976Proceeds from sale of assets held for sale
    
    
    1,719
    
    
    
    Proceeds from sale of property and equipment
    
    
    135
    
    
    
    1,878Changes in other non-current assets
    
    
    (492
    )
    
    
    (862
    )Cash used in investing activities
    
    
    (42,399
    )
    
    
    (168,538
    )FINANCING ACTIVITIES:Proceeds from Revolving Credit Facility to finance ALC acquisition
    
    
    
    
    
    
    60,000Proceeds from 6% EHI Term Note to finance ALC acquisition
    
    
    
    
    
    
    55,000Payments of long-term debt
    
    
    (1,644
    )
    
    
    (20,350
    )Payments on line of credit
    
    
    (12,000
    )
    
    
    (8,000
    )Proceeds from issuance of long-term debt
    
    
    29,000
    
    
    
    10,000Payment of deferred financing costs
    
    
    (1
    )
    
    
    (125
    )Outstanding checks in excess of bank balance
    
    
    (13,453
    )
    
    
    Other long-term liabilities
    
    
    1,932
    
    
    
    981Cash provided by financing activities
    
    
    3,834
    
    
    
    97,506Decrease in cash and cash equivalents
    
    
    (5,816
    )
    
    
    (19,683
    )Cash and cash equivalents, beginning of period
    
    
    13,347
    
    
    
    29,612Cash and cash equivalents, end of period
    
    $
    7,531
    
    
    $
    9,929
  6




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In thousands)
 Six Months Ended
    
    
    Six Months EndedJune 30, 2006
    
    
    June 30, 2005Supplemental schedule of cash flow information:Cash paid during the period for:Interest
    
    $
    21,046
    
    
    $
    16,455Income tax payments, net of refunds
    
    
    13,069
    
    
    
    14,581Supplemental schedule of noncash investing and financing activities:The Company acquired all of the capital stock of Assisted Living
Concepts, Inc. for $144,316. In connection with the acquisition,
liabilities were assumed as follows:Fair value of assets acquired
    
    $
    
    
    
    $
    316,984Cash paid
    
    
    
    
    
    
    (144,316
    )Liabilities assumed
    
    $
    
    
    
    $
    172,668Capital lease obligations incurred to purchase properties
    
    $
    
    
    
    $
    12,822
  7




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Summary of Significant Accounting Policies
  Basis of Presentation
     2. New Accounting Policies
 Asset Retirement Obligations
  8




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##### Table of Contents



(In thousands)Cumulative effect of accounting change, net of
income taxes
    
    $
    6,414Property and equipment, net
    
    
    1,671Deferred state income taxes
    
    
    535Due to shareholder and affiliates:Deferred federal income taxes
    
    
    3,741Total asset retirement obligation
    
    $
    12,361
   Six Months EndedJune 30, 2005(in thousands)Net income, as reported
    
    $
    27,353Effect of adoption of FIN No. 47 on prior year:Income before income taxes
    
    
    (458
    )Income tax expense (benefit)
    
    
    (184
    )Net income
    
    
    (274
    )Adjusted net income after effect of adoption of
FIN No. 47
    
    $
    27,079
 3. New Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes
  9




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##### Table of Contents



4. Extendicares Strategic Initiative
 a) Announcement of Reorganization
      b) Deferred Income Taxes Relating to Difference between Book and Tax Basis of ALC Stock
  10




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##### Table of Contents



5. Acquisition of ALC
    Three Months Ended
    
    
    Six Months EndedJune 30, 2005
    
    
    June 30, 2005( in thousands)
    
    
    ( in thousands)Total revenues
    
    $
    312,348
    
    
    $
    621,605Income before income taxes
    
    
    24,980
    
    
    
    44,060Net income
    
    
    15,299
    
    
    
    26,858
 6. Other Acquisitions and New Construction
 a) Acquisition in Pennsylvania
  (in thousands)Cash used to finance the acquisition
    
    $
    (24,723
    )Other current assets
    
    
    99Total current assets
    
    
    (24,624
    )Property, plant and equipment
    
    
    22,685Resident relationships intangible
    
    
    149Goodwill
    
    
    2,221Total assets
    
    $
    431Current liabilities
    
    $
    431
  b) New Construction
  11




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##### Table of Contents



7. Approval of Indiana and Pennsylvania State Plans and Amendments Relating to Medicaid Revenues
   8. Line of Credit and Long-term Debt
 Summary of Long-term Debt
  Interest
    
    
    June 30,
    
    
    December 31,Rate (1)
    
    
    2006
    
    
    2005(in thousands)9.50% Senior Notes due 2010
    
    
    9.54
    %
    
    $
    149,778
    
    
    $
    149,7566.875% Senior Subordinated Notes due 2014
    
    
    7.23
    %
    
    
    122,378
    
    
    
    122,255Term Loan due 2010, at variable interest rates
    
    
    6.70
    %
    
    
    85,140
    
    
    
    85,5706.00% EHI Term Note due 2010
    
    
    6.00
    %
    
    
    55,000
    
    
    
    55,0006.00% EI Term Note due 2010
    
    
    6.00
    %
    
    
    8,900
    
    
    
    8,900Mortgage notes payable, interest rates ranging from 0% to 8.0%,
maturing through 2008
    
    
    6.64
    %
    
    
    3,663
    
    
    
    3,8366.25% Industrial Development Revenue Bond, maturing 2008
    
    
    6.25
    %
    
    
    735
    
    
    
    735Revolving Credit Facility due 2010 at variable interest rates
    
    
    7.02
    %
    
    
    17,000
    
    
    
    ALC Debt:6.24% Red Mortgage Capital Note due 2014
    
    
    6.51
    %
    
    
    36,198
    
    
    
    36,533DMG Mortgage notes payable, interest rates ranging from 5.98%
to 6.06%, due 2008
    
    
    6.01
    %
    
    
    26,694
    
    
    
    27,263Capital lease obligations, interest rates ranging from 2.84%
to 13.54%, maturing through 2009
    
    
    6.36
    %
    
    
    12,029
    
    
    
    12,222Oregon Trust Deed Notes, interest rates ranging from 0% to
9.0%, maturing from 2020 through 2026
    
    
    6.72
    %
    
    
    9,367
    
    
    
    9,483HUD Insured Mortgages, interest rates ranging from 7.40% to
7.55%, due 2036
    
    
    6.89
    %
    
    
    7,636
    
    
    
    7,673Long-term debt before current maturities
    
    
    
    
    
    
    534,518
    
    
    
    519,226Less current maturities
    
    
    
    
    
    
    4,250
    
    
    
    4,142Total long-term debt
    
    
    
    
    
    $
    530,268
    
    
    $
    515,084
 
 (1)
    
    Interest rate is effective interest rate as of June 30, 2006. 12




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##### Table of Contents



2010 Senior Notes
      Year
    
    Redemption Price2006
    
    
    104.750
    %2007
    
    
    102.375
    %2008 and thereafter
    
    
    100.000
    %
  13




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##### Table of Contents



2014 Notes
 .
    Year
    Redemption Price2009
    
    
    103.438
    %2010
    
    
    102.292
    %2011
    
    
    101.146
    %2012 and thereafter
    
    
    100.000
    %
  Amended and Restated Credit Facility
   
    
    the credit extended to the Company under the Amended and Restated Credit Facility
includes a Term Loan for $86.0 million. The principal balance of the Term Loan is payable
in equal quarterly installments of $215,000 over the first four years of the Amended and
Restated Credit Facility, equal quarterly installments of $20.6 million over the first three
quarters of the last year of the Amended and Restated Credit Facility, and a final principal
installment of $20.6 million due on the maturity date.
 14




