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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549





FORM 10-Q





(Mark One)





|                                                                             | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 
|---------------------------------------------------------------------------- | --------------------------------------------------------
|                                                                             | SECURITIES EXCHANGE ACT OF 1934                         
|                                                                             |                                                         
|For    the quarterly period ended December 31, 2005                         
|                                                                             |                                                         
|or                                                                          
|                                                                             |                                                         
|                                                                             | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
|                                                                             | SECURITIES EXCHANGE ACT OF 1934                         
|                                                                             |                                                         
|For    the transition period from ___________________ to ___________________
|                                                                             |                                                         
|Commission    File Number: 000-50351                                        




|GENESIS    HEALTHCARE CORPORATION                                
|-----------------------------------------------------------------
|(Exact    name of registrant as specified in its charter)        
|                                                                 
|Pennsylvania                                                     
|(State or    other jurisdiction of incorporation or organization)
|                                                                 
|101 East State Street    Kennett Square, Pennsylvania            
|(Address    of principal executive offices)                      




(610) 444-6350


(Registrants telephone number,  including area code)





N/A


(Former name, former address and  former fiscal year, if changed since last report)





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 |  | NO
|--- |  | --




Indicate by  check mark whether the registrant is a large accelerated filer, an accelerated  filer, or a non-accelerated filer.  See  definition of accelerated filer and large accelerated filer in Rule 12b-2 of  the Exchange Act.





|Large accelerated    filer |  | Accelerated    filer |  | Non-accelerated filer
|-------------------------- |  | -------------------- |  | ---------------------




Indicate  by check mark whether the registrant is a shell company (as defined in Rule  12b-2 of the Exchange Act).





|YES |  | NO
|--- |  | --




APPLICABLE ONLY TO  ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING  THE PRECEDING FIVE YEARS.





Indicate by  check mark whether the registrant has filed all documents and reports required  to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934  subsequent to the distribution of securities under a plan confirmed by a court.





|YES   (1) |  | NO
|--------- |  | --




|(1) | In 2000, prior to the creation of the registrant, a    substantial majority of the registrants subsidiaries filed for relief under    Chapter 11 of the Bankruptcy Code and emerged from such proceedings in 2001.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




APPLICABLE ONLY TO  CORPORATE ISSUERS.





As of  January 31, 2006: 19,425,774 shares of the registrants common stock were  outstanding, including 134,009 shares currently held in escrow to be issued in  connection with a joint plan of reorganization confirmed by the Bankruptcy Court  on September 20, 2001.





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TABLE OF CONTENTS





|                                                             | Page                                                                                    
|------------------------------------------------------------ | ----------------------------------------------------------------------------------------
|                                                             |                                                                                         
|CAUTIONARY STATEMENT REGARDING    FORWARD-LOOKING STATEMENTS | 1                                                                                       
|                                                             |                                                                                         
|PART I:                                                      | FINANCIAL INFORMATION                                                                   
|                                                             |                                                                                         
|ITEM 1:                                                      | Financial    Statements                                                                 
|                                                             |                                                                                         
|ITEM 2:                                                      | Managements    Discussion and Analysis of Financial Condition and Results of Operations
|                                                             |                                                                                         
|ITEM 3:                                                      | Quantitative    and Qualitative Disclosures About Market Risk                           
|                                                             |                                                                                         
|ITEM 4:                                                      | Controls    and Procedures                                                              
|                                                             |                                                                                         
|PART II:                                                     | OTHER INFORMATION                                                                       
|                                                             |                                                                                         
|ITEM 1:                                                      | Legal Proceedings                                                                       
|                                                             |                                                                                         
|ITEM 2:                                                      | Unregistered    Sales of Equity Securities and Use of Proceeds                          
|                                                             |                                                                                         
|ITEM 3:                                                      | Defaults    Upon Senior Securities                                                      
|                                                             |                                                                                         
|ITEM 4:                                                      | Submission    of Matters to a Vote of Security Holders                                  
|                                                             |                                                                                         
|ITEM 5:                                                      | Other    Information                                                                    
|                                                             |                                                                                         
|ITEM 6:                                                      | Exhibits                                                                                
|                                                             |                                                                                         
|SIGNATURES                                                   | 36                                                                                      




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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS





As used  herein, unless the context otherwise requires, all references to GHC, the  Company, we, our, us, and similar terms in this report refer to Genesis  HealthCare Corporation together with its subsidiaries.





Statements  made in this report, and in our other public filings and releases, which are  not historical facts, contain forward-looking statements (as defined in the  Private Securities Litigation Reform Act of 1995) that involve risks and  uncertainties and are subject to change at any time.  These forward-looking statements may include, but are not limited  to:





| |  | statements contained in Managements Discussion and    Analysis of Financial Condition and Results of Operations, and the notes to    our unaudited condensed consolidated financial statements, such as    demographic trends and our ability to take advantage of such demographic    trends; the expected impact of staffing and retention programs; our ability    to meet our working capital requirements, debt service, and future cash    needs; future earnings, capital sources and capital expenditure, debt and    lease requirements; our potential extension of credit to our joint venture
partners; the expected changes in and effects of government legislation, regulation and funding on our business; estimates in our critical accounting    policies, including the adequacy of our allowance for doubtful accounts, any    anticipated impact of long-lived asset impairments and our ability to provide    for outstanding losses and loss expenses for our self-insured programs; and    the estimated impact of new accounting pronouncements upon adoption;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | statements contained in Quantitative and    Qualitative Disclosures About Market Risk; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | statements contained in the notes to our unaudited    condensed consolidated financial statements and in Legal Proceedings    regarding the effects of litigation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     




The  forward-looking statements involve known and unknown risks, uncertainties and  other factors that are, in some cases, beyond our control.  You are cautioned that these statements are  not guarantees of future performance and that actual results and trends in the  future may differ materially.





Factors that could cause actual results to differ materially include,  but are not limited to, the following, certain of which are discussed more  fully in our Annual Report on Form 10-K for the fiscal year ended September 30,  2005:





| |  | changes in the reimbursement rates or methods of    payment from Medicare and Medicaid, including those described herein, or the    implementation of other measures to reduce the reimbursement for our    services;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                      
| |  | the expiration of enactments providing for    additional governmental funding;                                                                                                                                       
| |   |                                                                                                                                                                                                                      
| |  | the impact of federal and state regulations;                                                                                                                                                                         
| |   |                                                                                                                                                                                                                      
| |  | changes in case mix, payor mix and payment    methodologies;                                                                                                                                                         
| |   |                                                                                                                                                                                                                      
| |  | competition in our businesses;                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                      
| |  | the capital intensive nature of our inpatient    services segment and the need for extensive capital expenditures in order to    modernize and improve our physical infrastructure;                                  
| |   |                                                                                                                                                                                                                      
| |  | an increase in insurance costs and potential    liability for losses not covered by, or in excess of, our insurance;                                                                                                 
| |   |                                                                                                                                                                                                                      
| |  | competition for, and availability of, qualified    staff in the healthcare industry, and risks of potential labor strikes;                                                                                           




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| |  | our ability to control operating costs and generate    sufficient cash flow to meet operational and financial requirements;                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                               
| |  | our ability, and the ability of our subsidiary    guarantors, to fulfill debt obligations;                                                                                    
| |   |                                                                                                                                                                               
| |  | the economic condition of, or changes in, the laws    affecting our business in those markets in which we operate;                                                            
| |   |                                                                                                                                                                               
| |  | our ability to realize tax benefits relating to our    estimated net operating loss carryforwards;                                                                            
| |   |                                                                                                                                                                               
| |  | the increasing cost of being a publicly owned    company and our ability to provide reasonable assurance of the effectiveness    of internal control over financial reporting;
| |   |                                                                                                                                                                               
| |  | the impact of new accounting pronouncements;                                                                                                                                  
| |   |                                                                                                                                                                               
| |  | the impact of implementing new information systems;                                                                                                                           
| |   |                                                                                                                                                                               
| |  | the ability to engage successfully in acquisitions    and other strategic transactions;                                                                                       
| |   |                                                                                                                                                                               
| |  | the impact of acquisitions on our operations and    finances, and our ability to integrate acquired businesses; and                                                           
| |   |                                                                                                                                                                               
| |  | acts of God or public authorities, war, civil    unrest, terrorism, fire, floods, earthquakes and other matters beyond our    control.                                        




In addition  to these factors and any risks and uncertainties specifically identified in the  text surrounding forward-looking statements, any statements in this report or  the reports and other documents filed by us with the Securities and Exchange  Commission that warn of risks or uncertainties associated with future results,  events or circumstances also identify factors that could cause actual results  to differ materially from those expressed in or implied by the forward-looking  statements.





We do not  undertake any obligation to release publicly any revisions to these  forward-looking statements to reflect events or circumstances after the date of  this report or to reflect the occurrence of unanticipated events, except as may  be required under applicable securities law.





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|PART    I: | FINANCIAL    INFORMATION
|---------- | ------------------------




|ITEM    1: | Financial    Statements
|---------- | -----------------------




GENESIS  HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED  CONDENSED CONSOLIDATED BALANCE SHEETS


DECEMBER  31, 2005 AND SEPTEMBER 30, 2005


(IN  THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)





|                                                                                                                                                                                                               |  | December 31,    2005 |           | September 30,    2005 |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------- | --------- | --------------------- | -
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Assets:                                                                                                                                                                                                        |  |                      |           |                       |  
|Current assets:                                                                                                                                                                                                |  |                      |           |                       |  
|Cash    and equivalents, $8,039 and $7,442 restricted at December 31, 2005 and September    30, 2005, respectively                                                                                             |  | $                    | 90,363    |                       | $
|Current portion of    restricted investments in marketable securities                                                                                                                                          |  |                      | 36,162    |                       |  
|Accounts    receivable, net of allowances for doubtful accounts of $23,724 and $22,921,    at December 31, 2005 and September 30, 2005, respectively                                                           |  |                      | 205,050   |                       |  
|Prepaid expenses and    other current assets                                                                                                                                                                   |  |                      | 37,344    |                       |  
|Current portion of    deferred income taxes                                                                                                                                                                    |  |                      | 39,478    |                       |  
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Total current assets                                                                                                                                                                                           |  |                      | 408,397   |                       |  
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Property and equipment,    net of accumulated depreciation of $174,965 and $161,229, at December 31,    2005 and September 30, 2005, respectively                                                              |  |                      | 791,209   |                       |  
|Assets held for sale                                                                                                                                                                                           |  |                      | 3,911     |                       |  
|Restricted investments in marketable securities                                                                                                                                                                |  |                      | 55,318    |                       |  
|Deferred income taxes                                                                                                                                                                                          |  |                      | 6,820     |                       |  
|Other long-term assets                                                                                                                                                                                         |  |                      | 95,252    |                       |  
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Total assets                                                                                                                                                                                                   |  | $                    | 1,360,907 |                       | $
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Liabilities and Shareholders    Equity:                                                                                                                                                                       |  |                      |           |                       |  
|Current liabilities:                                                                                                                                                                                           |  |                      |           |                       |  
|Current installments of    long-term debt                                                                                                                                                                      |  | $                    | 4,163     |                       | $
|Accounts payable and    accrued expenses                                                                                                                                                                       |  |                      | 154,760   |                       |  
|Current portion of    self-insurance liability reserves                                                                                                                                                        |  |                      | 36,162    |                       |  
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Total current    liabilities                                                                                                                                                                                   |  |                      | 195,085   |                       |  
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Long-term debt                                                                                                                                                                                                 |  |                      | 404,839   |                       |  
|Self-insurance liability reserves                                                                                                                                                                              |  |                      | 59,248    |                       |  
|Other long-term liabilities                                                                                                                                                                                    |  |                      | 41,287    |                       |  
|Commitments and contingencies                                                                                                                                                                                  |  |                      |           |                       |  
|Shareholders equity:                                                                                                                                                                                          |  |                      |           |                       |  
|Common    stock - par $0.01, 45,000,000 shares authorized at December 31, 2005 and    September 30, 2005, 20,474,998 and 20,429,110 shares issued at December 31,    2005 and September 30, 2005, respectively |  |                      | 205       |                       |  
|Additional paid-in    capital                                                                                                                                                                                  |  |                      | 635,689   |                       |  
|Retained earnings                                                                                                                                                                                              |  |                      | 74,359    |                       |  
|Accumulated other    comprehensive loss                                                                                                                                                                        |  |                      | (684      | )                     |  
|Treasury    stock at cost, 1,075,737 and 787,337 shares at December 31, 2005 and    September 30, 2005, respectively                                                                                           |  |                      | (42,787   | )                     |  
|Common    stock held in deferred compensation plan at cost, 171,067 and 163,135 shares    at December 31, 2005 and September 30, 2005, respectively                                                            |  |                      | (6,334    | )                     |  
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Total shareholders    equity                                                                                                                                                                                  |  |                      | 660,448   |                       |  
|                                                                                                                                                                                                               |  |                      |           |                       |  
|Total liabilities and    shareholders equity                                                                                                                                                                  |  | $                    | 1,360,907 |                       | $
|                                                                                                                                                                                                               |  |                      |           |                       |  




See accompanying notes to unaudited condensed consolidated financial  statements.





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GENESIS  HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


THREE  MONTHS ENDED DECEMBER 31, 2005 AND 2004


(IN  THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)





|                                                                                                                 |  | Three months ended   |           
|---------------------------------------------------------------------------------------------------------------- |  | -------------------- | ----------
|                                                                                                                 |  | December 31,    2005 |           
|                                                                                                                 |  |                      |           
|Net revenues                                                                                                     |  | $                    | 430,593   
|Operating expenses:                                                                                              |  |                      |           
|Salaries, wages and    benefits                                                                                  |  |                      | 261,391   
|Other operating    expenses                                                                                      |  |                      | 93,230    
|General and    administrative costs                                                                              |  |                      | 28,321    
|Provision for losses on    accounts receivable and notes receivable                                              |  |                      | 2,844     
|Loss on early    extinguishment of debt                                                                          |  |                      |          
|Lease expense                                                                                                    |  |                      | 5,438     
|Depreciation and amortization expense                                                                            |  |                      | 14,310    
|Interest expense                                                                                                 |  |                      | 5,754     
|                                                                                                                 |  |                      |           
|Income before income tax    expense, equity in net income of unconsolidated affiliates and minority    interests |  |                      | 19,305    
|Income tax expense                                                                                               |  |                      | 8,062     
|                                                                                                                 |  |                      |           
|Income before equity in    net income of unconsolidated affiliates and minority interests                        |  |                      | 11,243    
|Equity in net income of unconsolidated affiliates                                                                |  |                      | 667       
|Minority interests                                                                                               |  |                      | (249      
|                                                                                                                 |  |                      |           
|Income from continuing operations                                                                                |  |                      | 11,661    
|Income from discontinued operations, net of taxes                                                                |  |                      | 25        
|                                                                                                                 |  |                      |           
|Net income                                                                                                       |  | $                    | 11,686    
|                                                                                                                 |  |                      |           
|Per common share data:                                                                                           |  |                      |           
|Basic:                                                                                                           |  |                      |           
|Income from continuing    operations                                                                             |  | $                    | 0.60      
|Income from    discontinued operations                                                                           |  |                      | 0.00      
|Net income                                                                                                       |  | $                    | 0.60      
|Weighted average shares                                                                                          |  |                      | 19,462,199
|Diluted:                                                                                                         |  |                      |           
|Income from continuing    operations                                                                             |  | $                    | 0.59      
|Income from    discontinued operations                                                                           |  |                      | 0.00      
|Net income                                                                                                       |  | $                    | 0.59      
|Weighted average shares                                                                                          |  |                      | 19,739,352




See accompanying notes to unaudited condensed consolidated financial  statements.





