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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 THESECURITIES EXCHANGE ACT OF 1934
| | --------------------------------------------------------------------------------------

For the quarterly period ended June 30, 2006

or

| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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 ofincorporation or organization) |  | 20-0023783(I.R.S. Employer Identification No.) | 
| | ------------------------------------------------------------------------- |  | ---------------------------------------------- | 

| |  |  |  | 
| |  |  |  | 

| | 101 East State StreetKennett Square, Pennsylvania(Address of principal executive offices) |  | 19348(Zip Code) | 
| | ----------------------------------------------------------------------------------------- |  | --------------- | 

(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.

YESNO

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).

YESNO

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 ofAugust 1, 2006: 19,648,650 shares of the registrants common stock were outstanding, including 131,680 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                                                                 | 3   
|                                                          |    |                                                                                       |     
|ITEM 1:                                                   |    | Financial Statements                                                                  | 3   
|                                                          |    |                                                                                       |     
|ITEM 2:                                                   |    | Managements Discussion and Analysis of Financial Condition and Results of Operations | 29  
|                                                          |    |                                                                                       |     
|ITEM 3:                                                   |    | Quantitative and Qualitative Disclosures About Market Risk                            | 47  
|                                                          |    |                                                                                       |     
|ITEM 4:                                                   |    | Controls and Procedures                                                               | 47  
|                                                          |    |                                                                                       |     
|PART II:                                                  |    | OTHER INFORMATION                                                                     | 48  
|                                                          |    |                                                                                       |     
|ITEM 1:                                                   |    | Legal Proceedings                                                                     | 48  
|                                                          |    |                                                                                       |     
|ITEM 1A:                                                  |    | Risk Factors                                                                          | 48  
|                                                          |    |                                                                                       |     
|ITEM 2:                                                   |    | Unregistered Sales of Equity Securities and Use of Proceeds                           | 48  
|                                                          |    |                                                                                       |     
|ITEM 3:                                                   |    | Defaults Upon Senior Securities                                                       | 48  
|                                                          |    |                                                                                       |     
|ITEM 4:                                                   |    | Submission of Matters to a Vote of Security Holders                                   | 48  
|                                                          |    |                                                                                       |     
|ITEM 5:                                                   |    | Other Information                                                                     | 48  
|                                                          |    |                                                                                       |     
|ITEM 6:                                                   |    | Exhibits                                                                              | 49  
|                                                          |    |                                                                                       |     
|SIGNATURES                                                | 50



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CAUTIONARY
  STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

As used herein, unless the context otherwise requires, all references to GHC, 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; expected closings of transactions and sources of funding; expected accounting treatment of transactions; 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 recognition of stock-based compensation costs; 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; the containment of asbestos in accordance with environmental regulations; 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

JUNE 30, 2006 AND SEPTEMBER 30, 2005

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)