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##### Table of Contents




    
    the revolving credit limit under the Amended and Restated Credit Facility reflects a
reduction by $41.0 million from the $155.0 million limit under the former Revolving Credit
Facility to $114.0 million under the Amended and Restated Credit Facility. The Company may
request an increase in the credit extended or available under the Amended and Restated
Credit Facility by up to $15.0 million, but such request must be approved by one or more
participating lenders. The increase may be in the form of additional term loans or in the
form of an increase in the revolving credit limit.
    
    the maturity date of the Amended and Restated Credit Facility is July 31, 2010,
reflecting an extension of more than one year from the maturity date of the former Revolving
Credit Facility.
    
    the interest rate margins over the Eurodollar rate or the base rate, as applicable,
have been reduced and fixed at 1.75% per annum for Eurodollar rate loans and 0.75% per annum
for base rate loans. Under the former Revolving Credit Facility the interest rate margin
ranged from 2.50% per annum to 3.25% per annum for Eurodollar rate loans and from 1.50% per
annum to 2.25% per annum for base rate loans, subject, in each case, to adjustments based on
the Companys senior leverage ratio.
    
    the Amended and Restated Credit Facility includes a $10.0 million swing line
commitment within the $114 million revolving credit limit.
    
    the financial covenants under the Amended and Restated Credit Facility include ALCs
debt and earnings, whereas the financial covenants under the former Revolving Credit
Facility did not. The financial covenants are otherwise substantially the same as under the
former Revolving Credit Facility.
    
    the Amended and Restated Credit Facility includes procedures for ALC and its
subsidiaries to be designated as restricted subsidiaries and guarantors of the Amended and
Restated Credit Facility over time. As this occurs, these subsidiaries will become subject
to the covenants of the Amended and Restated Credit Facility that apply to the Companys
restricted subsidiaries. Also, the Company is permitted to make investments in these
subsidiaries to the same extent that it is permitted to make investments in its other
restricted subsidiaries that have guaranteed the Amended and Restated Credit Facility.
    
    the Amended and Restated Credit Facility increases the Companys ability to make
investments in unrestricted subsidiaries (the unrestricted subsidiaries being ALC and its
subsidiaries unless and until they have been designated as restricted subsidiaries) such
that the Company and its restricted subsidiaries may have investments in unrestricted
subsidiaries outstanding from time to time up to the sum of the amount of investments in
unrestricted subsidiaries at June 30, 2005 plus $40 million.
    
    the Amended and Restated Credit Facility required that ALCs debt in connection with
the $22.0 million of Revenue Bonds secured by ALC facilities located in the States of
Washington, Idaho and Ohio be repaid in full within 180 days after the closing of the
Amended and Restated Credit Facility. The Revenue Bonds were prepaid in December 2005, and
as a result, ALC became a restricted subsidiary under the Amended and Restated Credit
Facility.
    
    the Amended and Restated Credit Facility increases the Companys ability to make
restricted payments to permit annual dividends up to the lesser of (i) 50% of net income, or
(ii) $25 million plus the unused restricted payment amount for the previous fiscal year, or
(iii) $50 million.
  15




---



##### Table of Contents



Loss on Refinancing and Retirement of Debt
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Loss on early retirement of Mortgage Note
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    140Loss on early retirement of Industrial Development Revenue Bond
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    135$
    
    
    
    $
    
    
    
    $
    
    
    
    $
    275
 Interest expense, net
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,(in thousands)2006
    
    
    2005
    
    
    2006
    
    
    2005Interest expense
    
    $
    11,727
    
    
    $
    10,179
    
    
    $
    22,897
    
    
    $
    18,735Interest income
    
    
    (342
    )
    
    
    (266
    )
    
    
    (813
    )
    
    
    (638
    )$
    11,385
    
    
    $
    9,913
    
    
    $
    22,084
    
    
    $
    18,097
 16




---



##### Table of Contents



9. Derivative Instruments and Hedging Activities
 Objectives and Strategies
  Interest Rate Swap and Cap Agreements
     17




---



##### Table of Contents



Risk Management Policies
  Quantitative Disclosures
    Valuation Adjustment on Interest Rate Caps
  18




---



##### Table of Contents



10. Due to Shareholder and Affiliates
  June 30,
    
    
    December 31,Affiliate
    
    Purpose
    
    2006
    
    
    2005(in thousands)Receivable (payable)Current assets:Extendicare Holdings, Inc.
    
    Federal income taxes receivable
    
    $
    8,970
    
    
    $
    10,450Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    16,471
    
    
    
    15,78725,441
    
    
    
    26,237Current liabilities:Virtual Care Provider, Inc.
    
    Working capital advances
    
    
    (3,000
    )
    
    
    (3,000
    )The Northern Group, Inc.
    
    Intercompany operating expenses
    
    
    (2
    )
    
    
    16Laurier Indemnity Company,
Ltd.
    
    Intercompany insurance premium
    
    
    4
    
    
    
    6Extendicare Holdings, Inc.
    
    Working capital advances
    
    
    3
    
    
    
    3(2,995
    )
    
    
    (2,975
    )Long-term liabilities:Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    (11,740
    )
    
    
    (9,815
    )Other:Extendicare Inc.
    
    Advances
    
    
    (837
    )
    
    
    281Extendicare Holdings, Inc.
    
    Advances
    
    
    (3,483
    )
    
    
    (3,483
    )Virtual Care Provider, Inc.
    
    Advances
    
    
    (778
    )
    
    
    (2,738
    )(5,098
    )
    
    
    (5,940
    )$
    5,608
    
    
    $
    7,507
   19




---



##### Table of Contents



11. Loss (Gain) on Disposal of Assets
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Costs related to Spin-off of ALC
    
    $
    2,300
    
    
    $
    
    
    
    $
    2,300
    
    
    $
    Gain on sale of Omnicare common stock
    
    
    
    
    
    
    
    
    
    
    (276
    )
    
    
    Unrealized loss on Omnicare common stock
    
    
    378
    
    
    
    
    
    
    
    573
    
    
    
    Gain on sale of MetLife common shares
    
    
    
    
    
    
    (630
    )
    
    
    
    
    
    
    (630
    )Gain on sale of Madison, Indiana property
    
    
    (42
    )
    
    
    
    
    
    
    (42
    )
    
    
    Gain on sale of Greenbelt, Maryland property
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (448
    )$
    2,636
    
    
    $
    (630
    )
    
    $
    2,555
    
    
    $
    (1,078
    )
   12. Discontinued Operations
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Revenues
    
    $
    2,915
    
    
    $
    7,314
    
    
    $
    6,611
    
    
    $
    14,652Costs and expenses (income):Operating
    
    
    3,994
    
    
    
    7,699
    
    
    
    9,719
    
    
    
    15,886Lease costs
    
    
    19
    
    
    
    103
    
    
    
    123
    
    
    
    202Depreciation and amortization
    
    
    37
    
    
    
    470
    
    
    
    124
    
    
    
    942Accretion
    
    
    4
    
    
    
    
    
    
    
    9
    
    
    
    Interest income
    
    
    
    
    
    
    (45
    )
    
    
    
    
    
    
    (85
    )Gain on disposal of assets
    
    
    (210
    )
    
    
    
    
    
    
    (1,144
    )
    
    
    Loss on impairment of long-lived assets
    
    
    1,014
    
    
    
    5,700
    
    
    
    2,745
    
    
    
    5,7004,858
    
    
    
    13,927
    
    
    
    11,576
    
    
    
    22,645Loss from discontinued operations
before income taxes
    
    
    (1,943
    )
    
    
    (6,613
    )
    
    
    (4,965
    )
    
    
    (7,993
    )Income tax benefit
    
    
    (801
    )
    
    
    (2,614
    )
    
    
    (2,050
    )
    
    
    (3,159
    )Net loss from discontinued operations
    
    $
    (1,142
    )
    
    $
    (3,999
    )
    
    $
    (2,915
    )
    