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GENESIS  HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


THREE  MONTHS ENDED DECEMBER 31, 2005 AND 2004


(IN  THOUSANDS)





|                                                             |  | Three months ended     |        
|------------------------------------------------------------ |  | ---------------------- | -------
|                                                             |  | December 31, 
    2005 |        
|                                                             |  |                        |        
|Cash flows from operating activities:                        |  |                        |        
|Net income                                                   |  | $                      | 11,686 
|Net charges included in    operations not requiring funds    |  |                        | 25,086 
|Changes in assets and    liabilities:                        |  |                        |        
|Accounts receivable                                          |  |                        | (20,128
|Accounts payable and    accrued expenses                     |  |                        | 1,482  
|Other, net                                                   |  |                        | 535    
|                                                             |  |                        |        
|Total adjustments                                            |  |                        | 6,975  
|                                                             |  |                        |        
|Net cash provided by    operating activities                 |  |                        | 18,661 
|                                                             |  |                        |        
|Cash flows from investing activities:                        |  |                        |        
|Capital expenditures                                         |  |                        | (31,598
|Net sales (purchases)    of restricted marketable securities |  |                        | 4,510  
|Purchase of eldercare    centers                             |  |                        | (5,023 
|Proceeds from sales of    eldercare assets                   |  |                        |       
|Other, net                                                   |  |                        | 6,284  
|                                                             |  |                        |        
|Net cash used in    investing activities                     |  |                        | (25,827
|                                                             |  |                        |        
|Cash flows from financing activities:                        |  |                        |        
|Repayment of long-term    debt                               |  |                        | (1,168 
|Purchase of common    stock for treasury                     |  |                        | (10,691
|Proceeds from exercise    of stock options                   |  |                        | 269    
|Other, net                                                   |  |                        | 78     
|                                                             |  |                        |        
|Net cash used in    financing activities                     |  |                        | (11,512
|                                                             |  |                        |        
|Net decrease in cash and equivalents                         |  | $                      | (18,678
|Cash and equivalents:                                        |  |                        |        
|Beginning of period                                          |  |                        | 109,041
|                                                             |  |                        |        
|End of period                                                |  | $                      | 90,363 
|                                                             |  |                        |        
|Supplemental disclosure of cash flow information:            |  |                        |        
|Interest paid                                                |  | $                      | 7,557  
|Taxes paid                                                   |  |                        | 3,455  
|Non-cash financing activities:                               |  |                        |        
|Capital leases                                               |  | $                      |       




See accompanying notes to unaudited condensed consolidated financial  statements.





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Genesis  HealthCare Corporation and Subsidiaries


Notes to  Unaudited Condensed Consolidated Financial Statements





|(1) | Organization and Basis of    Presentation
|--- | -----------------------------------------




Description  of Business





GHCs  business is comprised of two primary business segments, inpatient services and  rehabilitation therapy services.  These  segments are supported by complementary service capabilities and a general and  administrative function.





GHC  provides inpatient services through skilled nursing and assisted living centers  primarily located in the eastern United States.  At December 31, 2005, GHC had 211 owned, leased, managed and  jointly owned eldercare centers with 25,711 beds.  Revenues of GHCs owned and leased centers constitute  approximately 89% of GHCs revenues, and are presented in GHCs segment  information as inpatient services revenues.   Management fees earned from eldercare centers that are managed and/or  jointly owned by GHC are included in all other revenues presented in GHCs  segment information.  See note 6   Segment Information.





GHC  provides an extensive range of rehabilitation therapy services, including  speech pathology, physical therapy and occupational therapy.  These services are provided by approximately  4,900 licensed rehabilitation therapists and assistants employed or contracted  at substantially all of the eldercare centers operated by GHC, as well as by  contract to healthcare facilities operated by others and through any one of  GHCs 13 certified outpatient rehabilitation agencies.  After the elimination of intercompany  revenues, the rehabilitation therapy services segment constitutes approximately  8% of GHCs revenues.





GHC also  provides an array of other complementary services, including respiratory health  services, physician services, hospitality services, staffing services and other  healthcare related services.





Basis  of Presentation





The  accompanying unaudited condensed consolidated financial statements have been  prepared in accordance with accounting principles generally accepted in the  United States of America which requires the use of managements estimates.  In the opinion of management, the unaudited  condensed consolidated financial statements for the periods presented include  all necessary adjustments for a fair presentation of the financial position and  results of operations for the periods presented and all such adjustments are of  a normal recurring nature.  Certain  prior period balances have been reclassified to conform to the current period  classification, the effect of which was not material.





Factors  Affecting Comparability of Financial Information





During the  three months ended September 30, 2005, the Company reevaluated the  classification of certain of its leases and determined that five center leases  previously classified as operating leases beginning in fiscal 2004 should have  been classified as capital leases.  In  addition, during the three months ended September 30, 2005, the Company determined  it was not properly accounting for operating lease expense on a straight-line  basis.   The correction of this accounting took place  in the three months ended September 30, 2005 and had the effect of decreasing  lease expense and increasing interest expense and depreciation expense.  As a result of the change in classification  of these leases and the accounting for operating lease expense on a  straight-line basis, the unaudited condensed consolidated statement  of operations for the three months ended December 31, 2005 reflect


an increase  to depreciation expense of approximately $0.6 million, an increase to interest  expense of approximately $0.6 million and a decrease to lease expense of  approximately $1.1 million, resulting in a decrease to pre tax and net income  of $0.1 million as compared to the three months ended December 31, 2004.  In fiscal 2005, management  evaluated the quantitative and qualitative impact of the corrections,  individually and in the aggregate, on previously reported periods, on the 2005  fiscal year and on earnings trends.   Based upon this evaluation, management concluded the errors were not  material to the Companys consolidated financial statements taken as a whole  and recognized the errors in the period such errors were identified.





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|(2) | Certain Significant Risks and    Uncertainties
|--- | ----------------------------------------------




Revenue  Sources





GHC  receives revenues from Medicare, Medicaid, private insurance, self-pay  residents, other third-party payors and long-term care facilities that utilize  its rehabilitation therapy and other services.





The sources  and amounts of GHCs revenues are determined by a number of factors, including  licensed bed capacity and occupancy rates of its eldercare centers, the mix of  patients and the rates of reimbursement among payors.  Likewise, payment for ancillary medical services, including  services provided by GHCs rehabilitation therapy services business, vary based  upon the type of payor and payment methodologies.  Changes in the case mix of the patients as well as payor mix among  Medicare, Medicaid and private pay can significantly affect GHCs  profitability.





It is not  possible to quantify fully the effect of legislative changes, the  interpretation or administration of such legislation or other governmental  initiatives on GHCs business and the business of the customers served by GHCs  rehabilitation therapy business.   Accordingly, there can be no assurance that the impact of any future  healthcare legislation or regulation will not adversely affect GHCs business.  There can be no assurance that payments under  governmental and private third-party payor
 programs will be timely, will remain  at levels similar to present levels or will, in the future, be sufficient to  cover the costs allocable to patients eligible for reimbursement pursuant to  such programs.  GHCs financial  condition and results of operations will be affected by the reimbursement  process, which in the healthcare industry is complex and can involve lengthy  delays between the time that revenue is recognized and the time that  reimbursement amounts are settled.





Use  of Estimates





The Company  has made a number of estimates relating to the reporting of assets,  liabilities, revenues and expenses and the disclosure of contingent assets and  liabilities to prepare these unaudited condensed consolidated financial  statements in conformity with accounting principles generally accepted in the  United States of America.  Some of the  more significant estimates impact accounts receivable, long-lived assets and  loss reserves for self-insured programs.   It is at least reasonably possible that GHC will revise its estimates  significantly in the near term.  Any  subsequent differences arising are recorded in the period in which they are  determined.





|(3) | Significant Transactions and Events
|--- | -----------------------------------




Share  Repurchase





In February  2005, GHCs board of directors authorized an increase to the size of its  previously established share repurchase program from $25.0 million to $50.0  million of the Companys common stock through December 31, 2005.  Share repurchases took place at managements  discretion and/or under pre-established, nondiscretionary programs from time to  time, depending on market conditions, in the open market, and in privately  negotiated transactions.  Under this  program, 1,075,737 shares of common stock were repurchased at a cost of $42.8  million through December 31, 2005, of which 288,400 shares were repurchased at  a cost of $10.7 million during the three months ended December 31, 2005.





Purchase  of Joint Venture Interests





In December  2005, GHC deposited into escrow $4.1 million to acquire all of its joint  venture partners interests in three skilled nursing facilities located in the  State of West Virginia having a combined 208 beds.  GHC currently owns a 50% interest in and manages the operations  of each of the three facilities, but upon completion of the transaction will  own 100% of each facility and will therefore consolidate the related revenues,  expenses and net assets.  In accordance  with FASB Interpretation No. 46, Consolidation of Variable Interest Entities  an  Interpretation of ARB No. 51 (FIN46), GHC already consolidates the  financial statements of one of the facilities and records minority interest to  reflect its joint venture partners interests.   Because GHC extended this partnership mortgage financing, GHC is the  primary beneficiary of the partnership


, as defined by FIN 46, and is therefore





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required to consolidate it under FIN 46.  The combined annual revenues and pre tax income of the two  unconsolidated facilities is approximately $10.0 million and $1.2 million,  respectively.  The transaction, which is  subject to GHCs receipt of certain state regulatory approvals, is expected to  be completed during GHCs second or third fiscal quarter of 2006.





|(4) | Earnings Per Share
|--- | ------------------




The  computation of basic net income per common share is calculated by dividing net  income by the weighted average number of common shares outstanding during the  reporting period.  The computation of  diluted net income per common share is calculated by dividing net income by the  sum of the weighted average basic common shares and potentially dilutive  securities.  GHC applies the treasury  stock method in calculating potentially dilutive securities which assumes that  the proceeds from the exercise of all GHC stock options and their related tax  benefits are used to repurchase GHC common stock at the average market price  for the period.  Beginning October 1,  2005 and in connection with the Companys adoption of SFAS 123R (see note 7  Stock-Based Benefit Plans),
the  assumed proceeds include the average amount of compensation cost for stock  options during the reporting period attributed to future services and not yet  recognized.  For the three months ended  December 31, 2005 and 2004, GHCs outstanding stock options yielded 169,566 and  139,532, respectively, potentially dilutive securities.  For the three months ended December 31, 2005  and 2004, GHCs unvested restricted stock yielded an additional 107,587 and  112,989, respectively, potentially dilutive securities under the treasury stock  method.





|(5) | Comprehensive Income
|--- | --------------------




The  following table sets forth the computation of comprehensive income for the  three months ended December 31, 2005 and 2004 (in thousands):





|                                                                          |  | Three months ended December 31, |       
|------------------------------------------------------------------------- |  | ------------------------------- | ------
|                                                                          |  | 2005                            |       
|                                                                          |  |                                 |       
|Net income                                                                |  | $                               | 11,686
|Net unrealized loss on restricted investments in    marketable securities |  |                                 | (81   
|                                                                          |  |                                 |       
|Total comprehensive income                                                |  | $                               | 11,605
|                                                                          |  |                                 |       




The  unrealized loss on restricted investments in marketable securities is net of  income tax benefits.  The income tax  benefit for the three months ended December 31, 2005 was not significant.  The income tax benefit for the three months  ended December 31, 2004 was $0.2 million.





|(6) | Segment Information
|--- | -------------------




The  Companys principal operating segments are identified by the types of products  and services from which revenues are derived and are consistent with the  reporting structure of the Companys internal organization.





The Company  includes in inpatient services revenues all room and board charges and  ancillary service revenue for its eldercare customers at the eldercare centers  which the Company owns or leases.





The Company  includes in rehabilitation therapy services all revenues earned from the  provisions of speech pathology, physical therapy and occupational therapy.





The  accounting policies of the segments are the same as those of the consolidated  organization.  All intersegment sales  prices are market based.





Summarized  financial information concerning the Companys reportable segments is shown in  the following table.  The All other  services and corporate costs category of revenues and EBITDA represents  operating





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information of business units below the prescribed quantitative  thresholds that trigger segment reporting requirements, and the Companys  corporate support functions.  The  operating business units in this category derive revenues from the following  services: management services, respiratory health services, physician services,  hospitality services, staffing services and other healthcare related  services.  The Loss on early  extinguishment of debt category has not been allocated to the Companys  reportable segments or the All other services and corporate costs category.  This approach to segment reporting is  consistent with the Companys internal financial reporting and the information  used by the chief operating decision maker regarding the performance of the  Companys reportable and non-reportable segments.


|                                                     |  | Three    months ended December 31, |        
|---------------------------------------------------- |  | ---------------------------------- | -------
|(in thousands)                                       |  | 2005                               |        
|                                                     |  |                                    |        
|Revenues:                                            |  |                                    |        
|Inpatient services -    external                     |  | $                                  | 384,171
|Rehabilitation    services:                          |  |                                    |        
|External                                             |  |                                    | 35,970 
|Intersegment                                         |  |                                    | 22,175 
|All other services:                                  |  |                                    |        
|External                                             |  |                                    | 10,452 
|Intersegment                                         |  |                                    | 12,498 
|Elimination of    intersegment revenues              |  |                                    | (34,673
|                                                     |  |                                    |        
|Total net revenues                                   |  |                                    | 430,593
|                                                     |  |                                    |        
|EBITDA (1):                                          |  |                                    |        
|Inpatient services                                   |  |                                    | 51,012 
|Rehabilitation services                              |  |                                    | 3,552  
|All other services and    corporate costs            |  |                                    | (15,195
|Loss on early    extinguishment of debt              |  |                                    |       
|                                                     |  |                                    |        
|Total EBITDA                                         |  |                                    | 39,369 
|                                                     |  |                                    |        
|Capital and other:                                   |  |                                    |        
|Depreciation and    amortization expense             |  |                                    | (14,310
|Interest expense                                     |  |                                    | (5,754 
|Income tax expense                                   |  |                                    | (8,062 
|Equity in net income of    unconsolidated affiliates |  |                                    | 667    
|Minority interests                                   |  |                                    | (249   
|                                                     |  |                                    |        
|Income from continuing    operations                 |  |                                    | 11,661 
|Income from    discontinued operations, net of taxes |  |                                    | 25     
|                                                     |  |                                    |        
|Net income                                           |  | $                                  | 11,686 
|                                                     |  |                                    |        




|   
|---
|(1)




| | The EBITDA of the segments for the three months    ended December 31, 2004 previously reported was adjusted to reflect incentive    compensation expenses at the segment level.     This adjustment was made to conform to the current quarter    presentation which includes such expenses at the segment level and for the    change in GHCs internal financial reporting during the quarter.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                 




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Total assets by segment at December 31, 2005 and    September 30, 2005 were as follows (in thousands):





|                                   |  | December 31,    2005 |           | September 30,    2005 |  
|---------------------------------- |  | -------------------- | --------- | --------------------- | -
|                                   |  |                      |           |                       |  
|Inpatient services                 |  | $                    | 969,201   |                       | $
|Rehabilitation therapy    services |  |                      | 40,573    |                       |  
|All other                          |  |                      | 351,133   |                       |  
|                                   |  |                      |           |                       |  
|Total assets                       |  | $                    | 1,360,907 |                       | $
|                                   |  |                      |           |                       |  




|(7) | Stock-Based    Benefit Plans
|--- | ----------------------------




Adoption  of New Accounting Standard





Effective  October 1, 2005, the Company adopted the provisions of SFAS No. 123(R), Share-Based  Payment (SFAS 123R).  SFAS  123R establishes accounting for stock-based awards exchanged for employee  services.  Accordingly, stock-based  compensation cost is measured at the grant date, based on the fair value of the  award, and is recognized as expense over the requisite employees service  period.  The Company previously applied  Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to  Employees, and related Interpretations and provided the required  pro forma disclosures of SFAS No. 123, Accounting for Stock-Based Compensation  (SFAS 123).