|                                                                                                                                                                                              |  | June 30, 2006 |           | September 30, 2005 |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | --------- | ------------------ | -
|                                                                                                                                                                                              |  |               |           |                    |  
|Assets:                                                                                                                                                                                       |  |               |           |                    |  
|Current
        assets:                                                                                                                                                                       |  |               |           |                    |  
|Cash and equivalents                                                                                                                                                                          |  | $             | 59,994    |                    | $
|Current portion of restricted cash and investments in marketable securities                                                                                                                   |  |               | 38,234    |                    |  
|Accounts receivable, net of allowances for doubtful accounts of $25,710 and $22,982, at June 30, 2006 and September 30, 2005, respectively                                                    |  |               | 215,936   |                    |  
|Prepaid expenses and other current assets                                                                                                                                                     |  |               | 44,624    |                    |  
|Current portion of deferred income taxes                                                                                                                                                      |  |               | 43,179    |                    |  
|                                                                                                                                                                                              |  |               |           |                    |  
|Total current assets                                                                                                                                                                          |  |               | 401,967   |                    |  
|                                                                                                                                                                                              |  |               |           |                    |  
|Property and equipment, net of accumulated depreciation of $219,311 and $173,714, at June 30, 2006 and September 30, 2005, respectively                                                       |  |               | 849,696   |                    |  
|Assets held for sale                                                                                                                                                                          |  |               | 3,911     |                    |  
|Restricted cash and investments in marketable securities                                                                                                                                      |  |               | 64,250    |                    |  
|Deferred income taxes                                                                                                                                                                         |  |               | 6,647     |                    |  
|Other long-term assets                                                                                                                                                                        |  |               | 89,114    |                    |  
|                                                                                                                                                                                              |  |               |           |                    |  
|Total assets                                                                                                                                                                                  |  | $             | 1,415,585 |                    | $
|                                                                                                                                                                                              |  |               |           |                    |  
|Liabilities
        and Shareholders Equity:                                                                                                                                                 |  |               |           |                    |  
|Current liabilities:                                                                                                                                                                          |  |               |           |                    |  
|Current installments of long-term debt                                                                                                                                                        |  | $             | 4,640     |                    | $
|Accounts payable and other accrued expenses                                                                                                                                                   |  |               | 134,710   |                    |  
|Current portion of self-insurance liability reserves                                                                                                                                          |  |               | 38,234    |                    |  
|                                                                                                                                                                                              |  |               |           |                    |  
|Total current liabilities                                                                                                                                                                     |  |               | 177,584   |                    |  
|                                                                                                                                                                                              |  |               |           |                    |  
|Long-term debt                                                                                                                                                                                |  |               | 435,301   |                    |  
|Self-insurance liability reserves                                                                                                                                                             |  |               | 71,155    |                    |  
|Other long-term liabilities                                                                                                                                                                   |  |               | 42,285    |                    |  
|Commitments
        and contingencies
        Shareholders equity:                                                                                                                           |  |               |           |                    |  
|Common stock - par $0.01, 45,000,000 shares authorized at June 30, 2006 and September 30, 2005, 20,682,428 and 20,429,110 shares issued at June 30, 2006 and September 30, 2005, respectively |  |               | 207       |                    |  
|Additional paid-in capital                                                                                                                                                                    |  |               | 640,638   |                    |  
|Retained earnings                                                                                                                                                                             |  |               | 94,861    |                    |  
|Accumulated other comprehensive loss                                                                                                                                                          |  |               | (794      | )                  |  
|Treasury stock at cost, 1,075,745 and 787,337 shares at June 30, 2006 and September 30, 2005, respectively                                                                                    |  |               | (42,787   | )                  |  
|Common
        stock held in deferred compensation plan at cost, 215,953 and 163,135
        shares at June 30, 2006 and September 30, 2005, respectively                                     |  |               | (8,497    | )                  |  
|Deferred compensation                                                                                                                                                                         |  |               | 5,632     |                    |  
|                                                                                                                                                                                              |  |               |           |                    |  

|Total shareholders equity                 |  |   | 689,260   |  |   | 650,813   | 
|------------------------------------------ |  | - | --------- |  | - | --------- | 
|                                           |  |   |           |  |   |           | 
|Total liabilities and shareholders equity |  | $ | 1,415,585 |  | $ | 1,412,700 | 
|                                           |  |   |           |  |   |           | 

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 JUNE 30, 2006 AND 2005

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)



|                                                                                                           |  | Three months ended |           
|---------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------
|                                                                                                           |  |                    |           
|                                                                                                           |  | June 30, 2006      |           
|                                                                                                           |  |                    |           
|                                                                                                           |  |                    |           
|Net revenues                                                                                               |  | $                  | 442,230   
|Salaries, wages and benefits                                                                               |  |                    | 272,814   
|Other operating expenses                                                                                   |  |                    | 96,871    
|General and administrative costs                                                                           |  |                    | 27,735    
|Provision for losses on accounts receivable and notes receivable                                           |  |                    | 2,511     
|Loss on early extinguishment of debt                                                                       |  |                    | 605       
|Lease expense                                                                                              |  |                    | 5,445     
|Depreciation and amortization expense                                                                      |  |                    | 15,843    
|Interest expense                                                                                           |  |                    | 6,387     
|Investment income                                                                                          |  |                    | (2,178    
|                                                                                                           |  |                    |           
|Income before income tax expense, equity in net income of unconsolidated affiliates and minority interests |  |                    | 16,197    
|Income tax expense                                                                                         |  |                    | 6,559     
|                                                                                                           |  |                    |           
|Income before equity in net income of unconsolidated affiliates and minority interests                     |  |                    | 9,638     
|Equity in net income of unconsolidated affiliates                                                          |  |                    | 540       
|Minority interests                                                                                         |  |                    | (621      
|                                                                                                           |  |                    |           
|Income from continuing operations                                                                          |  |                    | 9,557     
|Income (loss) from discontinued operations, net of taxes                                                   |  |                    | 129       
|                                                                                                           |  |                    |           
|Net income                                                                                                 |  | $                  | 9,686     
|                                                                                                           |  |                    |           
|Per common share data:                                                                                     |  |                    |           
|Basic:                                                                                                     |  |                    |           
|Income from continuing operations                                                                          |  | $                  | 0.49      
|Income (loss) from discontinued operations                                                                 |  |                    | 0.01      
|Net income                                                                                                 |  | $                  | 0.50      
|Weighted average shares                                                                                    |  |                    | 19,328,064
|Diluted:                                                                                                   |  |                    |           
|Income from continuing operations                                                                          |  | $                  | 0.49      
|Income (loss) from discontinued operations                                                                 |  |                    | 0.01      
|Net income                                                                                                 |  | $                  | 0.49      
|Weighted average shares                                                                                    |  |                    | 19,607,162