    $
    (4,834
    )
  20




---



##### Table of Contents



(a) Closure and Disposition of Nursing Facility in Wisconsin
  (b) Closure and Disposition of Assisted Living Facility in Texas
  (c) Closure of Assisted Living Facility in Washington
  (d) Lakeside Nursing Facility in Wisconsin
  (e) Closure and Disposition of Three Nursing Facilities in Minnesota
  (f) Sale of Florida Properties
  21




---



##### Table of Contents



13. Other Commitments and Contingencies
 Capital Expenditures
   Insurance and Self-insured Liabilities
  Litigation
   14. Uncertainties and Certain Significant Risks
 Interests in Unrelated Long-Term Care Providers
  22




---



##### Table of Contents



Accrual for Self-Insured General and Professional Liabilities
  Claims and Contingencies
   15. Comprehensive Income
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)NET INCOME
    
    $
    7,491
    
    
    $
    15,299
    
    
    $
    17,520
    
    
    $
    27,353OTHER COMPREHENSIVE INCOME (LOSS):Unrealized gain (loss) on investments, before tax
    
    
    
    
    
    
    (538
    )
    
    
    
    
    
    
    (570
    )Other comprehensive income (loss), before tax
    
    
    
    
    
    
    (538
    )
    
    
    
    
    
    
    (570
    )Income tax benefit (provision) related to items
of other comprehensive income
    
    
    
    
    
    
    215
    
    
    
    
    
    
    
    228Other comprehensive income (loss), net of tax
    
    
    
    
    
    
    (323
    )
    
    
    
    
    
    
    (342
    )COMPREHENSIVE INCOME
    
    $
    7,491
    
    
    $
    14,976
    
    
    $
    17,520
    
    
    $
    27,011
 23




---



##### Table of Contents



16. Subsequent Events
 a) Acquisition in Kentucky
  Purchase of ALC Office Building
  Medicare Market Basket Rate Increase
  24




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Forward-Looking Statements
  
    
    the proposed Reorganization (as defined below);
    
    Medicare and Medicaid payment levels and reimbursement methodologies and the application
of such methodologies and policies adopted by the government and its fiscal intermediaries;
    
    liabilities and claims asserted against us, such as resident care litigation, including
our exposure for punitive damage claims and increased insurance costs;
    
    national and local economic conditions, including their effect on the ability to hire and
retain qualified staff and employees and the associated costs;
    
    federal and state regulation of our business and change in such regulations, as well as
our compliance with such regulations;
    
    actions by our competitors; and
    
    our ability to maintain and increase census levels.
  25




---



##### Table of Contents



Executive Overview
   
    
    provide quality, clinically based services;
    
    strengthen Medicare census in our nursing facilities, private census in our assisted living
facilities and total average daily census, or ADC, in both our nursing and assisted living
facilities;
    
    expand non-government based revenue sources, thereby decreasing the risk and reliance on
government funding;
    
    expand, and actively manage, our asset portfolio through acquisition or internal growth, and
where appropriate, divest facilities that fail to meet our performance goals;
    
    diversify within the long-term care industry through growth of facilities under full
management and selected consulting services agreements and rehabilitation clinics;
    
    increase our operating efficiency; and
    
    increase operating cash flow.
    26




---



##### Table of Contents



Revenues
  Nursing and Assisted Living Facilities.
 Percentage of Total Nursing and Assisted Living Revenues
 For Three Months
    
    
    For Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Medicare
    
    
    28.8
    %
    
    
    28.8
    %
    
    
    29.0
    %
    
    
    29.7
    %Private and other
    
    
    28.2
    %
    
    
    27.4
    %
    
    
    28.0
    %
    
    
    26.2
    %Quality Mix
    
    
    57.0
    %
    
    
    56.2
    %
    
    
    57.0
    %
    
    
    55.9
    %Medicaid
    
    
    43.0
    %
    
    
    43.8
    %
    
    
    43.0
    %
    
    
    44.1
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  Nursing Facilities.
 27




---



##### Table of Contents



Percentage of Total Nursing
 For Three Months
    
    
    For Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Medicare
    
    
    35.5
    %
    
    
    35.7
    %
    
    
    35.8
    %
    
    
    35.8
    %Private and other
    
    
    16.3
    %
    
    
    15.1
    %
    
    
    16.1
    %
    
    
    15.4
    %Quality Mix
    
    
    51.8
    %
    
    
    50.8
    %
    
    
    51.9
    %
    
    
    51.2
    %Medicaid
    
    
    48.2
    %
    
    
    49.2
    %
    
    
    48.1
    %
    
    
    48.8
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  Assisted Living Facilities.
 Percentage of Total Assisted Living Revenues
 For Three Months
    
    
    For Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Private and other (Quality Mix)
    
    
    79.3
    %
    
    
    78.4
    %
    
    
    79.0
    %
    
    
    78.5
    %Medicaid
    
    
    20.7
    %
    
    
    21.6
    %
    
    
    21.0
    %
    
    
    21.5
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  Other Revenues.
 Legislative Actions that Affect Revenues
 Legislative Actions that Affect Medicare Revenues
  28




---



##### Table of Contents



Medicaid Rates and State Plan Amendments that Affect Medicaid Revenues
     29




---



##### Table of Contents



For Three Months
    
    
    For Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Prior year revenue adjustments:Pennsylvania Medicaid state plan amendment
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    15,800Indiana Medicaid state plan amendment
    
    
    
    
    
    
    10,934
    
    
    
    
    
    
    
    10,934Pennsylvania IGT and other Medicaid adjustments
    
    
    
    
    
    
    
    
    
    
    250
    
    
    
    946Other states Medicaid
    
    
    397
    
    
    
    123
    
    
    
    1,480
    
    
    
    331397
    
    
    
    11,057
    
    
    
    1,730
    
    
    
    28,011Prior year provider tax expense associated with:Pennsylvania state plan amendment above
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,333Indiana state plan amendment above
    
    
    
    
    
    
    6,260
    
    
    
    
    
    
    
    6,260
    
    
    
    6,260
    
    
    
    
    
    
    
    19,593Net impact on income from continuing operations
before income taxes
    
    $
    397
    
    
    $
    4,797
    
    
    $
    1,730
    
    
    $
    8,418
 Regulatory Environment Affecting Operations
   30




---



##### Table of Contents



Significant Events and Developments
 Events of 2006
 Extendicares Strategic Initiative.
    31




---



##### Table of Contents




    
    The risks outlined in our Annual Report on Form 10K associated with our assisted living
operations will be reduced
significantly. We will only operate two free-standing assisted living facilities (141 units) and
an additional 129 units that are contained within our skilled nursing facilities. However, our
percentage of non-government based revenue sources, and more stable revenue and earnings
associated with the assisted living operations, will decrease correspondingly. We will also be
less diversified within our long-term care business after the Spin-Off of ALC;
    
    Several of our corporate management will transfer to ALC and new management will be hired
within our operations. In addition, considerable resources will be spent in preparation for the
Spin-Off of ALC, the refinancing of our operations and re-alignment of our organization after
conversion to the real estate investment trust;
    
    We will incur charges in connection with the Spin-Off of ALC and the refinancing of our debt.
In addition, we will be subject to taxes on the transfer of the 29 assisted living facilities and
properties and the Spin-Off of ALC. The tax liability on the Spin-Off of ALC will be determined
based upon the excess of the initial trading value of ALC shares after the Spin-Off over the cost
basis of ALC, and therefore can not be precisely determined at this time. We believe we will have
arranged sufficient financing to replace our current debt, provide a line of credit to meet our
operational needs, and fund the costs and taxes associated with the ALC Spin-Off and refinancing.
 Increase in Medicare Part A rate.
 32




---



##### Table of Contents



Total and Medicare Census in Our Skilled Nursing Facilities.
 Total and Private Census in Our Assisted Living Facilities
 Impact of Below Inflationary Medicaid Rate Increases and Prior Year Revenue Adjustments.
 Acquisitions.
 New Construction.
 Lease Extensions.
 33