Generally,  the approach in SFAS 123R to stock based payment accounting is similar to SFAS  123.  However, SFAS 123R requires all  share-based payments to employees, including grants of employee stock options,  to be recognized as compensation cost in the statement of operations at their  fair values.  Pro forma disclosure is no  longer an alternative under SFAS 123R.





The  Company elected to adopt SFAS 123R using the modified prospective application  method in which compensation cost is recognized beginning with the effective  date (a) based upon the requirements of SFAS 123R for all share-based payments  granted after the effective date, and (b) based on the requirements of SFAS 123  for all awards granted to employees prior to the effective date of SFAS 123R  that remain unvested on the effective date.





Stock-Based  Compensation Expenses





The  Company recorded stock-based compensation expense for the three months ended  December 31, 2005 and 2004 as follows (in thousands):





|                                         |  | Three    months ended |      
|---------------------------------------- |  | --------------------- | -----
|                                         |  | December    31,2005   |      
|                                         |  |                       |      
|Stock options                            |  | $                     | 573  
|Stock incentive plan                     |  |                       | 1,773
|Stock held in deferred compensation plan |  |                       | (687 
|                                         |  |                       |      
|Total                                    |  | $                     | 1,659
|                                         |  |                       |      




The  stock-based compensation expenses in the table above are presented before the  effect of income taxes which were a benefit of $0.7 million and $0.5 million for the three months ended December 31, 2005 and 2004, respectively.  Net income was reduced $1.0 million and $0.8 million  for the three months ended December 31, 2005 and 2004, respectively, as a  result of stock-based compensation expenses.





The  Companys stock option and stock incentive plans are more fully described under  their respective sections below.  Stock  held in deferred compensation plan is associated with a non-qualified deferred  compensation plan established in fiscal 2004 for certain employees.  Under the provisions of the plan, a rabbi  trust was established to





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maintain the amount of compensation deferred  by the participants.  A rabbi trust is a  funding vehicle used to protect deferred compensation benefits from various  events, excluding bankruptcy or insolvency.   Certain of the plan participants have elected to invest their deferred  compensation in GHC stock units, which effectively mirror the performance of  GHCs common stock.  To satisfy this  portion of the Companys obligation under the plan, GHC held 171,067 shares of  its common stock in the rabbi trust at December 31, 2005.  The Company funds the rabbi trust with an  amount of shares of GHC common stock that approximates the number of stock  units invested by plan participants.  In  accordance with the provisions of the Emerging Issues Task Force (EITF) Issue  No. 97-14, Accounting  for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi  Trust and Invested, (EITF 97-14),
the Company has recorded the $6.3  million cost of the shares of common stock as a reduction of shareholders  equity at December 31, 2005.  Also, as  prescribed by EITF 97-14, the Company is required to recognize future changes  in the fair value of the common stock units as designated by the plan  participants in the deferred compensation plan as periodic charges or credits  to compensation cost.  For the three  months ended December 31, 2005 and 2004, GHC recognized $(0.7) million and $0.5  million, respectively, of net compensation (benefit) cost from such changes in  the fair value of the common stock units of the deferred compensation plan.





Prior to October 1, 2005, as permitted by  SFAS 123, the Company accounted for share-based payments to employees using APB  25s intrinsic value method and recognized no compensation cost for employee  stock options in prior years.  Had the  Company adopted SFAS 123R prior to October 1, 2005, the impact of that standard  would have approximated the impact of SFAS 123 in the disclosure of pro forma  net income and earnings per share described as follows (in thousands, except  per share data):





|                                                                                         |  | Three    months    ended    December 31,    2004 |       
|---------------------------------------------------------------------------------------- |  | ------------------------------------------------ | ------
|                                                                                         |  |                                                  |       
|Net income, as reported                                                                  |  | $                                                | 10,848
|Adjustments:                                                                             |  |                                                  |       
|Stock-based    compensation included in net income, net of tax effects                   |  |                                                  | 793   
|Stock-based    compensation determined under fair value based method, net of tax effects |  |                                                  | (1,605
|                                                                                         |  |                                                  |       
|Pro forma net income                                                                     |  | $                                                | 10,036
|                                                                                         |  |                                                  |       
|Per common share data:                                                                   |  |                                                  |       
|Basic:                                                                                   |  |                                                  |       
|Net income as reported                                                                   |  | $                                                | 0.54  
|Net income pro forma                                                                     |  | $                                                | 0.50  
|Diluted:                                                                                 |  |                                                  |       
|Net income as reported                                                                   |  | $                                                | 0.54  
|Net income pro forma                                                                     |  | $                                                | 0.49  
|                                                                                         |  |                                                  |       




The Company  previously reported diluted (pro forma) net income per share of $0.49 for the  three months ended December 31, 2004.   The revised diluted (pro forma) net income per share of $0.50 per share  reflects changes to the Companys previous assumptions regarding expected  volatility, expected life and the related tax effects of stock options.  These changes were prompted by the Companys  evaluation of more recent guidance regarding the application and methods used  to determine fair value based compensation expense.





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Stock  Option Plan





GHC has a  stock option plan that provides for the grant of incentive stock options and  non-qualified stock options for officers, key employees and non-employee  directors.  A total of 1,500,000 shares  of GHC common stock were reserved for issuance under the stock option plan, of  which 123,000 were available for grant at December 31, 2005.  The exercise price of each stock option  equals 100% of the market price of GHCs common stock on the date of grant and  generally each stock option has a maximum term of 10 years.  Stock options are generally subject to  vesting, which means the optionee earns the right to exercise an increasing  number of the shares underlying the option over a specific period of time only  if he or she continues to provide services to GHC over that period.  Options generally vest quarterly over three  years and provide for accelerated vesting if there is a


change in control of  the Company, as defined in the option grant.   The Company distributes newly issued common shares to satisfy its  obligations under the stock option plan.





The fair  value of each option award granted prior to October 1, 2005 was estimated on  the date of grant using a Black-Scholes-Merton option valuation model.  The fair value of each option award granted  after the October 1, 2005 adoption of SFAS 123R is estimated on the grant date  using a lattice-based binomial option pricing model.  Because GHC was a newly formed public company effective December  1, 2003, expected volatility is based on the historical volatility of similar  companies and also on the implied volatility from traded options on the stocks  of similar companies.  The risk free  rate for the expected life of each option award is based on the U.S. Treasury  yield curve in effect at the time of grant. 
The expected term of each option award used as an input to the  Black-Scholes-Merton option valuation model is derived from the output of a  lattice-based option valuation model, in which option exercise and employee  termination rates are based on published research studies regarding executive  behavior in these areas.  A range of  expected terms results from certain groups of employees exhibiting different  behavior and from the graded vesting nature of the awards.





The  weighted average fair value of stock options of $17.47 per share for options  granted during the three months ended December 31, 2005 was determined using  the lattice-based binomial option pricing model with the following  assumptions:  expected volatility (46%),  weighted average expected life (6.6 years), weighted average risk free rate of  return (4.35%) and dividend yield (0.00%).   There were no stock options granted during the three months ended  December 31, 2004.  The Company believes  that the valuation technique and the approach utilized to develop the  underlying assumptions are appropriate in estimating the fair values of GHC  stock options granted during the three months ended December 31, 2005
and are  consistent with those used in prior disclosures in the footnotes to the 2005  GHC Annual Report on Form 10-K for the year ended September 30, 2005.  Estimates of fair value are not intended to  predict actual future events or the value ultimately realized by employees who  receive equity awards, and subsequent events are not indicative of the  reasonableness of the original estimates of fair value made by the Company  under SFAS 123R.





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Changes to  the stock option plan for the three months ended December 31, 2005 are as  follows:


|                                 |  | Shares |           | Weighted    Average    Exercise     Price |   | Intrinsic    Value  (in thousands) |  | Weighted    Average    Remaining    Contractual    Life |      
|-------------------------------- |  | ------ | --------- | ----------------------------------------- | - | ---------------------------------- |  | ------------------------------------------------------- | -----
|                                 |  |        |           |                                           |   |                                    |  |                                                         |      
|Outstanding at October 1, 2005   |  |        | 576,976   |                                           | $ | 23.72                              |  |                                                         |      
|                                 |  |        |           |                                           |   |                                    |  |                                                         |      
|Granted                          |  |        | 477,000   |                                           |   | 36.40                              |  |                                                         |      
|Exercised                        |  |        | (12,062   | )                                         |   | 24.55                              |  | $                                                       | 195  
|                                 |  |        |           |                                           |   |                                    |  |                                                         |      
|Outstanding at December 31, 2005 |  |        | 1,041,914 |                                           |   | 29.51                              |  |                                                         | 7,303
|                                 |  |        |           |                                           |   |                                    |  |                                                         |      
|Exercisable at December 31, 2005 |  |        | 267,409   |                                           | $ | 23.53                              |  | $                                                       | 3,474
|                                 |  |        |           |                                           |   |                                    |  |                                                         |      




No
    stock options were forfeited or expired during the three months ended December
    31, 2005.  Cash received from stock option  exercises totaled $0.3 million
    and $1.2 million in the three months ended December 31, 2005 and 2004, respectively.





The  following table summarizes information about stock options outstanding at  December 31, 2005:





|                         |  | Stock Options Outstanding |         | Stock Options Exercisable                               | 
|------------------------ |  | ------------------------- | ------- | ------------------------------------------------------- | 
|                         |  |                           |         |                                                         | 
|Range of Exercise Prices |  | Number                    |         | Weighted    Average    Remaining    Contractual    Life | 
|                         |  |                           |         |                                                         | 
|$20.00 - $29.99          |  |                           | 564,914 |                                                         | 
|$30.00 - $39.99          |  |                           | 477,000 |                                                         | 
|                         |  |                           |         |                                                         | 




The  following table presents information regarding unvested option activity during  the three month period ended December 31, 2005:





|                                |  | Non-Vested    Number of    Options |         | Weighted    Average    Grant-Date    Fair    Value |  
|------------------------------- |  | ---------------------------------- | ------- | -------------------------------------------------- | -
|                                |  |                                    |         |                                                    |  
|Non-vested at October 1, 2005   |  |                                    | 381,263 |                                                    | $
|Granted                         |  |                                    | 477,000 |                                                    |  
|Vested                          |  |                                    | (83,758 | )                                                  |  
|                                |  |                                    |         |                                                    |  
|Non-vested at December 31, 2005 |  |                                    | 774,505 |                                                    | $
|                                |  |                                    |         |                                                    |  




As of December 31, 2005, there was $8.2 million of total unrecognized  compensation cost related to non-vested stock options granted under the  plan.  That cost is expected to be  recognized over the remaining weighted-average period of 1.4 years.





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Stock  Incentive Plan





GHC has a  stock incentive plan that provides for the grant of restricted stock to certain  GHC officers, directors and employees.   The
    number of shares of common stock available for issuance under the 2003 stock
    incentive plan is 1,000,000, of which 175,750 shares are available for grant
    at December 31, 2005.   Restrictions on the awards to GHC employees typically vest quarterly  over a five year period from the date of grant such that the employee cannot  sell or trade the restricted stock until it becomes vested.  In fiscal 2004 and fiscal 2005, GHC made  annual restricted stock grants of $95,000 worth of shares of its common stock  to each of its seven non-employee directors.   In the three months ended December 31, 2005, GHC made its fiscal 2006  annual grant of restricted shares to its seven non-employee directors each  having a market value of $105,000.  All  restricted stock grants made to non-employee directors vest on the earlier of  three


 years from the date of grant or the date the director no longer serves as  a member of the board.  During the three months ended December 31, 2005, GHC granted 141,750 restricted shares to employees with a grant date fair value of $40.87 per share. The Company  distributes newly issued common shares to satisfy its obligations under the  stock incentive plan.





GHC  recognizes compensation expense ratably over each quarterly vesting period at  the market value of GHCs common stock on the grant date.  GHC recorded compensation expense of $1.8  million and $0.8 million in the three months ended December 31, 2005 and 2004,  respectively, for employee and director restricted stock grants.





The  following table presents restricted stock activity during the three months  ended December 31, 2005:





|                                |  | Non-Vested    Number of    Shares |         | Weighted    Average    Grant-Date    Fair    Value |  
|------------------------------- |  | --------------------------------- | ------- | -------------------------------------------------- | -
|                                |  |                                   |         |                                                    |  
|Non-vested at October 1, 2005   |  |                                   | 492,253 |                                                    | $
|Granted                         |  |                                   | 159,085 |                                                    |  
|Vested and Distributed          |  |                                   | (33,826 | )                                                  |  
|Forfeited                       |  |                                   | (650    | )                                                  |  
|                                |  |                                   |         |                                                    |  
|Non-vested at December 31, 2005 |  |                                   | 616,862 |                                                    | $
|                                |  |                                   |         |                                                    |  




As of  December 31, 2005, there was $15.2 million of total unrecognized compensation  cost related to non-vested restricted stock granted.  This unrecognized compensation cost is expected to be recognized  over the remaining weighted-average period of 3.7 years.





|(8) | New    Accounting Pronouncements
|--- | --------------------------------




The  Meaning of Other-Than-Temporary Impairment and Its Application to Certain  Investments





In November  2005, the final version of FASB Staff Position (FSP) SFAS 115-1 and SFAS 124-1,  The  Meaning of Other-Than-Temporary Impairment and Its Application to Certain  Investments (FSP SFAS 115-1) was issued and addresses the  determination of when an investment is considered impaired; whether the  impairment is other than temporary; and how to measure an impairment loss.  FSP SFAS 115-1 also addresses accounting  considerations subsequent to the recognition of an other-than-temporary  impairment on a debt security, and requires certain disclosures about  unrealized losses that have not been recognized as other-than-temporary  impairments. 
FSP SFAS 115-1 replaces  the impairment guidance in EITF Issue No. 03-1 with references to existing  authoritative literature concerning other-than-temporary impairment  determinations (principally SFAS No. 115 and Staff Accounting Bulletin No.  59).  Under FSP SFAS 115-1, impairment  losses must be recognized in earnings equal to the entire difference between  the securitys cost and its fair value at the financial statement date, without  considering partial recoveries subsequent to that date.  FSP SFAS 115-1 also requires that an  investor recognize an





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other-than-temporary impairment loss when a decision to sell a security  has been made and the investor does not expect the fair value of the security  to fully recover prior to the expected time of sale.  FSP SFAS 115-1 is effective for reporting periods beginning after  December 15, 2005, or January 1, 2006 for GHC.  As the  majority of GHCs investments are investment grade government and corporate  debt securities that have maturities of five years or less, it does not expect  FSP SFAS 115-1 to have a material impact on its consolidated financial  statements.