See accompanying notes to unaudited condensed consolidated financial statements.

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

NINE MONTHS ENDED JUNE 30, 2006 AND 2005

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)



|                                                                                                           |  | Nine months ended |           
|---------------------------------------------------------------------------------------------------------- |  | ----------------- | ----------
|                                                                                                           |  |                   |           
|                                                                                                           |  | June 30, 2006     |           
|                                                                                                           |  |                   |           
|                                                                                                           |  |                   |           
|Net revenues                                                                                               |  | $                 | 1,316,660 
|Salaries, wages and benefits                                                                               |  |                   | 810,080   
|Other operating expenses                                                                                   |  |                   | 288,834   
|General and administrative costs                                                                           |  |                   | 83,011    
|Provision for losses on accounts receivable and notes receivable                                           |  |                   | 9,394     
|Loss on early extinguishment of debt                                                                       |  |                   | 793       
|Lease expense                                                                                              |  |                   | 16,531    
|Depreciation and amortization expense                                                                      |  |                   | 46,212    
|Interest expense                                                                                           |  |                   | 19,242    
|Investment income                                                                                          |  |                   | (6,354    
|                                                                                                           |  |                   |           
|Income before income tax expense, equity in net income of unconsolidated affiliates and minority interests |  |                   | 48,917    
|Income tax expense                                                                                         |  |                   | 19,913    
|                                                                                                           |  |                   |           
|Income before equity in net income of unconsolidated affiliates and minority interests                     |  |                   | 29,004    
|Equity in net income of unconsolidated affiliates                                                          |  |                   | 1,509     
|Minority interests                                                                                         |  |                   | (1,439    
|                                                                                                           |  |                   |           
|Income from continuing operations                                                                          |  |                   | 29,074    
|Income (loss) from discontinued operations, net of taxes                                                   |  |                   | 117       
|                                                                                                           |  |                   |           
|Net income                                                                                                 |  | $                 | 29,191    
|                                                                                                           |  |                   |           
|Per common share data:                                                                                     |  |                   |           
|Basic:                                                                                                     |  |                   |           
|Income from continuing operations                                                                          |  | $                 | 1.50      
|Income (loss) from discontinued operations                                                                 |  |                   | 0.01      
|Net income                                                                                                 |  | $                 | 1.51      
|Weighted average shares                                                                                    |  |                   | 19,342,473
|Diluted:                                                                                                   |  |                   |           
|Income from continuing operations                                                                          |  | $                 | 1.48      
|Income (loss) from discontinued operations                                                                 |  |                   | 0.01      
|Net income                                                                                                 |  | $                 | 1.49      
|Weighted average shares                                                                                    |  |                   | 19,609,881