---



##### Table of Contents



Discontinued Operations.
   Events subsequent to June 30, 2006
 Acquisition in Kentucky
 Purchase of ALC Office Building.
 Medicare Market Basket Rate Increase.
 Events prior to 2006
 Acquisition of ALC.
 34




---



##### Table of Contents



Amended and Restated Credit Facility.
 Acquisitions and New Developments.
  Medicaid State Plan Amendments and Waivers.
 Dispositions and Discontinued Operations.
 Non-monetary Exchange of Omnicare Warrant to Omnicare Shares and Cash.
 35




---



##### Table of Contents



Impairment
Provision against Senior Health  Texas Advances.
 Other Disposal of Assets and Impairments of Long-lived Assets.
 Loan Repayments.
 Adoption of FIN No. 47.
  36




---



##### Table of Contents



(In thousands)Cumulative effect of accounting change, net of
income taxes
    
    $
    6,414Property and equipment
    
    
    1,671Deferred state income taxes
    
    
    535Due to shareholder and affiliates:Deferred federal income taxes
    
    
    3,741Total asset retirement obligation
    
    $
    12,361
 Key Performance Indicators
  Census
  Average Daily Census
  Occupancy Percentage
  Quality Mix
  Average Revenue Rate by Payor Source
  37




---



##### Table of Contents



EBITDA and EBITDA Percentage
  Review of Key Performance Indicators
  Nursing Facilities  ADC and Quality Mix
  All Nursing Facilities  Continuing Operations
 Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended March 312006
    
    
    2005
    
    
    2006
    
    
    2005Medicare
    
    
    2,383
    
    
    
    2,438
    
    
    
    2,397
    
    
    
    2,429Private and other
    
    
    2,025
    
    
    
    1,931
    
    
    
    1,996
    
    
    
    1,960Quality Mix
    
    
    4,408
    
    
    
    4,369
    
    
    
    4,393
    
    
    
    4,389Medicaid
    
    
    8,583
    
    
    
    8,264
    
    
    
    8,551
    
    
    
    8,291Total
    
    
    12,991
    
    
    
    12,633
    
    
    
    12,944
    
    
    
    12,680
 38




---



##### Table of Contents



Nursing Facilities  Same-Facility
 Three Months Ended June 30,2006
    
    
    2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Medicare
    
    
    2,250
    
    
    
    18.1
    %
    
    
    2,430
    
    
    
    19.3
    %
    
    
    (7.4
    %)Private and other
    
    
    1,933
    
    
    
    15.6
    %
    
    
    1,924
    
    
    
    15.3
    %
    
    
    0.5
    %Quality Mix
    
    
    4,183
    
    
    
    33.7
    %
    
    
    4,354
    
    
    
    34.6
    %
    
    
    (3.9
    %)Medicaid
    
    
    8,212
    
    
    
    66.3
    %
    
    
    8,242
    
    
    
    65.4
    %
    
    
    (0.4
    %)Total
    
    
    12,395
    
    
    
    100.0
    %
    
    
    12,596
    
    
    
    100.0
    %
    
    
    (1.6
    %)
 Nursing Facilities  Same-Facility
 Six Months Ended June 30,2006
    
    
    2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Medicare
    
    
    2,293
    
    
    
    18.4
    %
    
    
    2,425
    
    
    
    19.2
    %
    
    
    (5.4
    %)Private and other
    
    
    1,918
    
    
    
    15.4
    %
    
    
    1,956
    
    
    
    15.4
    %
    
    
    (1.9
    %)Quality Mix
    
    
    4,211
    
    
    
    33.8
    %
    
    
    4,381
    
    
    
    34.6
    %
    
    
    (3.9
    %)Medicaid
    
    
    8,252
    
    
    
    66.2
    %
    
    
    8,280
    
    
    
    65.4
    %
    
    
    (0.3
    %)Total
    
    
    12,463
    
    
    
    100.0
    %
    
    
    12,661
    
    
    
    100.0
    %
    
    
    (1.6
    %)
   Same-Facility Nursing ADC
 Second
    
    
    Third
    
    
    Fourth
    
    
    FirstQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter2005
    
    
    2005
    
    
    2005
    
    
    2006Medicare ADC
    
    
    2,430
    
    
    
    2,224
    
    
    
    2,207
    
    
    
    2,337Total ADC
    
    
    12,596
    
    
    
    12,580
    
    
    
    12,572
    
    
    
    12,532
 Assisted Living Facilities  ADC and Quality Mix
  All Assisted Living Facilities  Continuing Operations
 Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Private and other (Quality Mix)
    
    
    5,130
    
    
    
    5,239
    
    
    
    5,098
    
    
    
    4,555Medicaid
    
    
    2,059
    
    
    
    2,153
    
    
    
    2,080
    
    
    
    1,796Total
    
    
    7,189
    
    
    
    7,392
    
    
    
    7,178
    
    
    
    6,351
 39




---



##### Table of Contents



All Assisted Living Facilities  Same-Facility (excludes ALC acquisition)
 Three Months Ended June 30,2006
    
    
    2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Private and other (Quality Mix)
    
    
    1,071
    
    
    
    86.2
    %
    
    
    1,112
    
    
    
    89.7
    %
    
    
    (3.7
    %)Medicaid
    
    
    172
    
    
    
    13.8
    %
    
    
    127
    
    
    
    10.3
    %
    
    
    35.4
    %Total
    
    
    1,243
    
    
    
    100.0
    %
    
    
    1,239
    
    
    
    100.0
    %
    
    
    0.3
    %
 All Assisted Living Facilities  Same-Facility (excludes ALC acquisition)
 Six Months Ended June 30,2006
    
    
    2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Private and other (Quality Mix)
    
    
    1,070
    
    
    
    86.0
    %
    
    
    1,096
    
    
    
    89.5
    %
    
    
    (2.4
    %)Medicaid
    
    
    174
    
    
    
    14.0
    %
    
    
    129
    
    
    
    10.5
    %
    
    
    34.9
    %Total
    
    
    1,244
    
    
    
    100.0
    %
    
    
    1,225
    
    
    
    100.0
    %
    
    
    1.6
    %
  All Assisted Living Facilities  Same-Facility (including ALC acquisition)
 Three Months Ended
    
    
    Three Months EndedJune 30, 2006
    
    
    June 30, 2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Private and other (Quality Mix)
    
    
    5,066
    
    
    
    71.1
    %
    
    
    5,221
    
    
    
    71.0
    %
    
    
    (3.0
    %)Medicaid
    
    
    2,060
    
    
    
    28.9
    %
    
    
    2,130
    
    
    
    29.0
    %
    
    
    (3.3
    %)Total
    
    
    7,126
    
    
    
    100.0
    %
    
    
    7,351
    
    
    
    100.0
    %
    
    
    (3.1
    %)
  40




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##### Table of Contents



Assisted Living ADCSecond
    
    
    Third
    
    
    Fourth
    
    
    First
    
    
    SecondQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter2005
    
    
    2005
    
    
    2005
    
    
    2006
    
    
    2006EHSI Assisted Living Facilities (same facility):Private and other ADC
    
    
    1,112
    
    
    
    1,123
    
    
    
    1,105
    
    
    
    1,070
    
    
    
    1,071Total ADC
    
    
    1,239
    
    
    
    1,256
    
    
    
    1,250
    
    
    
    1,245
    
    
    
    1,243ALC Assisted Living Facilities (same facility):Private and other ADC
    
    
    4,108
    
    
    
    4,049
    
    
    
    3,995
    
    
    
    3,948
    
    
    
    3,995Total ADC
    
    
    6,112
    
    
    
    6,089
    
    
    
    5,998
    
    
    
    5,872
    
    
    
    5,883Total Assisted Living Facilities (same facility)Private and other ADC
    
    
    5,220
    
    
    
    5,172
    
    
    
    5,100
    
    
    
    5,018
    
    
    
    5,066Total ADC
    
    
    7,351
    
    
    