Matters  Involving Convertible Debt Instruments





In  September 2005, the FASB ratified the EITFs Issue No. 05-7, Accounting  for Modifications to Conversion Options Embedded in Debt Instruments and  Related Issues (EITF 05-7), which addresses whether a modification  to a conversion option that changes its fair value effects the recognition of  interest expense for the associated debt instrument after the modification, and  whether a borrower should recognize a beneficial conversion feature, not a debt  extinguishment, if a debt modification increases the intrinsic value of the  debt (for example, the modification reduces the conversion price of the  debt). 
This treatment should be  applied to future modifications of debt instruments beginning in the first  interim or annual reporting period beginning after December 15, 2005, or  January 1, 2006 for GHC.  The adoption of EITF 05-7 is not expected to  have a material impact on the Companys financial statements.





In  September 2005, the FASB ratified the EITFs Issue No. 05-8, Income Tax  Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature.  (EITF 05-8).  Under EITF 05-8,  the issuance of convertible debt with a beneficial conversion feature results  in a basis difference for purposes of applying SFAS No. 109, Accounting  for Income Taxes (SFAS 109).   The Task Force reached a consensus that the basis difference that  results from the issuance of convertible debt with a beneficial conversion  feature is a temporary difference for purposes of applying SFAS 109, and that  such temporary difference should be recorded as an adjustment to additional  paid-in capital. 
This treatment should  be applied to the first financial statements beginning in the first interim or  annual reporting period beginning after December 15, 2005, or January 1, 2006  for GHC.  The adoption of EITF 05-8 is not expected to have a material impact on the  Companys financial statements.





Embedded  Derivatives





In  June 2005, the FASB issued guidance on SFAS No. 133, Accounting  for Derivative Instruments and Hedging Activities as amended (SFAS  133) in Derivative Implementation Group (DIG) Issue B38, Embedded Derivatives:  Evaluation of Net Settlement with Respect to  the Settlement of a Debt Instrument through Exercise of an Embedded Put Option  or Call Option (DIG Issue B38) and Issue B39, Embedded Derivatives:  Application of Paragraph 13(b) to Call  Options That Are Exercisable Only by the Debtor (DIG Issue  B39).  The guidance in DIG Issue B38  clarifies that the potential settlement of a debtors obligation to a creditor  that would occur upon exercise of a put or call option meets the net settlement  criteria of SFAS No. 133. 
The  guidance in DIG Issue B39 clarifies that an embedded call option that can  accelerate the settlement of a debt host financial instrument should not be  bifurcated and fair valued if the right to accelerate the settlement can be  exercised only by the debtor (issuer/borrower), it is underlying an interest  rate index and the investor will recover substantially all of its initial net  investment.  Both DIG issues will be  effective for the fiscal quarter beginning after December 15, 2005, or January  1, 2006 for GHC.  The Company is  currently evaluating the impact, if any, of adopting DIG Issue B38 and DIG  Issue B39 on its consolidated financial statements.





General  Partner Control of Limited Partnerships





In June  2005, the EITF reached a consensus on EITF Issue No. 04-5, Determining Whether a General Partner,  or the General Partners as a Group, Controls a Limited Partnership or Similar  Entity When the Limited Partners Have Certain Rights (EITF 04-5).  This consensus applies to voting right entities not within the scope of FIN  46(R) in which the investor is the general partner(s) in a limited partnership  or functional equivalent. The EITF consensus is that the general partner(s) in  a limited partnership is presumed to control that limited partnership and  therefore should include the limited partnership in its consolidated financial  statements. The general partner(s) may overcome this presumption of control and  not consolidate the entity if the limited partners have: (a) the substantive  ability to dissolve (liquidate) the limited partnership or otherwise remove the  general partner


 through substantive kick-out rights that can be exercised  without having to show cause; or (b) substantive participating rights in  managing the





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partnership. This guidance became immediately effective upon  ratification by the FASB on June 29, 2005 for all newly formed limited  partnerships and for existing limited partnerships for which the partnership  agreements have been modified. For general partners in all other limited partnerships,  the guidance is effective no later than the beginning of the first reporting  period in fiscal years beginning after December 15, 2005, or October 1, 2006  for the Company. The Company continues, but has not completed, evaluating the  impact of applying the provisions of EITF No. 04-5 to its existing  unconsolidated joint venture partnerships, but does not expect the adoption  will have a material impact on its consolidated financial statements.





Accounting  Changes and Error Corrections





In  May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error  Correctionsa replacement of APB Opinion No. 20 and FASB Statement  No. 3.  This statement  changes the requirements for the accounting for and reporting of a change in  accounting principle.  This statement  applies to all voluntary changes in accounting principle.  It also applies to changes required by an  accounting pronouncement in the unusual instance that the pronouncement does  not include specific transition provisions.   When a pronouncement includes specific transition provisions, those  provisions should be followed. APB No. 20 previously required that most  voluntary changes in accounting principle be recognized by including in net  income of the period of the change the cumulative effect of changing to the new  accounting principle.
SFAS 154 requires retrospective application to prior  period financial statements of changes in accounting principle, unless it is  impracticable to determine either the period-specific effects or the cumulative  effect of the change.  This statement  does not change the guidance for reporting the correction of an error in  previously issued financial statements or the change in an accounting estimate.  SFAS No. 154 is effective for accounting changes and corrections of errors  made in fiscal years beginning after December 15, 2005, or October 1, 2006  for GHC.  The Company does not expect  this statement to have a material impact on its consolidated financial statements.





Accounting for Conditional Asset Retirement Obligations





In
    March 2005, the FASB issued Interpretation No. 47, “Accounting for
    Conditional Asset Retirement Obligationsan Interpretation of SFAS
    No. 143,” (FIN 47). This interpretation provides clarification with
    respect to the timing of liability recognition for legal obligations associated
    with the retirement of tangible long-lived assets when the timing and/or
    method of settlement of the obligation are conditional on a future event.
    FIN 47 is effective no later than the end of all fiscal years ending after
    December 15, 2005, or September 30, 2006 for GHC. Retrospective application
    for interim financial information is permitted but is not required. The Company
    does not expect the adoption of this statement to have a material impact
on its financial statements.





|(9) | Commitments    and Contingencies
|--- | --------------------------------




GHC is a  party to litigation and regulatory investigations arising in the ordinary  course of business.  Management does not  believe the results of such litigation or regulatory investigations would have  a material adverse effect on the financial position of GHC.





At December  31, 2005 GHC has:





| |  | extended $4.1 million in working capital lines of    credit to certain jointly owned and managed companies, of which $2.2 million    was unused;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                 
| |  | posted $1.8 million of outstanding letters of credit    to guarantee the performance to third parties of various trade activities;    and       
| |   |                                                                                                                                                 
| |  | provided $0.3 million of financial guarantees    related to loan commitments of one jointly owned and managed company.                          




|(10) | Condensed Consolidating Financial    Statements of Genesis HealthCare Corporation and Subsidiaries
|---- | --------------------------------------------------------------------------------------------------




The  following condensed consolidating financial statements of GHC and subsidiaries  have been prepared pursuant to Rule 3-10 of Regulation S-X.





These  unaudited condensed consolidating financial statements have been prepared on  the same basis of accounting as the unaudited condensed consolidated financial  statements.  GHC is the borrower under a  senior credit facility, senior subordinated notes and convertible senior  subordinated debentures.  In April 2004,  GHC filed a registration statement on Form S-4 with the Securities and Exchange  Commission in connection with the exchange offer relating to the senior  subordinated notes. 
In July  2004, upon the expiration of the exchange offer, $224.0 million aggregate  principal amount of senior subordinated notes registered under the Securities  Act of 1933, as amended, were exchanged for the unregistered notes issued in  October 2003.  The aggregate principal  amount of $1.0 million of unregistered notes was not exchanged and remains  outstanding.  In March 2005, GHC  completed the private placement of its 2.5% convertible senior subordinated  debentures due 2025 to qualified institutional buyers





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under Rule 144A of the Securities Act of 1933, as amended.  In June 2005, the Company filed a  registration statement on Form S-3 with the Securities and Exchange Commission  to register the resale of the convertible senior subordinated debentures and  the relating guarantees and underlying common stock.  The senior subordinated  notes and the convertible senior subordinated debentures are fully and  unconditionally guaranteed on a joint and several basis by certain 100% owned  subsidiaries of GHC (Guarantors). 
Non-guarantor  subsidiaries do not guarantee the senior subordinated notes or the convertible  senior subordinated debentures and principally consist of Liberty Health Corporation  (LHC), GHCs wholly owned insurance captive, and certain separately mortgaged  eldercare centers (Non-guarantors).  The  following tables present the unaudited condensed consolidating financial  statements of GHC (Parent), the Guarantors and the Non-guarantors.





GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS


DECEMBER 31, 2005


(IN THOUSANDS)





|                                              |  | Parent |           | Guarantors |   | Non-guarantors |  | Eliminations |         | Consolidated |  
|--------------------------------------------- |  | ------ | --------- | ---------- | - | -------------- |  | ------------ | ------- | ------------ | -
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Assets:                                       |  |        |           |            |   |                |  |              |         |              |  
|Current    assets                             |  | $      | 128,267   |            | $ | 232,226        |  | $            | 50,157  |              | $
|Property    and equipment, net                |  |        | 25,805    |            |   | 758,213        |  |              | 7,191   |              |  
|Other    long-term assets                     |  |        | 110,630   |            |   | 23,817         |  |              | 67,053  |              |  
|Investments    in subsidiaries                |  |        | 478,134   |            |   |               |  |              |        |              |  
|Intercompany    receivables                   |  |        | 373,909   |            |   |               |  |              |        |              |  
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Total assets                                  |  | $      | 1,116,745 |            | $ | 1,014,256      |  | $            | 124,401 |              | $
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Liabilities and    shareholders equity:      |  |        |           |            |   |                |  |              |         |              |  
|Current    liabilities                        |  | $      | 64,338    |            | $ | 93,441         |  | $            | 38,940  |              | $
|Intercompany    payables                      |  |        |          |            |   | 363,767        |  |              | 10,142  |              |  
|Long-term    debt                             |  |        | 338,285   |            |   | 58,906         |  |              | 12,091  |              |  
|Other    long-term liabilities                |  |        | 53,674    |            |   | 993            |  |              | 47,550  |              |  
|Shareholders    equity                       |  |        | 660,448   |            |   | 497,149        |  |              | 15,678  |              |  
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Total liabilities and    shareholders equity |  | $      | 1,116,745 |            | $ | 1,014,256      |  | $            | 124,401 |              | $
|                                              |  |        |           |            |   |                |  |              |         |              |  




GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS


SEPTEMBER 30, 2005


(IN THOUSANDS)





|                                              |  | Parent |           | Guarantors |   | Non-guarantors |  | Eliminations |         | Consolidated |  
|--------------------------------------------- |  | ------ | --------- | ---------- | - | -------------- |  | ------------ | ------- | ------------ | -
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Assets:                                       |  |        |           |            |   |                |  |              |         |              |  
|Current    assets                             |  | $      | 150,087   |            | $ | 211,733        |  | $            | 52,090  |              | $
|Property    and equipment, net                |  |        | 25,043    |            |   | 751,055        |  |              | 7,261   |              |  
|Other    long-term assets                     |  |        | 104,668   |            |   | 25,738         |  |              | 67,352  |              |  
|Investments    in subsidiaries                |  |        | 424,662   |            |   |               |  |              |        |              |  
|Intercompany    receivables                   |  |        | 397,272   |            |   |               |  |              |        |              |  
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Total assets                                  |  | $      | 1,101,732 |            | $ | 988,526        |  | $            | 126,703 |              | $
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Liabilities and    shareholders equity:      |  |        |           |            |   |                |  |              |         |              |  
|Current    liabilities                        |  | $      | 54,979    |            | $ | 98,287         |  | $            | 47,596  |              | $
|Intercompany    payables                      |  |        |          |            |   | 391,104        |  |              | 6,168   |              |  
|Long-term    debt                             |  |        | 338,780   |            |   | 59,185         |  |              | 12,111  |              |  
|Other    long-term liabilities                |  |        | 51,324    |            |   | 1,611          |  |              | 47,289  |              |  
|Shareholders    equity                       |  |        | 656,649   |            |   | 438,339        |  |              | 13,539  |              |  
|                                              |  |        |           |            |   |                |  |              |         |              |  
|Total liabilities and    shareholders equity |  | $      | 1,101,732 |            | $ | 988,526        |  | $            | 126,703 |              | $
|                                              |  |        |           |            |   |                |  |              |         |              |  




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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS


THREE MONTHS ENDED DECEMBER 31, 2005


(IN THOUSANDS)





|                                                                                                                                  |  | Parent |        | Guarantors |   | Non-guarantors |   | Eliminations |        | Consolidated |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ------ | ------ | ---------- | - | -------------- | - | ------------ | ------ | ------------ | -
|                                                                                                                                  |  |        |        |            |   |                |   |              |        |              |  
|Net revenues                                                                                                                      |  | $      | 1,690  |            | $ | 449,269        |   | $            | 14,307 |              | $
|Equity in net income of    subsidiaries                                                                                           |  |        | 40,202 |            |   |               |   |              |       |              |  
|Operating expenses                                                                                                                |  |        | 29,571 |            |   | 375,839        |   |              | 14,823 |              |  
|Lease expense                                                                                                                     |  |        | 446    |            |   | 4,992          |   |              |       |              |  
|Depreciation and    amortization expense                                                                                          |  |        | 2,789  |            |   | 11,422         |   |              | 99     |              |  
|Interest expense                                                                                                                  |  |        | 4,529  |            |   | 1,061          |   |              | 260    |              |  
|                                                                                                                                  |  |        |        |            |   |                |   |              |        |              |  
|Income (loss) before    income tax (benefit) expense, equity in net income of unconsolidated    affiliates and minority interests |  |        | 4,557  |            |   | 55,955         |   |              | (875   | )            |  
|Income tax (benefit)    expense                                                                                                   |  |        | (6,138 | )          |   | 14,810         |   |              | (358   | )            |  
|                                                                                                                                  |  |        |        |            |   |                |   |              |        |              |  
|Income (loss) before    equity in net income of unconsolidated affiliates and minority interests                                  |  |        | 10,695 |            |   | 41,145         |   |              | (517   | )            |  
|Equity in net income of    unconsolidated affiliates                                                                              |  |        | 905    |            |   |               |   |              |       |              |  
|Minority interests                                                                                                                |  |        |       |            |   |               |   |              |       |              |  
|                                                                                                                                  |  |        |        |            |   |                |   |              |        |              |  
|Income (loss) from    continuing operations                                                                                       |  |        | 11,600 |            |   | 41,145         |   |              | (517   | )            |  
|Income (loss) from    discontinued operations, net of taxes                                                                       |  |        | 86     |            |   | (118           | ) |              | 57     |              |  
|                                                                                                                                  |  |        |        |            |   |                |   |              |        |              |  
|Net income (loss)                                                                                                                 |  | $      | 11,686 |            | $ | 41,027         |   | $            | (460   | )            | $
|                                                                                                                                  |  |        |        |            |   |                |   |              |        |              |  




GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS


THREE MONTHS ENDED DECEMBER 31, 2004


(IN THOUSANDS)





|                                                                                                                                  |  | Parent |         | Guarantors |   | Non-guarantors |  | Eliminations |        | Consolidated |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ------ | ------- | ---------- | - | -------------- |  | ------------ | ------ | ------------ | -
|                                                                                                                                  |  |        |         |            |   |                |  |              |        |              |  
|Net revenues                                                                                                                      |  | $      | 1,350   |            | $ | 414,485        |  | $            | 16,819 |              | $
|Equity in net income of    subsidiaries                                                                                           |  |        | 29,888  |            |   |               |  |              |       |              |  
|Operating expenses                                                                                                                |  |        | 25,174  |            |   | 351,031        |  |              | 15,394 |              |  
|Lease expense                                                                                                                     |  |        | 505     |            |   | 6,536          |  |              | (70    | )            |  
|Depreciation and    amortization expense                                                                                          |  |        | 2,025   |            |   | 9,130          |  |              | 164    |              |  
|Interest expense                                                                                                                  |  |        | 6,037   |            |   | 428            |  |              | 240    |              |  
|                                                                                                                                  |  |        |         |            |   |                |  |              |        |              |  
|Income (loss) before    income tax (benefit) expense, equity in net income of unconsolidated    affiliates and minority interests |  |        | (2,503  | )          |   | 47,360         |  |              | 1,091  |              |  
|Income tax (benefit)    expense                                                                                                   |  |        | (11,984 | )          |   | 18,284         |  |              | 421    |              |  
|                                                                                                                                  |  |        |         |            |   |                |  |              |        |              |  
|Income before equity in    net income of unconsolidated affiliates and minority interests                                         |  |        | 9,481   |            |   | 29,076         |  |              | 670    |              |  
|Equity in net income of    unconsolidated affiliates                                                                              |  |        | 1,367   |            |   |               |  |              |       |              |  
|Minority interests                                                                                                                |  |        |        |            |   |               |  |              |       |              |  
|                                                                                                                                  |  |        |         |            |   |                |  |              |        |              |  
|Income from continuing    operations                                                                                              |  |        | 10,848  |            |   | 29,076         |  |              | 670    |              |  
|Income (loss) from    discontinued operations, net of taxes                                                                       |  |        |        |            |   | 740            |  |              | (217   | )            |  
|                                                                                                                                  |  |        |         |            |   |                |  |              |        |              |  
|Net income                                                                                                                        |  | $      | 10,848  |            | $ | 29,816         |  | $            | 453    |              | $
|                                                                                                                                  |  |        |         |            |   |                |  |              |        |              |  




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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS


THREE MONTHS ENDED DECEMBER 31, 2005


(IN THOUSANDS)





|                                                       |  | Parent |         | Guarantors |   | Non-guarantors |   | Consolidated |       
|------------------------------------------------------ |  | ------ | ------- | ---------- | - | -------------- | - | ------------ | ------
|                                                       |  |        |         |            |   |                |   |              |       
|Net cash (used in)    provided by operating activities |  | $      | (29,196 | )          | $ | 51,817         |   | $            | (3,960
|Net cash (used in)    provided by investing activities |  |        | (3,154  | )          |   | (27,405        | ) |              | 4,732 
|Net cash provided by (used    in) financing activities |  |        | 16,085  |            |   | (27,603        | ) |              | 6     
|                                                       |  |        |         |            |   |                |   |              |       
|Net (decrease) increase in    cash and equivalents     |  | $      | (16,265 | )          | $ | (3,191         | ) | $            | 778   
|                                                       |  |        |         |            |   |                |   |              |       




GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES


UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS


THREE MONTHS ENDED DECEMBER 31, 2004


(IN THOUSANDS)





|                                                       |  | Parent |         | Guarantors |   | Non-guarantors |   | Consolidated |       
|------------------------------------------------------ |  | ------ | ------- | ---------- | - | -------------- | - | ------------ | ------
|                                                       |  |        |         |            |   |                |   |              |       
|Net cash (used in)    provided by operating activities |  | $      | (28,942 | )          | $ | 48,247         |   | $            | 5,197 
|Net cash (used in)    provided by investing activities |  |        | (1,947  | )          |   | (8,241         | ) |              | 3,072 
|Net cash provided by (used    in) financing activities |  |        | 19,545  |            |   | (38,681        | ) |              | (6,021
|                                                       |  |        |         |            |   |                |   |              |       
|Net (decrease) increase in    cash and equivalents     |  | $      | (11,344 | )          | $ | 1,325          |   | $            | 2,248 
|                                                       |  |        |         |            |   |                |   |              |       




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|ITEM    2: | Managements    Discussion and Analysis of Financial Condition and Results of Operations
|---------- | ----------------------------------------------------------------------------------------




For a  description of our material challenges and risks, including an analysis of  industry trends and the effect of recent legislation on our operations, see  Risk Factors  Risks Related to Our Business included in our Annual Report on  Form 10-K for the fiscal year ended September 30, 2005.  The  following discussion and analysis of our results of operations and financial  condition for the three months ended December 31, 2005 and 2004 should be read  in conjunction with our audited consolidated financial statements, and the  notes to those statements, and the overview summarizing the key matters on  which our management focuses in evaluating our financial condition and  operating performance included in our Annual Report on Form 10-K for the fiscal  year ended September 30, 2005.





Revenue  Sources





We receive  revenues from Medicare, Medicaid, private insurance, self-pay residents and  other third-party payors.  Our  rehabilitation therapy services and other service related businesses also  receive revenues from skilled nursing facilities that utilize our services.





The sources  and amounts of our revenues are determined by a number of factors, including  licensed bed capacity and occupancy rates of our skilled nursing centers, the  mix of patients and the rates of reimbursement among payors.  Likewise, payment for ancillary medical  services, including services provided by our rehabilitation therapy services  business, vary based upon the type of payor and payment methodologies.  Changes in these and other factors could  significantly affect our profitability.





On July 28,  2005, the Centers for Medicare and Medicaid Services (CMS) released the final  fiscal 2006 skilled nursing facility prospective payment rules, including  refinement to the resource utilization group (RUG) classification system (RUGs  refinement).  Effective October 1, 2005,  the skilled nursing facility prospective payment rates were increased by a 3.1%  annual inflation update factor.   Effective January 1, 2006, the rules established nine new payment  classifications, altered the case-mix weights for the remaining 44 RUG payment  categories and adjusted upward the nursing component of most RUG payment  categories. 
Excluding the additional  3.1% annual inflation factor, and after considering the distribution of our Medicare  patient population under the new system, RUGs refinement is expected to reduce  our Medicare payment rates approximately $9 per patient day beginning January  1, 2006, thereby reducing fiscal 2006 revenue and EBITDA approximately $7.5  million and reducing net income approximately $4.5 million.





The federal  budget for 2006 proposes to reduce by 30% the amount that Medicare reimburses  skilled nursing facilities and other non-hospital providers for bad debts  arising from uncollectible Medicare coinsurance and deductibles.  As proposed by CMS, the reduction would be  phased-in over a three-year period at 10% per year.  Based on our current volume of Medicare coinsurance bad debts,  this proposed rule would reduce our EBITDA and net income by $1.8 million and  $1.1 million in the first year, respectively.    On February 1, 2006, the U.S. House of Representatives completed action  on the Deficit Reduction Reconciliation Act, sending the legislation to the  President to sign into law.  This  enactment substantially modified the proposed bad debt provision.  Under the enactment, the 30% bad debt  penalty would apply only to collectible bad debt (non-government


payors),  effective for cost report years beginning on or after October 1, 2005. The  impact of the final law on fiscal 2006 EBITDA and net income is not expected to  be material.





The  Medicare Prescription Drug Improvement and Modernization Act (MMA), enacted on  December 8, 2003, created a new Medicare prescription drug benefit, created  incentives for greater private competition within Medicare, adjusted coverage  and payment terms for a number of providers and Medicare Part B prescription  drugs, and reformed the administration of the Medicare benefit.  The MMA may have an impact on institutional pharmacy  services provided in the long-term care setting.  The law constitutes a  significant overhaul of the Medicare system, including provisions to provide  subsidies to insurers and managed care organizations, and establishes  mechanisms to allow private healthcare coverage plans to compete with Medicare,  initially on a pilot basis.





The MMA  suspended application of payment caps (therapy caps) on Medicare Part B  rehabilitation through December 31, 2005.   CMS announced in its publication of the final 2006 physician fee  schedules the implementation of the therapy caps effective January 1,  2006.  CMS has reinstated the therapy  caps.  The therapy caps will be  increased to an annual allowance of $1,740 for occupational therapy and another  $1,740 annual allowance for





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physical therapy and speech therapy, combined.  Included in the Deficit Reduction  Reconciliation Act is a provision that directs CMS to develop an exceptions  process for medically necessary therapy services for beneficiaries that would  exceed the cap. The provision establishes a 10-day exceptions request  process.  CMS has not issued guidance on  how it will implement the exceptions process.   Absent Congressional direction, no assurances can be made as to the  amount of time required for CMS to establish an exceptions process.  Given the uncertainty of the instructions  CMS will establish for an exceptions process, we are unable to predict the  impact of the Medicare Part B therapy caps, or the exceptions process on our  financial condition and operating results.   We believe therapy caps will reduce our revenue, EBITDA and net income.





Effective  January 1, 2006, under the MMA, Medicaid coverage of prescription drugs for  Medicare beneficiaries who are also eligible for Medicaid have been shifted to  the Medicare program (Medicare Part D).   These residents are referred to as dual eligibles.  This change has affected a significant  percentage of residents in our nursing facilities.





As a result  of shifting prescription drug coverage from Medicaid to Medicare through  private plans, the MMA could affect the ability of long-term care pharmacies to  provide pharmacy service to our residents.   CMS announced final regulations relating to the MMA on January 21, 2005,  and provided specific sub-regulatory guidance for long-term care on March 16,  2005.  The final regulations  specifically require the new prescription drug plans and Medicare Advantage  Plans that offer prescription drug coverage to provide convenient access to  long-term care pharmacies and to offer standard contracts to all long-term care  pharmacies within the plans service areas that meet performance standards to  be specified by CMS.  Currently, under  contract, Omnicare, Inc., through its wholly owned subsidiary, provides  services required by federal law for residents.  Under Medicare Part D,


reimbursement for such services shifted  with the new Medicare benefit being the primary purchaser for prescription  drugs.  All dual eligible participants  were auto-assigned to private drug plans (PDPs).  Our long-term care pharmacy provider negotiates its payment terms  directly with the PDPs.  Implementation  of the new benefit has been challenging; however, our residents received  medically necessary medication on a timely basis.  CMS has re-issued instructions on transition period drugs and the  agency has transmitted a letter assuring nursing homes that they should not  have financial obligations caused by any CMS system problems. 
CMS has been responsive to issues as they  have been identified and transmitted.   Additionally, in a number of states, special provisions are being  implemented under the state Medicaid plans to safeguard individuals converted  to the new Medicare Part D benefit.   However, given the scale of the conversion, and the voluntary nature of  Medicare Part D enrollment for other than dually eligible residents, it is  still too soon to evaluate the benefits impact.  At this time, we do not yet know whether payment rates for the prescription  drugs provided by these plans will be sufficient to cover the costs of the  pharmacy needs of nursing home residents or whether the formulary and  utilization controls will be disruptive.   There continues to be a risk that the implementation of the MMA may  disrupt pharmacy services to our facilities.   We have a special operating task force in place to help facilities with  the transition to the new Medicare Part D benefit.  Any such change or reduction in long-term care pharmacy services  could create additional cost for us, reduce our ability to meet quality  standards and disrupt service delivery to our residents.





Moreover,  the MMA covers most prescription drugs, insulin and certain insulin supplies,  and approved vaccines.  However, certain  drugs are excluded from coverage under the new Medicare benefit in Part D,  including several drugs that are commonly prescribed for nursing home and other  long-term care residents.  A number of states announced that they will  continue to cover these excluded drugs under their Medicaid plans, however,  there remains the possibility that certain physician ordered medications may  fall outside of the PDPs and/or Medicaids formularies thereby requiring us to  bear the cost of these drugs.





We have  described only certain provisions of the MMA applicable to our business.  There may be other provisions of the  legislation that may impact our business by decreasing revenues or increasing  operational expenses.  The impact of  this legislation depends upon a variety of factors, including patient mix and  the implementing regulations.  CMS  continues to issue new regulations to implement the MMA, which we are in the  process of reviewing.  However, because  of the broad scope and phased-implementation of key provisions in the MMA, we  are not in a position to assess fully its impact on our business.





By  law, Medicare reimbursement for physician and non-physician professional  services (including Medicare Part B physical therapy, speech pathology and  occupational therapy services) are based on fee schedules.  CMS has





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published final payment rules for calendar year  2006.  As part of the Deficit Reduction  Reconciliation measure, Congress intervened to prevent a reduction in average  payments established as part of the final 2006 fee schedule rules.  The legislative provision maintains current  rates rather than the announced 4.4% reduction.  Anticipating final passage, CMS has issued a letter indicating  that it will expeditiously correct the fee schedules once the legislation is  signed into law.  Although we are unable  to predict the outcome of these measures, a reduction in payment for  professional services would have an adverse effect on our business, results of  operations, financial position and cash flows.





The  President delivered his State-of-the-Union address on January 31, 2006. Details  of his proposed work plan were unveiled on February 6, 2006 when the White  House transmitted to the Congress the proposed fiscal 2007 federal budget. Preliminary  evaluation suggests the President recommends curtailing the growth of  outlays for Medicare and Medicaid.  New  initiatives and spending decisions will be examined by the Congress.  At this time, we have insufficient  information to evaluate the recommendations, or to predict the outcome of  Congressional considerations.





State  budget pressures in recent years have translated into reductions in the rate of  state spending growth in certain jurisdictions.  Given that Medicaid outlays are a significant component of state  budgets, we expect continuing cost containment pressures on Medicaid outlays  for skilled nursing facilities in the states in which we operate.  In each of the major states where we provide  services, we are working with trade groups, consultants and government  officials to address responsibly the particular funding issues.





Medicaid  funding is set annually.  States have  completed legislative actions on their fiscal year 2006 state budgets.  We expect our average Medicaid rate per  patient day to increase between approximately 2% to 3% in our fiscal 2006.  Generally, state fiscal 2007 budgets will be  finalized by mid-year.  The governors in  a number of states where we operate have announced proposed fiscal 2007 budgets  and state legislatures are beginning the process of review and  ratification.  In other states, the  process begins a little later.