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

NINE MONTHS ENDED JUNE 30, 2006 AND 2005

(IN THOUSANDS)



|                                                               |  | Nine
        months ended |        
|-------------------------------------------------------------- |  | ------------------------- | -------
|                                                               |  |                           |        
|                                                               |  | June
        30, 2006     |        
|                                                               |  |                           |        
|                                                               |  |                           |        
|Cash
        flows from operating activities:                  |  |                           |        
|Net
        income                                             |  | $                         | 29,191 
|Net
        charges included in operations not requiring funds |  |                           | 82,253 
|Changes
        in assets and liabilities:                     |  |                           |        
|Accounts
        receivable                                    |  |                           | (38,646
|Accounts
        payable and other accrued expenses            |  |                           | (22,313
|Other,
        net                                             |  |                           | (2,697 
|                                                               |  |                           |        
|Total
        adjustments                                      |  |                           | 18,597 
|                                                               |  |                           |        
|Net
        cash provided by operating activities              |  |                           | 47,788 
|                                                               |  |                           |        
|Cash
        flows from investing activities:                  |  |                           |        
|Capital
        expenditures                                   |  |                           | (77,467
|Net
        purchases of restricted marketable securities      |  |                           | (6,804 
|Net
        change in restricted cash and equivalents          |  |                           | 7,367  
|Purchase
        of eldercare centers, net of cash acquired    |  |                           | (3,140 
|Proceeds
        from sales of eldercare assets                |  |                           |       
|Other,
        net                                             |  |                           | 5,993  
|                                                               |  |                           |        
|Net
        cash used in investing activities                  |  |                           | (74,051
|                                                               |  |                           |        
|Cash
        flows from financing activities:                  |  |                           |        
|Proceeds
        from issuance of long-term debt               |  |                           |       
|Repayment
        of long-term debt                            |  |                           | (14,345
|Debt
        issuance costs and debt prepayment premium        |  |                           | (534   
|Purchase
        of common stock for treasury                  |  |                           | (10,691
|Proceeds
        from exercise of stock options                |  |                           | 3,295  
|Other,
        net                                             |  |                           | 1,182  
|                                                               |  |                           |        
|Net
        cash used in financing activities                  |  |                           | (21,093
|                                                               |  |                           |        
|Net
        decrease in cash and equivalents                   |  | $                         | (47,356
|Cash
        and equivalents:                                  |  |                           |        
|Beginning
        of period                                    |  |                           | 107,350
|                                                               |  |                           |        
|End
        of period                                          |  | $                         | 59,994 
|                                                               |  |                           |        
|Supplemental
        disclosure of cash flow information:      |  |                           |        
|Interest
        paid                                          |  | $                         | 20,601 
|Taxes
        paid                                             |  |                           | 7,963  
|Non-cash
        financing activities:                         |  |                           |        
|Capital
        leases                                         |  | $                         |       
|Assumption
        of debt                                     |  |                           | 3,190  

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

Genesis HealthCare Corporations (GHC) 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 June 30, 2006, GHC had 208 owned, leased, managed and jointly owned eldercare centers with 25,494 beds. Revenues of GHCs owned, leased and otherwise consolidated centers constitute approximately 90% of GHCs revenues, and are presented in GHCs segment information as inpatient services revenues. Management fees earned from unconsolidated 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 8  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 4,800 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 U.S. generally accepted accounting principles 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, as discussed under the section herein entitled Restatement of Unaudited Condensed Consolidated Financial Statements.

Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements include the accounts of GHC, its wholly owned subsidiaries and its consolidated variable interest entities, as discussed further below. All significant intercompany accounts and transactions have been eliminated in consolidation for all periods presented.

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin (ARB) 51 (FIN 46). FIN 46 provides guidance with respect to the consolidation of certain entities referred to as variable interest entities (VIE). GHC adopted FIN 46 effective January 1, 2003. In October 2003, the FASB issued a revision to this pronouncement, FIN 46R, which clarified certain provisions of FIN 46. GHC adopted the provisions of FIN 46R effective December 31, 2003. References herein to FIN 46 refer to FIN 46 or FIN 46R as these interpretations are applicable to the respective periods. Prior to the filing of the Quarterly Report on Form 10-Q for the three and six months ended March 31, 2006, GHC reassessed whether certain of the
transaction structures of its jointly owned and managed facilities create VIEs and whether GHC is the primary beneficiary of the VIEs as defined pursuant to FIN 46. Upon re-examination of the interests at January 1, 2003 of all parties associated with all 12 of GHCs previously unconsolidated jointly owned and managed facilities, GHC concluded that nine of the transaction structures are, or were, VIEs, seven of which GHC is the primary beneficiary. Of these seven, GHC subsequently acquired 100% of the interests of one of the VIEs (the acquired VIE) and the conditions that caused one of the facilities to be a VIE were extinguished in May 2004 (the former VIE). Consequently, GHC now consolidates the financial statements of five previously unconsolidated VIEs beginning January 1, 2003, the acquired VIE from January 1, 2003 through December 31, 2004 and the former VIE from January 1, 2003 through May 31, 2004. See Restatement of Unaudited Condensed Consolidated Financial
Statements below.