    7,345
    
    
    
    7,248
    
    
    
    7,117
    
    
    
    7,126
 41




---



##### Table of Contents



All Nursing and Assisted Living Facilities  Occupancy and Number of Facilities Under Operation
  All Facilities:
  All Nursing and Assisted Living Facilities for Three Months Ended June 30,
 Occupancy
    
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    
    ADC
    
    
    Capacity2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Nursing
    
    
    91.3
    %
    
    
    92.6
    %
    
    
    12,991
    
    
    
    12,633
    
    
    
    14,236
    
    
    
    13,640Assisted Living:Mature facilities
    
    
    83.1
    %
    
    
    85.1
    %
    
    
    1,012
    
    
    
    1,086
    
    
    
    1,218
    
    
    
    1,276Developmental facilities
    
    
    63.9
    %
    
    
    67.6
    %
    
    
    295
    
    
    
    194
    
    
    
    462
    
    
    
    287ALC acquisition (all mature)
    
    
    86.0
    %
    
    
    89.2
    %
    
    
    5,882
    
    
    
    6,112
    
    
    
    6,838
    
    
    
    6,850Total Assisted Living
    
    
    84.4
    %
    
    
    87.9
    %
    
    
    7,189
    
    
    
    7,392
    
    
    
    8,518
    
    
    
    8,413Nursing and Assisted Living
    
    
    88.7
    %
    
    
    90.8
    %
    
    
    20,180
    
    
    
    20.025
    
    
    
    22,754
    
    
    
    22,053
 All Nursing and Assisted Living Facilities for Six Months Ended June 30,
 Occupancy
    
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    
    ADC
    
    
    Capacity2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Nursing
    
    
    91.8
    %
    
    
    93.0
    %
    
    
    12,944
    
    
    
    12,680
    
    
    
    14,094
    
    
    
    13,628Assisted Living:Mature facilities
    
    
    82.6
    %
    
    
    84.3
    %
    
    
    1,019
    
    
    
    1,076
    
    
    
    1,233
    
    
    
    1,276Developmental facilities
    
    
    62.3
    %
    
    
    77.5
    %
    
    
    282
    
    
    
    189
    
    
    
    453
    
    
    
    244ALC acquisition (all mature)
    
    
    85.9
    %
    
    
    89.6
    %
    
    
    5,877
    
    
    
    5,085
    
    
    
    6,838
    
    
    
    5,676Total Assisted Living
    
    
    84.2
    %
    
    
    88.3
    %
    
    
    7,178
    
    
    
    6,350
    
    
    
    8,524
    
    
    
    7,196Nursing and Assisted Living
    
    
    89.0
    %
    
    
    91.4
    %
    
    
    20,122
    
    
    
    19,030
    
    
    
    22,618
    
    
    
    20,824
  42




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##### Table of Contents



Same Facility Basis:
  Same Facility Basis for Three Months Ended June 30,
 Occupancy
    
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    
    ADC
    
    
    Capacity2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Nursing
    
    
    91.4
    %
    
    
    92.6
    %
    
    
    12,395
    
    
    
    12,596
    
    
    
    13,566
    
    
    
    13,598Assisted Living:Mature facilities
    
    
    83.1
    %
    
    
    85.5
    %
    
    
    1,012
    
    
    
    1,046
    
    
    
    1,218
    
    
    
    1,224Developmental facilities
    
    
    74.0
    %
    
    
    75.7
    %
    
    
    231
    
    
    
    193
    
    
    
    312
    
    
    
    255Total Assisted Living
    
    
    81.2
    %
    
    
    83.8
    %
    
    
    1,243
    
    
    
    1,239
    
    
    
    1,530
    
    
    
    1,479Nursing and Assisted Living
    
    
    90.3
    %
    
    
    91.8
    %
    
    
    13,638
    
    
    
    13,835
    
    
    
    15,096
    
    
    
    15,077
 Same Facility Basis for Six Months Ended June 30,
 Occupancy
    
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    
    ADC
    
    
    Capacity2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Nursing
    
    
    91.9
    %
    
    
    93.0
    %
    
    
    12,463
    
    
    
    12,661
    
    
    
    13,560
    
    
    
    13,607Assisted Living:Mature facilities
    
    
    84.1
    %
    
    
    84.6
    %
    
    
    1,024
    
    
    
    1,036
    
    
    
    1,218
    
    
    
    1,224Developmental facilities
    
    
    72.9
    %
    
    
    83.3
    %
    
    
    221
    
    
    
    189
    
    
    
    303
    
    
    
    227Total Assisted Living
    
    
    81.8
    %
    
    
    84.4
    %
    
    
    1,245
    
    
    
    1,225
    
    
    
    1,521
    
    
    
    1,451Nursing and Assisted Living
    
    
    90.9
    %
    
    
    92.2
    %
    
    
    13,708
    
    
    
    13,886
    
    
    
    15,081
    
    
    
    15,058
  43




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##### Table of Contents



Facilities Under Operation and Percent Ownership:
  As of
    
    
    As ofJune 30,
    
    
    December 31,2006
    
    
    2005Number of facilities under operation:Nursing
    
    
    140
    
    
    
    138Assisted Living
    
    
    208
    
    
    
    208Total
    
    
    348
    
    
    
    346Number of facilities owned:Nursing
    
    
    131
    
    
    
    129Assisted Living
    
    
    152
    
    
    
    152Total
    
    
    283
    
    
    
    281Number of facilities under capital leases:Assisted Living
    
    
    5
    
    
    
    5Percent of facilities:Owned
    
    
    81.3
    %
    
    
    81.2
    %Under capital leases
    
    
    1.4
    %
    
    
    1.4
    %Under operating leases
    
    
    17.3
    %
    
    
    17.4
    %100.0
    %
    
    
    100.0
    %
  Nursing Facilities  Average Revenue per Resident Day by Payor Source
  All Nursing Facilities  Continuing Operations
 Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    Change
    
    
    2006
    
    
    2005
    
    
    ChangeMedicare (Part A
and Part B)
    
    $
    403.76
    
    
    $
    371.85
    
    
    
    8.6
    %
    
    $
    400.93
    
    
    $
    371.29
    
    
    
    8.0
    %Private and other
    
    $
    218.00
    
    
    $
    198.91
    
    
    
    9.6
    %
    
    $
    217.65
    
    
    $
    197.67
    
    
    
    10.1
    %Medicaid
    
    $
    152.20
    
    
    $
    148.21
    
    
    
    2.7
    %
    
    $
    151.24
    
    
    $
    148.14
    
    
    
    2.1
    %Total
    
    $
    208.60
    
    
    $
    199.12
    
    
    
    4.8
    %
    
    $
    207.73
    
    
    $
    198.55
    
    
    
    4.6
    %Medicare Part A only
    
    $
    369.06
    
    
    $
    342.51
    
    
    
    7.8
    %
    
    $
    368.09
    
    
    $
    341.30
    
    
    
    7.8
    %
  44




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##### Table of Contents



All Nursing Facilities  Same Facility Basis
 Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    Change
    
    
    2006
    
    
    2005
    
    
    ChangeMedicaid
    
    $
    150.66
    
    
    $
    149.09
    
    
    
    1.1
    %
    
    $
    150.04
    
    
    $
    148.58
    
    
    
    1.0
    %State provider taxes
    
    $
    10.69
    
    
    $
    10.29
    
    
    
    3.9
    %
    
    $
    10.73
    
    
    $
    10.30
    
    
    
    4.2
    %Medicaid, net of state provider taxes
    
    $
    139.97
    
    
    $
    138.80
    
    
    
    0.8
    %
    
    $
    139.31
    
    
    $
    138.28
    
    
    
    0.7
    %
  45




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##### Table of Contents



Assisted Living Facilities  Average Revenue per Resident Day by Payor Source
  All Assisted Living Facilities
 Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    Change
    