Among the  alternative Medicaid funding approaches that states have explored, and in many  states implemented, are nursing home provider assessments as tools for  leveraging increased Medicaid matching funds.   Such initiatives are authorized under the law.  Provider assessment plans generate additional federal matching  funds to the states for Medicaid reimbursement purposes, and implementation of  a provider assessment plan requires approval by CMS in order to qualify for  federal matching funds.
These plans usually take the form of a bed tax or a  quality assessment fee, which is imposed uniformly across classes of providers  within the state. In turn, the state generally utilizes the additional federal  matching funds generated by the tax to pay increased reimbursement rates to the  providers, which often include a repayment of a portion of the provider tax  based on the providers percentage of Medicaid patients.





Nursing  home provider assessments have been implemented in eight states where we  operate (Massachusetts, West Virginia, Rhode Island, North Carolina, New  Hampshire, Pennsylvania, New Jersey and Connecticut).  Three of these plans received federal approval during the past  year and impacted our results for the quarter ended December 31, 2005.  In January 2005, CMS approved the Pennsylvania  provider assessment. 
The Pennsylvania  provider assessment, which was retroactive to July 1, 2003 and will expire on  June 30, 2007, was recognized cumulatively in the quarter ended March 31,  2005.  Recognition of the Pennsylvania  provider assessment resulted in increased revenue of $4.8 million in the three  months ended December 31, 2005 compared to the same period in the prior year,  with no material impact on EBITDA or net income.In February 2005, CMS approved the New Jersey provider  assessment.  The New Jersey provider  assessment, which was retroactive to July 1, 2004 and will expire on June 30,  2006, was recognized cumulatively in the quarter ended March 31, 2005. 
Recognition of the New Jersey provider  assessment resulted in increased revenue, EBITDA and net income of $4.7  million, $1.4 million and $0.8 million, respectively, in the three months ended  December 31, 2005 compared to the same period in the prior year.  The Connecticut provider assessment, which  was retroactive to July 1, 2005, was recognized in the quarter ended September  30, 2005. 
Recognition of the Connecticut  provider assessment resulted in increased revenue, EBITDA and net income of  $1.9 million, $0.6 million and $0.3 million, respectively, in the three months  ended December 31, 2005 compared to the same period in the prior year.





The  Commonwealth of Pennsylvania has proposed a reduction in the reimbursement  allowance under its provider assessment program effective July 1, 2005 through  June 30, 2006.  If the proposed  reduction is made final





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as expected, the amount we must pay the Commonwealth under this program  will exceed the amount we are reimbursed.   If the proposed reduction is made final, our fiscal 2006 revenue and  EBITDA would be reduced approximately $2.4 million, and our net income would be  reduced approximately $1.4 million or $0.08 per diluted share compared to the  provider assessment in place prior to July 1, 2005.  We believe this adjustment is unique to the methodology used by  the Commonwealth in implementing its Medicaid provider assessment plan.  The Commonwealth has indicated that provider  assessment payments made for fiscal years 2003 through 2005 were based on lower  than actual Medicaid utilization.   Adjustments in the reimbursement allowance are meant to correct faulty  assumptions underlying payment amounts for the prior two years.  Decisions on whether the Commonwealth will  go forward with the reductions or seek supplemental funding are expected


as  part of the upcoming budget release scheduled for February 8, 2006. Aside from  the budget issues, the Commonwealth has a mandate to redesign its nursing home  payment system before the beginning of its next fiscal year, July 1, 2006. It  is premature to determine the impact of the outcome of the payment system  re-design.





The Presidents  proposed federal budget for fiscal year 2006 included proposed reform of the  Medicaid program to cut a total of $60.0 billion in projected Medicaid  expenditure growth over 10 years, including a provision that would reduce  the maximum amount of provider taxes that a state may impose on providers for  purposes of qualifying for federal matching funds from 6% of a states Medicaid  outlay to 3%.  Congress, during  consideration of its fiscal year 2006 First Congressional Budget Resolution,  scaled back the proposed Medicaid reductions. 
The final fiscal year 2006 First Congressional Budget Resolution  established a Medicaid Commission authorized to make specific policy  recommendations, while agreeing to defer Medicaid cuts during fiscal year 2006,  and providing reconciliation instructions to Congress to make $10.0 billion in  Medicaid reductions during fiscal years 2007 to 2011.  As part of the Deficit Reduction Reconciliation legislation,  Congress further modified its Medicaid targets.  Under the final conference committee report, proposed Medicaid  cuts were scaled back to $6.9 billion over 5 years.  Congress recessed before completing action on this  legislation.  We cannot predict the  extent of the impact that such decrease, if any, in spending by the federal  government will have on our financial condition and results of operations.





The federal  government and state governments continue to focus on efforts to curb spending  on healthcare programs such as Medicare and Medicaid.  It is impossible to predict the outcome of the legislative and  regulatory processes.  We cannot at this  time predict the extent to which these proposals will be adopted or, if adopted  and implemented, what effect, if any, such proposals and existing new  legislation and regulation will have on us.   It is not possible to quantify fully the effect of legislative changes,  the interpretation or administration of such legislation or other governmental  initiatives on our business and the business of the customers served by our  rehabilitation services business. 
Accordingly, there can be no assurance that the impact of any future  healthcare legislation or regulation will not further adversely affect our  business. 
There can be no assurance  that payments under governmental and private third-party payor programs will be  timely, will remain at levels similar to present levels or will, in the future,  be sufficient to cover the costs allocable to patients eligible for  reimbursement pursuant to such programs.   Our financial condition and results of operations will be affected by  the reimbursement process, which in the healthcare industry is complex and can  involve lengthy delays between the time that revenue is recognized and the time  that reimbursement amounts are settled.





Significant  Transactions and Events





Share  Repurchase





In February  2005, our board of directors authorized an increase to the size of our  previously established share repurchase program from $25.0 million to $50.0  million of our common stock through December 31, 2005.  Share repurchases took place at managements  discretion and/or under pre-established, nondiscretionary programs from time to  time, depending on market conditions, in the open market, and in privately  negotiated transactions.  Under this program,  1,075,737 shares of common stock were repurchased at a cost of $42.8 million  through December 31, 2005, of which 288,400 shares were repurchased at a cost  of $10.7 million during the three months ended December 31, 2005.





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Purchase  of Joint Venture Interests





In December  2005, we deposited into escrow $4.1 million to acquire all of our joint venture  partners interests in three skilled nursing facilities located in the State of  West Virginia having a combined 208 beds.   We currently own a 50% interest in and manage the operations of each of  the three facilities, but upon completion of the transaction will own 100% of  each facility and will therefore consolidate the related revenues, expenses and  net assets.  In accordance with FASB  Interpretation No. 46, Consolidation of Variable Interest Entities  an  Interpretation of ARB No. 51 (FIN46), we already consolidate the  financial statements of one of the facilities and record minority interest to  reflect our joint venture partners interests. 
Because we extended this partnership mortgage financing, we are the  primary beneficiary of the partnership, as defined by FIN 46, and are therefore  required to consolidate it under FIN 46.   The combined annual revenues and pre tax income of the two  unconsolidated facilities is approximately $10.0 million and $1.2 million,  respectively.  The transaction, which is  subject to our receipt of certain state regulatory approvals, is expected to be  completed during our second or third fiscal quarter of 2006.





Adoption  of New Accounting Standard for Share-Based Payments





Effective  October 1, 2005, we adopted the provisions of SFAS No. 123(R), Share-Based  Payment (SFAS 123R).  SFAS  123R establishes accounting for stock-based awards exchanged for employee  services.  Accordingly, stock-based  compensation cost is measured at the grant date, based on the fair value of the  award, and is recognized as expense over the requisite employees service  period.  We previously applied  Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to  Employees, and related interpretations and provided the required  pro forma disclosures of SFAS No. 123, Accounting for Stock-Based Compensation  (SFAS 123).





Generally,  the approach in SFAS 123R to stock based payment accounting is similar to SFAS  123.  However, SFAS 123R requires all  share-based payments to employees, including grants of employee stock options,  to be recognized as compensation cost in the statement of operations at their  fair values.  Pro forma disclosure is no  longer an alternative under SFAS 123R.





We  elected to adopt SFAS 123R using the modified prospective application method in  which compensation cost is recognized beginning with the effective date (a)  based upon the requirements of SFAS 123R for all share-based payments granted  after the effective date, and (b) based on the requirements of SFAS 123 for all  awards granted to employees prior to the effective date of SFAS 123R that  remain unvested on the effective date.





We  recorded stock-based compensation expense for the three months ended December  31, 2005 and 2004 as follows (in thousands):


|                                         |  | Three    months ended   |      
|---------------------------------------- |  | ----------------------- | -----
|                                         |  | December    31,    2005 |      
|                                         |  |                         |      
|Stock options                            |  | $                       | 573  
|Stock incentive plan                     |  |                         | 1,773
|Stock held in deferred compensation plan |  |                         | (687 
|                                         |  |                         |      
|Total                                    |  | $                       | 1,659
|                                         |  |                         |      




The adoption of SFAS 123R is expected to reduce fiscal 2006 diluted earnings per share approximately $0.10. As of  December 31, 2005, there was $8.2 million of total unrecognized compensation  cost related to non-vested stock options granted under our stock option plan,  which is expected to be recognized over the remaining weighted-average period  of 1.4 years.  As of December 31, 2005,  there was $15.2 million of total unrecognized compensation cost related to  non-vested restricted stock granted under the stock incentive plan, which is  expected to be recognized over the remaining weighted-average period of 3.7  years.





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A  detailed description of the components of stock based compensation and the  assumptions and methodologies used to determine fair value are described in  note 7  Stock-Based Benefit  Plans  Stock-Based Compensation  Expenses to the unaudited condensed consolidated financial statements.





Results of Operations





Reasons  for Non-GAAP Financial Disclosure





The  following discussion includes EBITDA which is a non-GAAP financial  measure.  For purposes of SEC Regulation  G, a non-GAAP financial measure is a numerical measure of a registrants  historical or future financial performance, financial position or cash flows  that excludes amounts, or is subject to adjustments that have the effect of  excluding amounts, that are included in the most directly comparable financial  measure calculated and presented in accordance with GAAP in the statements of  operations, balance sheet or statements of cash flows (or equivalent  statements) of the registrant; or includes amounts, or is subject to  adjustments that have the effect of including amounts, that are excluded from  the most directly comparable financial measure so calculated and  presented.  In this regard, GAAP refers  to accounting principles generally accepted in the United States of  America


..  Pursuant to the requirements  of Regulation G, we have provided reconciliations of the non-GAAP financial  measures to the most directly comparable GAAP financial measures.





Management  believes that the presentation of EBITDA provides useful information to  investors regarding our results of operations because it is useful for  trending, analyzing and benchmarking the performance and value of our  business.  We use EBITDA primarily as a  performance measure and believe that the GAAP financial measure most directly  comparable to EBITDA is net income.  We  use EBITDA as a measure to assess the relative performance of our eldercare  properties and our other operating businesses, as well as the employees  responsible for operating such businesses.   EBITDA is useful in this regard because it does not include such costs  as interest expense, income taxes and depreciation and amortization expense  which may vary from business unit to business unit depending upon such factors  as the method used to finance the original purchase of the business unit or the  tax law


in the state in which a business unit operates. 
By excluding such factors when measuring  financial performance, many of which are outside of the control of the  employees responsible for operating our business units, management is better  able to evaluate operating performance of the business unit and the employees  responsible for business unit performance.   Consequently, management uses EBITDA to determine the extent to which  our employees have met performance goals, and therefore may or may not be  eligible for incentive compensation awards.   We also use EBITDA in our annual budget process.  We believe EBITDA facilitates internal  comparisons to historical operating performance of prior periods and external  comparisons to competitors historical operating performance.  Although we use EBITDA as a financial  measure to assess the performance of our business, the use of EBITDA is limited  because it does not consider certain material costs necessary to operate our  business. 
These costs include the cost  to service our debt, the non-cash depreciation and amortization associated with our long-lived assets, the cost of our federal and state tax obligations, our  share of the earnings or losses of our less than 100% owned operations and the  operating results of our discontinued businesses.  Because EBITDA does not consider these important elements of our  cost structure, a user of our financial information who relies on EBITDA as the  only measure of our performance could draw an incomplete or misleading  conclusion regarding our financial performance.  Consequently, a user of our financial information should consider  net income an important measure of our financial performance because it  provides the most complete measure of our performance.





We define  EBITDA as earnings from continuing operations before equity in net income of  unconsolidated affiliates, minority interests, interest expense, income taxes,  depreciation and amortization.  Other  companies may define EBITDA differently and, as a result, our measure of EBITDA  may not be directly comparable to EBITDA of other companies.  EBITDA does not represent net income, as  defined by GAAP.





EBITDA  should be considered in addition to, not as substitutes for, or superior to,  GAAP financial measures.





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|                                                  |  | Three    months ended December 31, |       
|------------------------------------------------- |  | ---------------------------------- | ------
|(in thousands)                                    |  |                                    | 2005  
|                                                  |  |                                    |       
|Net income                                        |  | $                                  | 11,686
|Add back:                                         |  |                                    |       
|Income from discontinued operations, net of taxes |  |                                    | (25   
|Equity in net income of unconsolidated affiliates |  |                                    | (667  
|Minority interests                                |  |                                    | 249   
|Income tax expense                                |  |                                    | 8,062 
|Interest expense                                  |  |                                    | 5,754 
|Depreciation and amortization expense             |  |                                    | 14,310
|                                                  |  |                                    |       
|EBITDA                                            |  | $                                  | 39,369
|                                                  |  |                                    |       




Factors  Affecting Comparability of Financial Information





During the  three months ended September 30, 2005, we reevaluated the classification of  certain of our leases and determined that five center leases previously  classified as operating leases beginning in fiscal 2004 should have been  classified as capital leases.  In  addition, during the three months ended September 30, 2005, we determined  we were not properly accounting for operating lease expense on a straight-line  basis.  The correction of  this accounting took place in the three months ended September 30, 2005 and had  the effect of decreasing lease expense and increasing interest expense and  depreciation expense. 
As a result of  the change in classification of these leases and the accounting for operating  lease expense on a straight-line basis, the  unaudited condensed consolidated statement of operations for the three months  ended December 31, 2005 reflect an increase to depreciation expense of  approximately $0.6 million, an increase to interest expense of approximately  $0.6 million and a decrease to lease expense of approximately $1.1 million,  resulting in a decrease to pre tax and net income of $0.1 million as compared  to the three months ended December 31, 2004. 
In fiscal 2005, management evaluated the quantitative and  qualitative impact of the corrections, individually and in the aggregate, on  previously reported periods, on the 2005 fiscal year and on earnings  trends.  Based upon this evaluation,  management concluded the errors were not material to our consolidated financial  statements taken as a whole and recognized the errors in the period such errors  were identified.