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In accordance with FIN 46, GHCs investments in VIEs in which it is the primary beneficiary are consolidated, while investments in VIEs in which it is not the primary beneficiary are accounted for under the equity method. Investments in and the operating results of 20% to 50% owned companies which are not VIEs are included in the consolidated financial statements using the equity method of accounting.

In total at June 30, 2006, GHC consolidated five VIEs. At June 30, 2006, total assets and debt of the VIEs were $46.7 million and $40.2 million, respectively. The total assets of the VIEs principally consist of property and equipment which serves as collateral for the VIEs non-recourse debt and is not available to satisfy any of GHCs other obligations. Creditors of the VIEs, including senior lenders, have no recourse against the general credit of GHC. The consolidated VIEs own and operate skilled nursing and assisted living facilities having approximately 700 beds. GHCs ownership interests in the consolidated VIEs range from 25% to 50% and GHC manages the day-to-day operations of the consolidated VIEs under management agreements. GHCs involvement with the VIEs began in years prior to 2000.

In the case of one VIE, GHC is not the primary beneficiary and, therefore, the VIE is not consolidated into its financial statements. The unconsolidated VIE owns and operates a skilled nursing facility having 224 beds. GHCs ownership interest in the unconsolidated VIE is 33.3%, and GHC manages the day-to-day operations of the unconsolidated VIE under a management agreement. GHCs involvement with the unconsolidated VIE began prior to 1991. At June 30, 2006, GHCs maximum exposure to loss associated with the unconsolidated VIE approximated the aggregate carrying-value of its equity method investments which was minimal.

Restatement of Unaudited Condensed Consolidated Financial Statements

Prior to filing the Quarterly Report on Form 10-Q for the three and six months ended March 31, 2006, certain accounting errors were identified requiring the restatement of GHCs previously issued consolidated financial statements.

GHCs policy with respect to discounting self-insured outstanding losses and loss expenses for both general and professional liability and workers compensation liability claims was reassessed, and it was determined that such discounting was not in accordance with U.S. generally accepted accounting principles. In connection with the evaluation of its accounting for self-insurance loss reserves, GHC also identified an accounting error that, upon correction, resulted in an increase to self-insurance loss reserves and related expenses of $2.4 million in fiscal 2004 and a corresponding decrease to self-insurance loss reserves and related expenses in fiscal 2005.

As discussed above, upon re-examination of the interests at January 1, 2003 of all parties associated with all 12 of GHCs previously unconsolidated jointly owned and managed facilities, GHC has concluded that it is the primary beneficiary of seven previously unconsolidated VIEs.

Also, as disclosed in GHCs previously issued Annual Report on Form 10-K, prior to restatement, for the fiscal year ended September 30, 2005, certain errors were identified and corrected by GHC in its fiscal 2005 consolidated financial statements. These errors involved accounting for operating lease expense on a straight-line basis, the classification of certain leases, accounting for GHC stock held in a deferred compensation plan, the useful lives assigned to certain fixed assets and unaccrued costs resulting from errors in purchasing cut-off. Based upon an evaluation conducted in fiscal 2005, GHC previously concluded that the errors were not material to GHCs consolidated financial statements taken as a whole and adjusted for the errors in the period such errors were identified.

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GHCs previously issued unaudited condensed consolidated financial statements for the three and nine months ended June 30, 2005 have been restated herein to correct all of the errors described in the previous three paragraphs. The discounting of self-insurance loss reserves correction, along with certain other immaterial errors that were identified and corrected in the appropriate periods, are presented in the tables below under the column entitled Adjustments. The consolidation of the joint ventures under FIN 46 is presented in the tables below under the column entitled Consolidation of VIEs. In addition, presented in the tables below under the column entitled Reclassifications, GHC has made changes in certain account classifications to conform with U.S. generally accepted accounting principles. The tables below are followed by footnote disclosures
that facilitate the referencing of adjustments and reclassifications between previously reported and restated amounts.