    
    2006
    
    
    2005
    
    
    ChangePrivate and other
Medicaid
    
    $
    96.80
    
    
    $
    91.55
    
    
    
    5.7
    %
    
    $
    97.40
    
    
    $
    89.08
    
    
    
    9.3
    %Medicaid Total
    
    $
    63.02
    
    
    $
    61.50
    
    
    
    2.5
    %
    
    $
    63.54
    
    
    $
    61.91
    
    
    
    2.6
    %Total
    
    $
    87.12
    
    
    $
    82.80
    
    
    
    5.2
    %
    
    $
    87.59
    
    
    $
    81.40
    
    
    
    7.6
    %
   EHSI Assisted Living Facilities
 Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    Change
    
    
    2006
    
    
    2005
    
    
    ChangePrivate and other
    
    $
    86.44
    
    
    $
    81.15
    
    
    
    6.5
    %
    
    $
    86.71
    
    
    $
    81.31
    
    
    
    6.6
    %Medicaid
    
    $
    58.57
    
    
    $
    54.33
    
    
    
    7.8
    %
    
    $
    60.00
    
    
    $
    54.49
    
    
    
    10.1
    %Total
    
    $
    82.77
    
    
    $
    78.02
    
    
    
    6.1
    %
    
    $
    83.14
    
    
    $
    78.06
    
    
    
    6.5
    %
 ALC Assisted Living Facilities
 Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    Change
    
    
    2006
    
    
    2005
    
    
    ChangePrivate and other
    
    $
    98.69
    
    
    $
    91.30
    
    
    
    8.1
    %
    
    $
    99.24
    
    
    $
    89.72
    
    
    
    10.6
    %Medicaid
    
    $
    63.42
    
    
    $
    62.04
    
    
    
    2.2
    %
    
    $
    63.86
    
    
    $
    62.60
    
    
    
    2.0
    %Total
    
    $
    87.37
    
    
    $
    81.71
    
    
    
    6.9
    %
    
    $
    87.77
    
    
    $
    80.96
    
    
    
    8.4
    %
 46




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##### Table of Contents



EBITDA and EBITDA Percentage
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,(in thousands)2006
    
    
    2005
    
    
    2006
    
    
    2005Income from continuing operations before
income taxes
    
    $
    18,322
    
    
    $
    31,593
    
    
    $
    36,913
    
    
    $
    52,867Add (deduct):Depreciation and amortization
    
    
    12,062
    
    
    
    11,797
    
    
    
    23,948
    
    
    
    21,665Accretion of retirement obligations
    
    
    215
    
    
    
    
    
    
    
    429
    
    
    
    Interest expense, net
    
    
    11,385
    
    
    
    9,913
    
    
    
    22,084
    
    
    
    18,097Valuation adjustment on interest rate caps
    
    
    (324
    )
    
    
    939
    
    
    
    (413
    )
    
    
    2,237Loss (gain) on disposal of assets and
impairment of long-lived assets
    
    
    2,636
    
    
    
    (630
    )
    
    
    2,555
    
    
    
    (1,078
    )Loss on refinancing and retirement of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    275EBITDA
    
    $
    44,296
    
    
    $
    53,612
    
    
    $
    85,516
    
    
    $
    94,063
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,(in thousands)2006
    
    
    2005
    
    
    2006
    
    
    2005EBITDA
    
    $
    44,296
    
    
    $
    53,612
    
    
    $
    85,516
    
    
    $
    94,063Total Revenues
    
    $
    311,735
    
    
    $
    305,034
    
    
    $
    617,811
    
    
    $
    591,843EBITDA as percentage of total revenues
    
    
    14.2
    %
    
    
    17.6
    %
    
    
    13.8
    %
    
    
    15.9
    %
    47




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##### Table of Contents



Results from Operations
  Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005RevenuesNursing and assisted living facilities
    
    
    97.5
    %
    
    
    97.6
    %
    
    
    97.5
    %
    
    
    97.5
    %Outpatient therapy
    
    
    1.0
    
    
    
    1.0
    
    
    
    0.9
    
    
    
    1.0Other
    
    
    1.5
    
    
    
    1.4
    
    
    
    1.6
    
    
    
    1.5100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Operating and general and administrative costs
    
    
    84.0
    
    
    
    80.6
    
    
    
    84.3
    
    
    
    82.4Lease, depreciation and amortization
    
    
    5.7
    
    
    
    5.7
    
    
    
    5.7
    
    
    
    5.4Accretion of retirement obligations
    
    
    0.1
    
    
    
    
    
    
    
    0.1
    
    
    
    Interest expense, net
    
    
    3.6
    
    
    
    3.3
    
    
    
    3.6
    
    
    
    3.0Valuation adjustment on interest rate caps
    
    
    (0.1
    )
    
    
    0.3
    
    
    
    (0.1
    )
    
    
    0.4Loss on disposal of assets, provision for closure and
exit costs and impairment of long-lived assets
    
    
    0.9
    
    
    
    (0.2
    )
    
    
    0.4
    
    
    
    (0.2
    )Loss on refinancing and retirement of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.1Income from continuing operations before income taxes
    
    
    5.8
    
    
    
    10.3
    
    
    
    6.0
    
    
    
    8.9Income tax expense
    
    
    3.1
    
    
    
    4.0
    
    
    
    2.7
    
    
    
    3.5Net income from continuing operations before income taxes
    
    
    2.7
    
    
    
    6.3
    
    
    
    3.3
    
    
    
    5.4Loss from discontinued operations before income taxes
    
    
    (0.6
    )
    
    
    (2.2
    )
    
    
    (0.8
    )
    
    
    (1.3
    )Income tax benefit on discontinued operations
    
    
    (0.3
    )
    
    
    (0.9
    )
    
    
    (0.3
    )
    
    
    (0.5
    )Net loss from discontinued operations
    
    
    (0.3
    )
    
    
    (1.3
    )
    
    
    (0.5
    )
    
    
    (0.8
    )Net income
    
    
    2.4
    %
    
    
    5.0
    %
    
    
    2.8
    %
    
    
    4.6
    %
 48




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##### Table of Contents



2006 June Quarter Compared with 2005 June Quarter
 Revenues
    (in Millions) Medicare revenues due to the improvement in RUGs mix and other factors
    
    $
    3.5 average daily nursing Medicaid rates
    
    
    1.6 an increase in private and other nursing rates
    
    
    3.2 Medicare revenues due to increases in Medicare Part A rates effective October 1, 2005
    
    
    2.2 an increase in assisted living revenues
    
    
    0.5 nursing ancillary revenues
    
    
    0.9 Medicare census decreasing from 19.3% of total in the 2005 June quarter to 18.2% in the 2006 June
quarter
    
    
    (2.9
    ) total nursing census decreasing from 12,596 in the 2005 June quarter to 12,395 in the 2006 June quarter
    
    
    (3.0
    )6.0Adjustments relating to prior years: Indiana Medicaid revenues, relating to prior periods, recognized in the 2006 June quarter attributable to
the approval of the state plan amendments and waivers for the period July 1, 2003 through March 31, 2005 (the
related increase in state assessment expense of $7.5 million is reflected in operating expenses below)
    
    
    (12.9
    ) Other prior year settlement adjustments in the 2006 June quarter as compared to the 2005 June quarter
    
    
    0.3Total decrease in revenues from same facility nursing and assisted living facilities
    
    $
    (6.6
    )
 49




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##### Table of Contents



Operating and General and Administrative Costs
  (in Millions) wages, benefits and contracted staffing, which included an average
wage rate increase of 3.5% in nursing home operations
    
    $
    8.2 bad debt expense
    
    
    1.2 professional fees
    
    
    0.5 supplies and food
    
    
    0.5 other operating and administrative expenses
    
    
    1.311.7Adjustment relating to prior periods: Indiana state assessment taxes in the 2005 June quarter for the period July
1, 2003 through March 31, 2005 due to final approval of the state plan
amendments and waivers
    