Three  Months Ended December 31, 2005 Compared to Three Months Ended December 31, 2004





In the  current quarter, revenues were $430.6 million, an increase of $31.6 million, or  7.9%, over the same period in the prior year.   Of this growth, inpatient services revenue increased by $30.0 million,  external rehabilitation therapy services revenue increased by $3.8 million and  other businesses revenue decreased by $2.2 million.





The $30.0  million of revenue growth in our inpatient services segment is primarily  attributed to increased payor rates.  In  aggregate, payor rates increased by $24.4 million versus the prior year quarter  with $14.7 million of such increase occurring in the Medicaid payor category,  of which $11.4 million was due to recurring provider tax assessments for New  Jersey, Pennsylvania and Connecticut.   The prior year quarter contained no provider tax assessments for these  three states.  Medicaid revenue  settlements and adjustments decreased by $1.4 million versus the prior year  quarter.  The $4.7 million balance of  Medicaid rate increases, which equate to a 2.5% increase, resulted from both  increased acuity levels and legislative rate increases.  A 7.3% increase in our average Medicare  rate, attributed to the October 1, 2005 upward Medicare rate adjustments of  3.1% and higher


Medicare patient acuity, and increases in private and insurance  rates of 4.5% and 5.3%, respectively, were the primary reasons for the  remainder of the overall rate increase.   Approximately $2.8 million of the overall revenue increase is due to the  step acquisition of an eldercare center, which we previously jointly owned and  managed.  We purchased our joint venture  partners ownership interests in the center and, beginning in January 2005, we  own and consolidate 100% of the operation.   Overall occupancy increased to 91.5% in the current quarter from 90.4%  in the same period in the prior year, resulting in a $0.4 million revenue  increase.  Our increased occupancy is  attributed to census growth and a reduction in our number of licensed  beds.  On a same store basis, adjusted  for the change in licensed beds,





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occupancy grew 40 basis points from the prior year quarter.  Total patient days increased 12,505 to  1,697,419 in the current quarter compared to 1,684,914 in the same period of  the prior year.  Of the total increase  in patient days, 10,859 patient days is attributed to the step acquisition of  an eldercare center with the 1,646 patient day balance of the increase  attributed to occupancy growth at our same facility centers which were included  in both reporting periods.  A net 213  licensed beds were taken out of service over the past twelve months partially  contributing to the increased census percentage.  Remaining net revenue increases of $2.4 million were primarily  due to increased Medicare Part B volume and increased quality mix resulting  from combined insurance and Medicare census comprising 0.1% more of our skilled  nursing facility census in the current year quarter versus the prior year  quarter.





Increased  revenue volume generated by ongoing customer contracts was the primary reason  for the $3.8 million increase in external rehabilitation therapy services  revenue.  We have negotiated a series of  price increases charged for external customer rehabilitation services that were  effective January 1, 2006.





The $2.2  million decrease in other business revenue primarily resulted from decreased  external business volume in our Hospitality, Staffing Services and Physicians  Services businesses.





For the  current year quarter, net income increased to $11.7 million from $10.8 million  in the same period in the prior year.   Revenue increases of $31.6 million, as previously discussed, were  partially offset by $13.4 million of increased salaries, wages and benefits and  $10.9 million of higher other operating expenses.  Of the $13.4 million of increased salaries, wages and benefits,  $1.3 million is attributed to the step acquisition of an eldercare center,  approximately $0.6 million is attributed to the replacement of higher cost  temporary agency nurses with internally employed nurses, with the balance of  the increase due to normal inflationary growth in wage and benefits in both our  inpatient services segment and rehabilitation therapy services segment,  increased occupancy within our inpatient segment, increased inpatient nursing  hours per patient day resulting from servicing higher


acuity patients and  increased rehabilitation therapy services business volume.  Of   the $10.9 million of increased other operating expenses, $9.6 million is  attributed to the recognition of provider assessment taxes in Pennsylvania, New Jersey,
New Hampshire and Connecticut, $0.3 million is attributed to increased utilization  of temporary agencies within our rehabilitation services business as a result  of an industry wide shortage of therapists, $0.3 million is attributed to  increased recruiting costs within our rehabilitation services business, $1.4  million is attributed to an increase in pharmacy and medical supply costs  incurred to treat a higher acuity patient population, $0.9 million is  attributed to the step acquisition of an eldercare center and $0.8 million is  due to increased natural gas costs.   These increases were offset by approximately $0.8 million of reduced  costs attributed to the replacement of higher cost temporary agency nurses with  internally employed nurses, $0.8 million of reduced costs resulting from  decreased business volume in our non-core businesses as discussed above and  $2.8 million of reduced operating expenses resulting from an adjustment made in  the prior year quarter to reflect an estimate of previously unaccrued costs  resulting from a weakness in our purchasing cut-off procedures. 
The balance of the increase in other  operating expenses of approximately $2.0 million is largely attributed to  normal inflationary increases in cost.   An increase in the average age of accounts receivable was the primary  reason for the $0.2 million increase in the provision for losses on accounts  receivable and notes receivable.   General and administrative costs increased by $3.7 million due to $0.6  million of increased audit fees and consulting costs incurred relative to  matters associated with the Sarbanes-Oxley Act, $1.0 million of increased costs  associated with our captive self-insured programs and $0.3 million of increased  stock-based compensation expense with the balance of the increase primarily  resulting from increased payroll costs resulting from both wage inflation and  additional costs to support our operational improvement initiatives.  Net income was further reduced from  increases in depreciation and amortization expense, income tax expense, lower  earnings of less than 100% owned subsidiaries and lower after-tax gains from  discontinued operations as further discussed below.  Net income increased due to lower early extinguishment of debt  costs, interest expense and lease expense, each of which is further discussed  below.





For the  current quarter, EBITDA increased $5.5 million to $39.4 million compared with  $33.9 million in the same period of the prior year.  Inpatient services EBITDA increased $4.1 million, of which $1.8  million was due to the recognition of provider tax assessments for New Jersey,  Pennsylvania, New Hampshire and Connecticut, $1.5 million was due to decreased lease costs as  discussed below and $0.5 million was due to the step acquisition of an  eldercare center, partially offset by a $1.4 million decrease in Medicaid  revenue settlements and adjustments, $0.8 million of increased natural gas  costs and $1.4 million of increased pharmacy and medical supply costs.  The remaining $3.9 million of the  increase resulted from the previously discussed other increases in payor rates,  increased Medicare Part B





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volume, increased quality mix and occupancy levels and reduced
utilization of agency labor offset by the impact of
increased nursing hours per patient day and
inflationary increases in cost.  Revenue and margin growth resulted in EBITDA of our rehabilitation therapy
services segment improving by $1.2 million versus
the same period in the prior year to $3.6 million in the current quarter.  Combined external and intersegment
rehabilitation therapy services revenues increased by $6.2 million, while  EBITDA as a percentage of
combined external and intersegment revenues (EBITDA  margin)
increased to 6.1% of revenues in the current quarter
from 4.5% in the same period in the prior year. 
The growth in EBITDA margin primarily resulted from a 3.7% increase in therapist  productivity in the current
quarter versus the same period in the prior year,
partially offset by increased utilization of temporary agencies and increased  recruiting costs, as discussed above, as well as increased internal wage  rates.  The increase in rehabilitation
therapy labor and temporary agency costs is primarily being driven by high  market demand for a
limited pool of qualified therapists.  Decreased loss on early extinguishment of  debt in the
current quarter increased EBITDA by $0.5 million.  The remaining decrease in EBITDA of $0.4
million in all other services and corporate costs was principally due to  increased payroll costs
resulting from both wage inflation and additional costs  to support our operational improvement initiatives.





Capital  Costs and Other





Lease expense decreased by $1.5 million  primarily due to a $1.1 million reduction of expense resulting from a  reclassification of certain of our leases from operating leases to capital  leases.





Depreciation  and amortization expense increased by $3.0 million to $14.3 million in the  current quarter compared to $11.3 million for the same period in the prior  year.  The increase is attributed to  $0.6 million of additional depreciation expense resulting from the  reclassification of certain of our leases from operating leases to capital  leases as well as additional depreciation expense on incremental capital  additions.





Interest  expense decreased $0.9 million in the current quarter to $5.8 million, compared  to $6.6 million for the same period in the prior year, primarily due to the  impact of the restructuring of our debt portfolio in the quarter ended March  31, 2005 and the resulting decline in overall debt and the weighted average  interest rate.  The interest expense  decrease was partially offset by $0.6 million of incremental interest expense  recorded as a result of the reclassification of certain of our leases from operating  leases to capital leases.





Our effective tax rate approximated 41% for the quarter ended December 31, 2005.  The rate was adversely impacted by the lapsing of certain jobs-related tax credit provisions at December 31, 2005, which increased our effective tax rate for fiscal 2006 by almost 1%.  If the credit provisions are reinstated retroactively, we would expect our full fiscal year effective tax rate to approximate 40%. Income tax expense in the prior year quarter was estimated using an effective tax rate of approximately 39.8%, offset by the recognition of certain tax credits retroactive to our fiscal 2004. Income tax expense includes the provision of taxes on both equity in net income of unconsolidated affiliates and minority interests.





Income  from discontinued operations, net of taxes, was $25 thousand in the current  year quarter and $0.5 million in the prior year quarter.  The decrease is primarily due to favorable  claims development recognized on self-insured Florida policies in the prior  year quarter that did not occur in the current year quarter.





Operating  results of our less than 100% owned subsidiaries in the current year quarter  declined compared to the same period in the prior year, resulting in a combined  decrease of $0.4 million in equity in net income of unconsolidated affiliates  and minority interests.





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Liquidity and Capital Resources





Working  Capital and Cash Flows





Reference  to our unaudited condensed consolidated balance sheets and unaudited condensed  consolidated statements of cash flows will facilitate an understanding of the  discussion that follows.





Our primary  source of cash inflows comes from government funded programs, principally  Medicaid and Medicare.  Our operating  cash flow has been used to finance trade accounts receivable, fund capital  expenditures, service and repurchase our indebtedness and repurchase our common  stock, and make selective acquisitions.   Financing trade accounts receivable is necessary because, on average,  the customers and payors for our services do not pay us as quickly as we pay  our vendors and employees for their services. 
Our cash flow from operations for the three months ended December 31,  2005 and 2004 were $18.7 million and $24.5 million, respectively.  The $5.8 million decline in cash flow from  operations in the three months ended December 31, 2005 primarily resulted from  $20.7 million in accounts receivable growth offset by $12.1 million in increased  cash flows from the timing of payments to vendors and employees.  The remaining $2.8 million improvement in  operating cash flow primarily resulted from growth in operations.





Our  investing activities principally consist of capital
expenditures and asset  acquisitions and dispositions.  Capital  expenditures consist primarily
of betterments and expansion of eldercare  centers and investments in computer hardware and software. 
For the foreseeable future, we expect to  increase our investment in both physical plant and information systems
over the  levels in prior years.  Capital  expenditures were $31.6 million and $11.1 million for the three
months ended  December 31, 2005 and 2004, respectively.   For fiscal 2006, capital expenditures are anticipated
to be within the  range of $65.0 million to $75.0 million.   Investing activities for the three months ended
December 31, 2005  include $4.1 million of cash used to fund into escrow a proposed purchase of  our joint venture
partners interests in three skilled nursing facilities and  $0.9 million to purchase two tracts of land. 
Investing activities for the three months ended December 31, 2004  include proceeds received from the sale of
eldercare centers of $5.3 million,  principally from the sale of eldercare centers located in the state of  Wisconsin.  We do not expect to receive  significant cash proceeds from asset sales in fiscal 2006.  Investing activities for the three months  ended December 31, 2005 also includes $4.5 million of net sales of restricted  marketable securities held by our wholly owned insurance captive compared to  $2.2 million of net purchases of restricted marketable securities for the three  months ended December 31, 2004.





Cash flows  from financing activities was a net use of cash of $11.5 million and $25.2  million for the three months ended December 31, 2005 and 2004,  respectively.  Impacting cash from net  financing activities, in November 2004, we repaid approximately $14.0 million  under the mandatory payment provisions of our then existing term loan under our  senior credit facility.  In November  2004, we prepaid an $11.0 million, 11% fixed rate mortgage and paid the lender  a $0.3 million prepayment penalty.





We  continually evaluate the most efficient use of our capital, including  investments in our property and equipment, information systems, potential asset  acquisitions or dispositions, purchasing, refinancing, exchanging or retiring  certain of our outstanding debt securities to the extent permitted by our  existing covenant restrictions.  As part  of such ongoing evaluation, our board of directors has authorized the  repurchase of up to $50.0 million of our common stock through December 31,  2005, as well as, certain principal amounts of our 8% senior subordinated notes  in accordance with the restrictions of our amended and restated senior credit  agreement through December 31, 2006. 
Share and debt repurchases may take place at managements discretion  and/or under pre-established, nondiscretionary programs from time to time, depending  on market conditions, in the open market, and in privately negotiated  transactions.  For the three months  ended December 31, 2005, 288,400 shares of common stock were repurchased at a  cost of $10.7 million and there were no repurchases of our 8% senior  subordinated notes.  Cumulatively  through December 31, 2005, 1,075,737 shares of common stock were repurchased at  a cost of $42.8 million and $70.9 million of our 8% senior subordinated notes  were repurchased.  The debt repurchases  resulted in a prepayment premium charge of $7.4 million and the write-off of  unamortized deferred financing fees and other fees of $2.7 million.





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We believe  that the net cash provided by our operating activities, supplemented as  necessary with cash reserves and borrowings available under our revolving  credit facility, will provide sufficient resources to meet our working capital  requirements, debt service and other liquidity needs over the next 12 months.  At December 31, 2005, $123.2 million was  available under our $125.0 million revolving credit facility after giving  effect to $1.8 million in outstanding letters of credit issued under the  revolving credit facility.





At December  31, 2005, we had restricted investments in marketable securities of $91.5  million, which are held by Liberty Health Corporation (LHC), our wholly owned  captive insurance subsidiary incorporated under the laws of Bermuda.  The investments held by LHC are restricted  by statutory capital requirements in Bermuda.   As a result of such restrictions and encumbrances, we and LHC are  precluded from freely transferring funds through intercompany loans, advances  or cash dividends.





Off-Balance  Sheet Commitments





We have  contingent obligations related to outstanding lines of credit, letters of  credit, guarantees and purchase commitments.





Requests  for providing commitments to extend financial guarantees and extend credit are  reviewed and approved by senior management subject to obligational authority  limitations.  Management regularly  reviews all outstanding commitments, letters of credit and financial  guarantees, and the results of these reviews are considered in assessing the  need for any reserves for possible credit and guarantee loss.





We have  extended $4.1 million in working capital lines of credit to certain jointly  owned and managed companies, of which $2.2 million were unused at December 31,  2005.  In addition, we have agreed to  extend credit for working capital needs of a nursing center managed by us.  Under that arrangement, the propertys owner  is responsible for funding working capital needs up to $0.9 million, and we  would be required to cover deficits in excess of that limit.  To date, we have not had to perform under  that agreement.  Credit risk represents  the accounting loss that would be recognized at the reporting date if the  affiliate companies were unable to repay any amounts utilized under the working  capital lines of credit.  Commitments to  extend credit to third parties are conditional agreements generally having  fixed expiration or termination dates and specific interest rates


and purposes.