The following unaudited tables illustrate the impact of the restatement to previously reported amounts for the three and nine months ended June 30, 2005, (in thousands, except share and per share data):

Unaudited Condensed Consolidated Statements of Operations Data:



|                                                                                                                           |  | Three
        months endedJune 30, 2005 |           
|-------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | ----------
|                                                                                                                           |  |                                         |           
|                                                                                                                           |  | PreviouslyReported                      |           
|                                                                                                                           |  |                                         |           
|Net
        revenues                                                                                                       |  | $                                       | 408,971   
|Salaries,
        wages and benefits                                                                                       |  |                                         | 251,945   
|Other
        operating expenses                                                                                           |  |                                         | 86,509    
|General
        and administrative costs                                                                                   |  |                                         | 23,602    
|Provision
        for losses on accounts
        receivable and notes receivable                                           |  |                                         | 2,522     
|Loss on early extinguishment of debt                                                                                       |  |                                         | 6,933     
|Lease
        expense                                                                                                      |  |                                         | 6,538     
|Depreciation and amortization expense                                                                                      |  |                                         | 12,723    
|Interest
        expense                                                                                                   |  |                                         | 5,096     
|Investment
        income                                                                                                  |  |                                         |          
|                                                                                                                           |  |                                         |           
|Income
        before income tax expense, equity in net income of unconsolidated affiliates
        and minority interests |  |                                         | 13,103    
|Income
        tax expense                                                                                                 |  |                                         | 4,775     
|                                                                                                                           |  |                                         |           
|Income
        before equity in net income of unconsolidated affiliates and minority
        interests                     |  |                                         | 8,328     
|Equity
        in net income of unconsolidated affiliates                                                                  |  |                                         | 591       
|Minority
        interests                                                                                                 |  |                                         | 72        
|                                                                                                                           |  |                                         |           
|Income
        from continuing operations                                                                                  |  |                                         | 8,991     
|Loss
        from discontinued operations, net of taxes                                                                    |  |                                         | (1,350    
|                                                                                                                           |  |                                         |           
|Net
        income                                                                                                         |  | $                                       | 7,641     
|                                                                                                                           |  |                                         |           
|Per
        common share data:                                                                                             |  |                                         |           
|Basic:                                                                                                                     |  |                                         |           
|Income
        from continuing operations                                                                                  |  | $                                       | 0.46      
|Loss
        from discontinued operations                                                                                  |  |                                         | (0.07     
|Net
        income                                                                                                         |  | $                                       | 0.39      
|Weighted
        average shares                                                                                            |  |                                         | 19,619,845
|Diluted:                                                                                                                   |  |                                         |           
|Income
        from continuing operations                                                                                  |  | $                                       | 0.45      
|Loss
        from discontinued operations                                                                                  |  |                                         | (0.07     
|Net
        income                                                                                                         |  | $                                       | 0.38      
|Weighted
        average shares                                                                                            |  |                                         | 19,937,181

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|                                                                                                                                             |  | Nine
        months endedJune 30, 2005 |                   
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------- | ------------------
|                                                                                                                                             |  |                                        |                   
|                                                                                                                                             |  |                                        | PreviouslyReported
|                                                                                                                                             |  |                                        |                   
|Net
        revenues                                                                                                                         |  | $                                      | 1,262,564         
|Salaries,
        wages and benefits                                                                                                         |  |                                        | 758,300           
|Other
        operating expenses                                                                                                             |  |                                        | 292,374           
|General and administrative costs                                                                                                             |  |                                        | 66,300            
|Provision for losses on accounts
        