    
    (7.5
    )Total increase in same facility operating and general and administrative costs
    
    $
    4.2
  Lease, Depreciation and Amortization
  Accretion of Retirement Obligation
  50




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##### Table of Contents



Interest Expense, Net
   Valuation Adjustment on Interest Rate Caps
  Loss (Gain) on Disposal of Assets
   Income Taxes
  Net Income from Continuing Operations
  Loss from Discontinued Operations
    51




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##### Table of Contents



Net Income
  Related Party Transactions
    52




---



##### Table of Contents



Six Months Ended June 30, 2006 Compared with Six Months Ended June 30, 2005
 Revenues
    (in Millions) Medicare revenues due to the improvement in RUGs mix and other factors
    
    $
    7.0 average daily nursing Medicaid rates
    
    
    2.8 an increase in private and other nursing rates
    
    
    6.2 Medicare revenues due to increases in Medicare Part A rates effective October 1, 2005
    
    
    4.4 an increase in assisted living revenues
    
    
    1.3 nursing ancillary revenues
    
    
    1.3 Medicare census decreasing from 19.2% of total in the 2005 June YTD period to 18.4%
in the 2006 June YTD period
    
    
    (4.3
    ) total nursing census decreasing from 12,661 in the 2005 June YTD period to 12,463 in
the 2006 June YTD period
    
    
    (5.9
    )12.8Adjustments relating to prior years: Indiana and Pennsylvania Medicaid revenues relating to prior periods recognized in the
2005 June YTD period attributable to the approval of the state plan amendments and waivers
for the period July 1, 2003 through December 31, 2004 (the related increase in state
assessment expense of $19.6 million is reflected in operating expenses below)
    
    
    (27.4
    ) Other prior year settlement adjustments in the 2006 June YTD period as compared to
the 2005 June YTD period
    
    
    1.1Total decrease in revenues from same facility nursing and assisted living facilities
    
    $
    (13.5
    )
 53




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##### Table of Contents



Operating and General and Administrative Costs
  (in Millions) wages, benefits and contracted staffing, which included an average
wage rate increase of 3.9% in nursing home operations
    
    $
    14.6 bad debt expense
    
    
    2.1 fines and penalties
    
    
    0.6 drugs
    
    
    0.8 professional fees
    
    
    1.0 travel and meeting
    
    
    0.7 repairs and maintenance
    
    
    0.7 other operating and administrative expenses
    
    
    2.022.5Adjustments relating to prior years: state assessment taxes in the 2005 June YTD period in Indiana and
Pennsylvania for the period July 1, 2003 through December 31, 2004 due to
final approval of the state plan amendments and waivers
    
    
    (19.6
    )Total increase in same facility operating and general and administrative costs
    
    $
    2.9
  Lease Costs, Depreciation and Amortization
  Accretion of Retirement Obligation
  54




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##### Table of Contents



Interest Expense, Net
   Valuation Adjustment on Interest Rate Caps
  Loss (Gain) on Disposal of Assets
   Loss on Refinancing and Retirement of Debt
   Income Taxes
  Net Income from Continuing Operations
  55




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##### Table of Contents



Loss from Discontinued Operations
    Net Income
  Related Party Transactions
   56




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##### Table of Contents



June 30
    
    
    December 31Affiliate
    
    Purpose
    
    2006
    
    
    2005(in thousands)Receivable (payable)Current assets:Extendicare Holdings, Inc.
    
    Federal income taxes receivable
    
    $
    8,970
    
    
    $
    10,450Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    16,471
    
    
    
    15,78725,441
    
    
    
    26,237Current liabilities:Virtual Care Provider, Inc.
    
    Working capital advances
    
    
    (3,000
    )
    
    
    (3,000
    )The Northern Group, Inc.
    
    Intercompany operating expenses
    
    
    (2
    )
    
    
    16Laurier Indemnity Company,
Ltd.
    
    Intercompany insurance premium
    
    
    4
    
    
    
    6Extendicare Holdings, Inc.
    
    Working capital advances
    
    
    3
    
    
    
    3(2,995
    )
    
    
    (2,975
    )Long-term liabilities:Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    (11,740
    )
    
    
    (9,815
    )Other:Extendicare Inc.
    
    Advances
    
    
    (837
    )
    
    
    281Extendicare Holdings, Inc.
    
    Advances
    
    
    (3,483
    )
    
    
    (3,483
    )Virtual Care Provider, Inc.
    
    Advances
    
    
    (778
    )
    
    
    (2,738
    )(5,098
    )
    
    
    (5,940
    )$
    5,608
    
    
    $
    7,507
   Liquidity and Capital Resources
 Sources and Uses of Cash
  Six Months EndedJune 302006
    
    
    2005(in thousand)Cash provided by operating activities
    
    $
    32,749
    
    
    $
    51,349Cash used in investing activities
    
    
    (42,399
    )
    
    
    (168,538
    )Cash provided by financing activities
    
    
    3,834
    
    
    
    97,506Decrease in cash and cash equivalents
    
    
    (5,816
    )
    
    
    (19,683
    )
 57




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58




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##### Table of Contents



Summary of Long-term Debt
  Interest
    
    
    June 30,
    
    
    December 31,Rate (1)
    
    
    2006
    
    
    2005(in thousands)9.50% Senior Notes due 2010
    
    
    9.54
    %
    
    $
    149,778
    
    
    $
    149,7566.875% Senior Subordinated Notes due 2014
    
    
    7.23
    %
    
    
    122,378
    
    
    
    122,255Term Loan due 2010, at variable interest rates
    
    
    6.70
    %
    
    
    85,140
    
    
    
    85,5706.00% EHI Term Note due 2010
    
    
    6.00
    %
    
    
    55,000
    
    
    
    55,0006.00% EI Term Note due 2010
    
    
    6.00
    %
    
    
    8,900
    
    
    
    8,900Mortgage notes payable, interest rates ranging from 0% to 8.0%,
maturing through 2008
    
    
    6.64
    %
    
    
    3,663
    
    
    
    3,8366.25% Industrial Development Revenue Bond, maturing 2008
    
    
    6.25
    %
    
    
    735
    
    
    
    735Revolving Credit Facility, due 2010 at variable interest rates
    
    
    7.02
    %
    
    
    17,000
    
    
    
    ALC Debt:6.24% Red Mortgage Capital Note due 2014
    
    
    6.51
    %
    
    
    36,198
    
    
    
    36,533DMG Mortgage notes payable, interest rates ranging from 5.98%
to 6.06%, due 2008
    
    
    6.01
    %
    
    
    26,694
    
    
    
    27,263Capital lease obligations, interest rates ranging from 2.84%
to 13.54%, maturing through 2009
    
    
    6.36
    %
    
    
    12,029
    
    
    
    12,222Oregon Trust Deed Notes, interest rates ranging from 0% to
9.0%, maturing from 2020 through 2026
    
    
    6.72
    %
    
    
    9,367
    
    
    
    9,483HUD Insured Mortgages, interest rates ranging from 7.40% to
7.55%, due 2036
    
    
    6.89
    %
    
    
    7,636
    
    
    
    7,673Long-term debt before current maturities
    
    
    
    
    
    
    534,518
    
    
    
    519,226Less current maturities
    
    
    
    
    
    
    4,250
    
    
    
    4,142Total long-term debt
    
    
    
    
    
    $
    530,268
    
    
    $
    515,084
 
 (1)
    
    Interest rate is effective interest rate as of June 30, 2006.   9.50% Senior Notes due 2010
   59