We have  posted $1.8 million of outstanding letters of credit.  The letters of credit guarantee performance to third parties of  various trade activities.  The letters  of credit are not recorded as liabilities on our consolidated balance sheet  unless they are probable of being utilized by the third party.  The financial risk approximates the amount  of outstanding letters of credit.





We have  provided $0.3 million of financial guarantees related to loan commitments of  one jointly owned and managed company.   The guarantees are not recorded as liabilities on our balance sheet  unless we are required to perform under the guarantee.  Credit risk represents the accounting loss  that would be recognized at the reporting date if counter-parties failed to  perform completely as contracted.  The  credit risk amounts are equal to the contractual amounts, assuming that the  amounts are fully advanced and that no amounts could be recovered from other  parties.





We have  entered into a commitment to purchase land with an aggregate purchase price of  approximately $3.0 million, of which $0.2 million was disbursed into escrow at  December 31, 2005.  We intend to build a  skilled nursing facility on the tract of land.





Income  Taxes





As of  December 31, 2005, we had net operating loss carryforwards available of $112.1  million, which can be utilized to offset future taxable income subject to an  annual limitation of $33.1 million.  The  net operating loss carryforwards serve to reduce the amount of cash payments we  make for income tax obligations.  We  regularly assess our ability to realize the tax benefit from our net operating  loss carryforwards.





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Critical  Accounting Policies





We consider  an accounting policy to be critical if it is important to our financial  condition and results of operations, and requires significant judgment and  estimates on the part of management in its application.  Our critical accounting estimates and the  related assumptions are evaluated periodically as conditions warrant, and  changes to such estimates are recorded as new information or changed conditions  require revision.  Application of the  critical accounting policies requires managements significant judgments, often  as the result of the need to make estimates of matters that are inherently uncertain. 
If actual results were to differ materially  from the estimates made, the reported results could be materially  affected.  Our senior management has  reviewed these critical accounting policies and estimates with our audit  committee.  We believe that the  following represents our critical accounting policies, which are described in  our Annual Report on Form 10-K for the fiscal year ended September 30, 2005:





| |  | Allowance for Doubtful Accounts;                 
| | - | -------------------------------------------------
| |   |                                                  
| |  | Loss Reserves for Certain Self-Insured Programs; 
| |   |                                                  
| |  | Revenue Recognition / Contractual Allowances; and
| |   |                                                  
| |  | Long-Lived Asset Impairments.                    




During the  current quarter, we did not make any material changes to our estimates or  methods by which estimates are derived with regard to our critical accounting  policies.





New Accounting Pronouncements





The  Meaning of Other-Than-Temporary Impairment and Its Application to Certain  Investments





In November  2005, the final version of Financial Accounting Standards Board (FASB) Staff Position  (FSP) SFAS 115-1 and SFAS 124-1, The Meaning of Other-Than-Temporary Impairment and  Its Application to Certain Investments (FSP SFAS 115-1) was issued  and addresses the determination of when an investment is considered impaired;  whether the impairment is other than temporary; and how to measure an  impairment loss.  FSP SFAS 115-1 also  addresses accounting considerations subsequent to the recognition of an  other-than-temporary impairment on a debt security, and requires certain  disclosures about unrealized losses that have not been recognized as  other-than-temporary impairments.  FSP  SFAS 115-1 replaces the impairment guidance in EITF Issue No. 03-1 with  references to existing authoritative literature concerning other-than-temporary  impairment determinations (principally


 SFAS No. 115 and Staff Accounting  Bulletin No. 59). 
 Under FSP SFAS 115-1,  impairment losses must be recognized in earnings equal to the entire difference  between the securitys cost and its fair value at the financial statement date,  without considering partial recoveries subsequent to that date.  FSP SFAS 115-1 also requires that an  investor recognize an other-than-temporary impairment loss when a decision to  sell a security has been made and the investor does not expect the fair value  of the security to fully recover prior to the expected time of sale.  FSP SFAS 115-1 is effective for reporting  periods beginning after December 15, 2005, or January 1, 2006 for us.  As the majority of our investments are investment grade government and  corporate debt securities that have maturities of five years or less, we do not  expect FSP SFAS 115-1 to have a material impact on our consolidated financial  statements.





Matters  Involving Convertible Debt Instruments





In  September 2005, the FASB ratified the EITFs Issue No. 05-7, Accounting  for Modifications to Conversion Options Embedded in Debt Instruments and  Related Issues (EITF 05-7), which addresses whether a modification  to a conversion option that changes its fair value effects the recognition of  interest expense for the associated debt instrument after the modification, and  whether a borrower should recognize a beneficial conversion feature, not a debt  extinguishment, if a debt modification increases the intrinsic value of the  debt (for example, the modification reduces the conversion price of the  debt). 
This treatment should be  applied to future modifications of debt instruments beginning in the first  interim or annual reporting period beginning after December 15, 2005, or  January 1, 2006 for us.  The adoption of EITF 05-7 is not expected to  have a material impact on our financial statements.





In  September 2005, the FASB ratified the EITFs Issue No. 05-8, Income Tax  Consequences of Issuing Convertible Debt with a Beneficial Conversion Feature.  (EITF 05-8).  Under EITF 05-8,  the issuance of





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convertible debt with a beneficial conversion feature results in a  basis difference for purposes of applying SFAS No. 109, Accounting for Income Taxes  (SFAS 109).  The Task Force reached a  consensus that the basis difference that results from the issuance of  convertible debt with a beneficial conversion feature is a temporary difference  for purposes of applying SFAS 109, and that such temporary difference should be  recorded as an adjustment to additional paid-in capital.  This treatment should be applied to the  first financial statements beginning in the first interim or annual reporting  period beginning after December 15, 2005, or January 1, 2006 for us.  The adoption of EITF 05-8 is not expected to have a material impact on our  financial statements.





Embedded  Derivatives





In June  2005, the FASB issued guidance on SFAS No. 133, Accounting for Derivative Instruments  and Hedging Activities as amended (SFAS 133) in Derivative  Implementation Group (DIG) Issue B38, Embedded Derivatives:  Evaluation of Net Settlement with Respect to the Settlement of a  Debt Instrument through Exercise of an Embedded Put Option or Call Option  (DIG Issue B38) and Issue B39, Embedded Derivatives:  Application of Paragraph 13(b) to Call Options That Are  Exercisable Only by the Debtor (DIG Issue B39).  The guidance in DIG Issue B38 clarifies that  the potential settlement of a debtors obligation to a creditor that would  occur upon exercise of a put or call option meets the net settlement criteria  of SFAS No. 133. 
The guidance in DIG  Issue B39 clarifies that an embedded call option that can accelerate the  settlement of a debt host financial instrument should not be bifurcated and  fair valued if the right to accelerate the settlement can be exercised only by  the debtor (issuer/borrower), it is underlying an interest rate index and the  investor will recover substantially all of its initial net investment.  Both DIG issues will be effective for the  fiscal quarter beginning after December 15, 2005, or January 1, 2006 for  us.  We are currently evaluating the  impact, if any, of adopting DIG Issue B38 and DIG Issue B39 on our consolidated  financial statements.





General  Partner Control of Limited Partnerships





In June  2005, the EITF reached a
consensus on EITF Issue No. 04-5, Determining Whether a General Partner,  or the General Partners as a Group,
Controls a Limited Partnership or Similar  Entity When the Limited Partners Have Certain Rights (EITF  04-5). 
This consensus applies to voting  right entities not within the scope of FIN 46(R) in which the investor is the  general partner(s)
in a limited partnership or functional equivalent.  The EITF consensus is that the general  partner(s) in a limited partnership
is presumed to control that limited  partnership and therefore should include the limited partnership in its  consolidated financial
statements.  The  general partner(s) may overcome this presumption of control and not consolidate  the entity if the limited
partners have:   (a) the substantive ability to dissolve (liquidate) the limited  partnership or otherwise remove the general
partner through substantive  kick-out rights that can be exercised without having to show cause; or (b)  substantive participating
rights in managing the partnership.  This guidance became immediately effective  upon ratification by the FASB on
June 29, 2005 for all newly formed limited  partnerships and for existing limited partnerships for which the partnership
agreements have been modified.  For  general partners in all other limited partnerships, the guidance is effective  no
later than the beginning of the first reporting period in fiscal years beginning  after December 15, 2005, or October 1, 2006
for us.  We continue, but have not completed, evaluating the impact of  applying the provisions of EITF No. 04-5 to our
existing unconsolidated joint  venture partnerships, but do not expect the adoption will have a material  impact on our consolidated financial statements.





Accounting  Changes and Error Corrections





In May  2005, the FASB issued SFAS No. 154, Accounting Changes and Error Correctionsa  replacement of APB Opinion No. 20 and FASB Statement No. 3.  This statement changes the requirements for  the accounting for and reporting of a change in accounting principle.  This statement applies to all voluntary  changes in accounting principle.  It  also applies to changes required by an accounting pronouncement in the unusual  instance that the pronouncement does not include specific transition  provisions.  When a pronouncement  includes specific transition provisions, those provisions should be followed. 
APB No. 20 previously required that most  voluntary changes in accounting principle be recognized by including in net  income of the period of the change the cumulative effect of changing to the new  accounting principle.  SFAS 154 requires  retrospective application to prior period financial statements of changes in  accounting principle, unless it is impracticable to determine either the  period-specific effects or the cumulative effect of the change.  This statement does not change the guidance  for reporting the





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correction of an error in previously issued financial statements or the  change in an accounting estimate.  SFAS  No. 154 is effective for accounting changes and corrections of errors made in  fiscal years beginning after December 15, 2005, or October 1, 2006 for us.  We do not expect this statement to have a  material impact on our consolidated financial statements.





Accounting for Conditional Asset Retirement Obligations





In
    March 2005, the FASB issued Interpretation No. 47, Accounting
      for Conditional Asset Retirement Obligationsan Interpretation
      of SFAS
No. 143, (FIN 47). This interpretation provides clarification with
respect to the timing of liability recognition for legal obligations associated
with the retirement of tangible long-lived assets when the timing and/or method
of settlement of the obligation are conditional on a future event. FIN 47 is
effective no later than the end of all fiscal years ending after December 15,
2005, or September 30, 2006 for us. Retrospective application for interim financial
information is permitted but is not required. We do not expect the adoption of
this statement to have a material impact on our financial statements.





Seasonality





Our  earnings generally fluctuate from quarter to quarter.  This seasonality is related to a combination of factors, which  include the timing of Medicaid and Medicare rate increases and payroll tax  obligations, inclement weather, seasonal census cycles, and the number of  calendar days in a given quarter.





Impact of Inflation





The  healthcare industry is labor intensive.   Wages and other labor costs are especially sensitive to inflation and  marketplace labor shortages.  To date,  we have sought to offset our increased operating costs by increasing charges  for our services and expanding our services.   We have also implemented cost control measures to limit increases in  operating costs and expenses but cannot predict our ability to control such  operating cost increases in the future.   See Cautionary Statements Regarding Forward-Looking Statements.





|ITEM    3: | Quantitative    and Qualitative Disclosures about Market Risk
|---------- | -------------------------------------------------------------




We are  exposed to the impact of interest rate changes.





At December  31, 2005, we have $8.0 million of debt subject to variable rates of  interest.  A one percent change in the  rate of interest would result in a change to our interest expense of $0.1  million annually.





At December  31, 2005, we have $90.4 million of cash and equivalents that are affected by  market rates of interest.  A one percent  change in the rate of interest would result in a change in interest income of  $0.9 million annually.





At December  31, 2005, we held $19.0 million of restricted investments in marketable  securities that are affected by market rates of interest.  A one percent change in the rate of interest  would result in a change in interest income of $0.2 million annually.





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|ITEM    4: | Controls    and Procedures
|---------- | --------------------------




(a)     Effectiveness  of disclosure controls and procedures.





As required  by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended, (the  Exchange Act), our management, including our chief executive officer and chief  financial officer, conducted an evaluation of the effectiveness of the design  and operation of our disclosure controls and procedures (as defined in Exchange  Act Rule 13a-15(e)) as of December 31, 2005.   Disclosure controls and procedures include controls and procedures  designed to ensure that information required to be disclosed in our reports  filed or submitted under the Exchange Act, such as this Quarterly Report on  Form 10-Q, is properly recorded, processed, summarized and reported within the  time periods required by the Securities and Exchange Commissions rules and  forms. Management necessarily applied its judgment in assessing the costs and  benefits of such controls and procedures that, by their nature, can provide


 only reasonable assurance regarding managements control objectives. Management  does not expect that its disclosure controls and procedures will prevent all  errors and fraud. A control system, irrespective of how well it is designed and  operated, can only provide reasonable assurance, and cannot guarantee that it  will succeed in its stated objectives.





Based on an  evaluation of the effectiveness of disclosure controls and procedures, our  chief executive officer and chief financial officer concluded that, as of  December 31, 2005, our disclosure controls and procedures were effective in  reaching a reasonable level of assurance that information required to be  disclosed by us in the reports that we file or submit under the Exchange Act is  recorded, processed, summarized and reported within the time period specified  in the Securities and Exchange Commissions rules and forms.





(b)     Changes  in internal control over financial reporting.





There was  no change in our internal controls over financial reporting identified in  connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that  occurred during the period covered by this Quarterly Report on Form 10-Q that  has materially affected, or is reasonably likely to affect materially, our  internal control over financial reporting.





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|PART    II: | OTHER    INFORMATION                                          
|----------- | --------------------------------------------------------------
|            |                                                               
|ITEM    1:  | Legal    Proceedings -None                                    
|            |                                                               
|ITEM    2:  | Unregistered    Sales of Equity Securities and Use of Proceeds




The  following table provides information with respect to common stock repurchased  by us during the three months ended December 31, 2005:





|Issuer    Purchases of Equity Securities
|----------------------------------------
|                                        
|Period                                  
|                                        
|10/1/05 - 10/31/05                      
|11/1/05 - 11/30/05                      
|12/1/05 - 12/31/05                      
|                                        
|Total                                   
|                                        




|   
|---
|(1)




|ITEM 3: | Defaults Upon Senior Securities None                       
|------- | ------------------------------------------------------------
|        |                                                             
|ITEM 4: | Submission of Matters to a Vote of    Security Holders -None
|        |                                                             
|ITEM 5: | Other Information -None                                     
|        |                                                             
|ITEM 6: | Exhibits                                                    




| | (a) | Exhibits
| | --- | --------
| |     |         
| |     | 31.1    
| |     |         
| |     | 31.2    
| |     |         
| |     | 32.1    
| |     |         
| |     | 32.2    




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SIGNATURES





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





|                           | Genesis HealthCare Corporation                   
|-------------------------- | -------------------------------------------------
|                           |                                                  
|Date:     February 8, 2006 | /s/ James V.    McKeon                           
|                           |                                                  
|                           | James V. McKeon,                                 
|                           | Chief Financial Officer                          
|                           |                                                  
|Date:     February 8, 2006 | /s/ George    V. Hager, Jr.                      
|                           |                                                  
|                           | George V. Hager, Jr.,                            
|                           | Chief Executive Officer and Chairman of the Board




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