        receivable and notes receivable                                                            |  |                                        | 8,397             
|Loss on early extinguishment of  debt                                                                                                        |  |                                        | 11,765            
|Lease
        expense                                                                                                                        |  |                                        | 20,119            
|Depreciation and amortization
        expense                                                                                                |  |                                        | 37,248            
|Interest
        expense                                                                                                                     |  |                                        | 17,989            
|Investment
        income                                                                                                                    |  |                                        |                  
|                                                                                                                                             |  |                                        |                   
|Income
        before income tax expense, 
        equity in net income of 
        unconsolidated affiliates and
        minority interests |  |                                        | 50,072            
|Income
        tax expense                                                                                                                   |  |                                        | 19,154            
|                                                                                                                                             |  |                                        |                   
|Income
        before equity in net income 
        of unconsolidated affiliates and
        minority interests                              |  |                                        | 30,918            
|Equity
        in net income of 
        unconsolidated affiliates                                                                           |  |                                        | 2,381             
|Minority
        interests                                                                                                                   |  |                                        | (352              
|                                                                                                                                             |  |                                        |                   
|Income
        from continuing operations                                                                                                    |  |                                        | 32,947            
|Loss
        from discontinued operations,
        net of taxes                                                                              |  |                                        | (991              
|                                                                                                                                             |  |                                        |                   
|Net
        income                                                                                                                           |  | $                                      | 31,956            
|                                                                                                                                             |  |                                        |                   
|Per
        common share data:                                                                                                               |  |                                        |                   
|Basic:                                                                                                                                       |  |                                        |                   
|Income from continuing operations                                                                                                            |  | $                                      | 1.67              
|Loss
        from discontinued operations                                                                                                    |  |                                        | (0.05             
|Net
        income                                                                                                                           |  | $                                      | 1.62              
|Weighted
        average shares                                                                                                              |  |                                        | 19,758,715        
|Diluted:                                                                                                                                     |  |                                        |                   
|Income
        from continuing operations                                                                                                    |  | $                                      | 1.64              
|Loss
        from discontinued operations                                                                                                    |  |                                        | (0.05             
|Net
        income                                                                                                                           |  | $                                      | 1.59              
|Weighted
        average shares                                                                                                              |  |                                        | 20,069,697        

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Unaudited Selected Condensed Consolidated Statement of Cash Flows Data:



|                                              |  | Nine months endedJune 30, 2005 |        
|--------------------------------------------- |  | ------------------------------ | -------
|                                              |  |                                |        
|                                              |  | Previously
        Reported    |        
|                                              |  |                                |        
|Net cash provided by operating activities     |  | $                              | 110,587
|Net
        cash used in investing activities |  |                                | (45,998
|Net cash used in financing activities         |  |                                | (77,407
|Cash and equivalents beginning of period      |  |                                | 126,071
|                                              |  |                                |        
|Cash and equivalents end of period            |  | $                              | 113,253
|                                              |  |                                |        

|(1) | Adjustments to revenue of $3.0 million and $1.0 million in the three and nine months ended June 30, 2005, respectively, for previously recognized changes in the market value of GHC common stock held in a rabbi trust. The accounting treatment for assets invested in a rabbi trust under 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) differs depending upon the level of restrictions placed on a participants ability to diversify deferred compensation that is invested in company stock. Under EITF 97-14, GHCs deferred compensation plan type requires that GHC common stock held in its rabbi trust be classified as a component of shareholders equity at cost, with no subsequent
adjustment for market value changes.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Three months ended June 30, 2005 - amount represents an accrual adjustment for self-insurance loss reserves.
|--- | ------------------------------------------------------------------------------------------------------------

Nine months ended June 30, 2005 - $2.8 million represents the reversal of an increase in operating expenses recognized in the three months ended December 31, 2004 to reflect an estimate of previously unaccrued costs resulting from errors in GHCs purchasing cut-off, $2.2 million represents a reduction to accruals for self-insurance loss reserves and $0.6 million represents other miscellaneous accrual adjustments.

|(3) | Adjustments to general and administrative costs represent corrections to self-insurance loss reserves to reflect such balances on an undiscounted basis. Adjustments to (loss) income from discontinued operations represent similar corrections to reflect self-insurance loss reserves associated with GHCs discontinued Florida operations on an undiscounted basis.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Three and nine months ended June 30, 2005 - Adjustments to lease, interest and depreciation and amortization expense include the correction to GHCs accounting for five nursing center leases previously classified as operating leases beginning in fiscal 2004 that should have been classified as capital leases, as well as adjustments to increase lease expense to properly recognize operating lease expense on a straight-line basis.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Nine months ended June 30, 2005  Depreciation expense was also reduced $1.2 million to reflect adjustments associated with a correction to the useful lives assigned to certain fixed assets.