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##### Table of Contents



Year
    
    Redemption Price2006
    
    
    104.750
    %2007
    
    
    102.375
    %2008 and thereafter
    
    
    100.000
    %
  6.875% Senior Subordinated Notes due 2014
 .
  60




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##### Table of Contents



Year
    
    Redemption Price2009
    
    
    103.438
    %2010
    
    
    102.292
    %2011
    
    
    101.146
    %2012 and thereafter
    
    
    100.000
    %
  Amended and Restated Credit Facility
  
    
    the credit extended to us under the Amended and Restated Credit Facility includes a
term loan for $86.0 million. The principal balance of the term loan is payable in equal
quarterly installments of $215,000 over the first four years of the Amended and Restated
Credit Facility, equal quarterly installments of $20.6 million over the first three quarters
of the last year of the Amended and Restated Credit Facility, and a final principal
installment of $20.6 million due on the maturity date.
    
    the revolving credit limit under the Amended and Restated Credit Facility reflects a
reduction by $41.0 million from the $155.0 million limit under the former Revolving Credit
Facility to $114.0 million under the Amended and Restated Credit Facility. We may request
an increase in the credit extended or available under the Amended and Restated Credit
Facility by up to $15.0 million, but such increase must be approved by one or more
participating lenders. The increase may be in the form of additional term loans or in the
form of an increase in the revolving credit limit.
    
    the maturity date of the Amended and Restated Credit Facility is July 31, 2010,
reflecting an extension of more than one year from the maturity date of the former Revolving
Credit Facility.
    
    the interest rate margins over the Eurodollar rate or the base rate, as applicable,
have been reduced and fixed at 1.75% per annum for Eurodollar rate loans and 0.75% per annum
for base rate loans. Under the former Revolving Credit Facility the interest rate margin
ranged from 2.50% per annum to 3.25% per annum for Eurodollar rate loans and from 1.50% per
annum to 2.25% per annum for base rate loans, subject, in each case, to adjustments based on
our senior leverage ratio.
    
    the Amended and Restated Credit Facility includes a $10.0 million swing line
commitment within the $114 million revolving credit limit.
 61




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##### Table of Contents




    
    the financial covenants under the Amended and Restated Credit Facility include ALCs
debt and earnings, whereas the financial covenants under the former Revolving Credit
Facility did not. The financial covenants are otherwise substantially the same as under the
former Revolving Credit Facility.
    
    the Amended and Restated Credit Facility includes procedures for ALC and its
subsidiaries to be designated as restricted subsidiaries and guarantors of the Amended and
Restated Credit Facility over time. As this occurs, these subsidiaries will become subject
to the covenants of the Amended and Restated Credit Facility that apply to our restricted
subsidiaries. Also, we are be permitted to make investments in these subsidiaries to the
same extent that we are permitted to make investments in our other restricted subsidiaries
that have guaranteed the Amended and Restated Credit Facility.
    
    the Amended and Restated Credit Facility increases the our ability to make
investments in unrestricted subsidiaries (the unrestricted subsidiaries being ALC and its
subsidiaries unless and until they have been designated as restricted subsidiaries) such
that we and our restricted subsidiaries may have investments in unrestricted subsidiaries
outstanding from time to time up to the sum of the amount of investments in unrestricted
subsidiaries at June 30, 2005 plus $40 million.
    
    the Amended and Restated Credit Facility required that ALCs debt in connection with
the $22.0 million of Revenue Bonds secured by ALC facilities located in the States of
Washington, Idaho and Ohio be repaid in full within 180 days after the closing of the
Amended and Restated Credit Facility. The Revenue Bonds were prepaid in full in December
2005, and as a result, ALC became a restricted subsidiary under the Amended and Restated
Credit Facility.
    
    the Amended and Restated Credit Facility increases our ability to make restricted
payments to permit annual dividends up to the lesser of (i) 50% of net income, or (ii) $25
million plus the unused restricted payment amount for the previous fiscal year, or (iii) $50
million.
    62




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##### Table of Contents



Credit Ratings
  S&P
    
    Moody's2010 Senior Notes
    
    B+
    
    B12014 Notes
    
    B
    
    B2Revolving Credit Facility and Term Loan
    
    BB
    
    Ba2
 Interest Rate Swap and Cap Agreements
     63




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##### Table of Contents



Letters of Credit
  Off Balance Sheet Arrangements
  Cash Management
  New Financing Under Negotiation Post ALC Spin-Off
  Future Liquidity and Capital Resources
   64




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##### Table of Contents



Capital Commitments
  Accrual for Self-Insured Liabilities
  Revenue Bonds Commitments
     65




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##### Table of Contents



Contractual Obligations
  Payments Due By YearAfterTotal
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2010(dollars in thousands)Long-term debt principal
    
    $
    534,518
    
    
    $
    2,290
    
    
    $
    7,111
    
    
    $
    27,682
    
    
    $
    53,800
    
    
    $
    273,248
    
    
    $
    170,387Interest on long-term debt
    
    
    215,235
    
    
    
    20,111
    
    
    
    39,953
    
    
    
    38,739
    
    
    
    36,981
    
    
    
    29,681
    
    
    
    49,770Operating lease commitments
    
    
    153,138
    
    
    
    10,351
    
    
    
    19,403
    
    
    
    19,488
    
    
    
    19,276
    
    
    
    19,380
    
    
    
    65,240Asset retirement obligations
    
    
    12,783
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,783New construction purchase
commitments
    
    
    11,400
    
    
    
    9,400
    
    
    
    2,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other capital expenditure
purchase commitments
    
    
    12,560
    
    
    
    12,560
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    939,634
    
    
    $
    54,712
    
    
    $
    68,467
    
    
    $
    85,909
    
    
    $
    110,057
    
    
    $
    322,309
    
    
    $
    298,180
    66




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##### Table of Contents



Critical Accounting Policies
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Qualitative Disclosures
     67




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##### Table of Contents



Quantitative Disclosures
  Maturity Date through December 31,EstimatedFair Value ofLiability2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    Thereafter
    
    
    Total
    
    
    (Asset)(dollars in thousands)LONG-TERM DEBT:Fixed Rate
    
    $
    1,860
    
    
    $
    6,252
    
    
    $
    26,822
    
    
    $
    12,090
    
    
    $
    214,968
    
    
    $
    170,387
    
    
    $
    432,379
    
    
    $
    444,415Average Interest Rate
    
    
    6.13
    %
    
    
    6.80
    %
    
    
    6.08
    %
    
    
    7.24
    %
    
    
    8.47
    %
    
    
    7.05
    %
    
    
    7.69
    %Variable Rate
    
    $
    430
    
    
    $
    860
    
    
    $
    860
    
    
    $
    41,710
    
    
    $
    58,280
    
    
    
    
    
    
    $
    102,140
    
    
    $
    102,140Average Interest Rate
    
    
    6.70
    %
    
    
    6.70
    %
    
    
    6.70
    %
    
    
    6.70
    %
    
    
    6.80
    %
    
    
    
    
    
    
    6.76
    %INTEREST RATE SWAPS:(fixed to variable)Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    275,000
    
    
    $
    275,000
    
    
    $
    12,917Average Pay Rate (variable rate)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9.09
    %
    
    
    9.09
    %Average Receive Rate (fixed rate)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.31
    %
    
    
    8.31
    %INTEREST RATE CAPS:Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    150,000
    
    
    $
    150,000
    
    
    $
    (298
    )Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    125,000
    
    
    $
    125,000
    
    
    $
    4,523
  
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls Over Financial Reporting
  68




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PART II
OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 6. Exhibits
  69




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 SIGNATURES
  EXTENDICARE HEALTH SERVICES, INC.Date: August 11, 2006
    By:
    /s/ Richard L. BertrandRichard L. BertrandSenior Vice President, Chief Financial
Officer and Treasurer and Director
(Principal Accounting Officer) 70




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 EXHIBIT INDEX
 31.1
    
    Certifications of Chairman of the Board and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certifications of Senior Vice President, Chief Financial Officer and
Treasurer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32
    
    Written Statement of Chairman of the Board and Chief Executive
Officer and Senior Vice President, Chief Financial Officer and
Treasurer pursuant to 18 U.S.C. Section 1350.
 71