|(5) | Represents the tax impact of the previously noted adjustments.
|--- | --------------------------------------------------------------

|(6) | Represents the following reclassifications:
|--- | -------------------------------------------

| | (i) | Net revenues were reduced to classify investment income as a separate line item on the statements of operations in the amounts of $2.8 million and $6.8 million for the three and nine months ended June 30, 2005, respectively.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | Net revenues were increased to reflect certain zero-margin reimbursements from NeighborCare, Inc. (NCI), GHCs former parent company, under the transitional services agreement in the amounts of $0.4 million and $1.4 million for the three and nine months ended June 30, 2005, respectively. These amounts were previously classified as an offset to general and administrative costs.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (iii) | Certain reclassifications were made between salaries, wages and benefits in the amounts of $4.8 million and $7.0 million for the three and nine months ended June 30, 2005, respectively; other operating expenses in the amounts of ($0.8) million and $1.2 million for the three and nine months ended June 30, 2005, respectively; and general and administrative expenses in the amounts of ($4.0) million and ($8.2) million for the three and nine months ended June 30, 2005, respectively, to better align changes in estimates of self-insurance loss reserves with functional expense categories. Specifically, changes in estimates associated with workers compensation claims are reclassified as a component of salaries, wages and benefits, while changes in estimates associated with general and professional liability claims are reclassified as a component of other operating
expenses.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (iv) | Certain reclassifications were made between salaries, wages and benefits and general and administrative expenses in the amounts of $3.3 million and $11.1 million for the three and nine months ended June 30, 2005, respectively, to better align cash-based incentive compensation and non-cash stock-based compensation expenses to the appropriate account captions that reflect the base wages of the individuals earning such compensation.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Represents the change in restricted cash previously reflected as a component of cash and equivalents. The change in restricted cash is reflected as an investing activity in the statements of cash flows.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Represents the consolidation of VIEs, after giving effect to related eliminations, for which GHC is deemed to be the primary beneficiary pursuant to FIN 46.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

Factors Affecting Comparability of Financial Information

In March 2005, GHC recognized revenues and operating expenses resulting from the recognition of provider assessments retroactive to prior periods. See note 3  Significant Transactions and Events  Prior Year Recognition of Pennsylvania and New Jersey Provider Assessments.

(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.

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Use of Estimates

GHC 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 U.S. generally accepted accounting principles. 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 and the change may be material if a different estimate were used in preparing its financial statements. Any subsequent differences arising are recorded in the period in which they are determined.

(3)   Significant
  Transactions and Events

Lease and Purchase Option Agreements

In May 2006, GHC announced that it signed an agreement to enter into lease and purchase option agreements with an unrelated provider of long-term care that operates 11 facilities with a combined total of approximately 970 skilled nursing and assisted living facility beds located in the State of Maine. The most significant terms of the transaction assume GHC will enter into 11 separate agreements to lease the facilities over a 10 year term, with two five year renewal options. GHC will also obtain an option to purchase all 11 properties in 2026 for $53.0 million. GHC expects to account for the transaction as a capital lease. GHC would pay approximately $16.0 million of cash consideration and the related capital lease obligation is expected to approximate $40.0 million. The 11 facilities currently generate approximately $65.0 million of annual revenue. The closing of the transaction, which is
expected to occur in the last calendar quarter of 2006, is subject to receipt of regulatory approvals and various other customary conditions. Accordingly, no assurances can be given that the transaction will be consummated or, if it is, what the final terms will be or what its ultimate impact will be on GHCs financial condition or results of operations.

Share Repurchase

In
  April 2006, GHCs board of directors authorized the repurchase of up to
  $150.0 million of GHCs common stock, with such repurchases to take place
  at GHC managements discretion and/or under pre-established, non-discretionary
  programs from time to time, depending on market conditions, in the open market
  and in privately negotiated transactions, subject to any covenants or restrictions
  contained in agreements governing GHCs indebtedness. Repurchases of common
  stock are restricted by GHCs debt agreements, the most restrictive of
  which is its 8% senior subordinated notes. Such restrictions preclude repurchases
  of common stock above 50% of GHCs net income since July 1, 2003. After
  considering common stock repurchases made to date and other repurchase provisions,
  GHCs maximum common stock repurchasing capacity at June 30, 2006 was $19.4
  million. In total, 1,075,745 shares of common stock have been repurchased under
  current and past common stock repurchase programs at a cost of $42.8 million,
  of which 288,408 shares at a cost of $10.7 million were repurchased during the
  nine months ended June 30, 2006.

Debt Repurchase

In February 2005, GHCs board of directors authorized the repurchase of a portion of GHCs 8% senior subordinated notes due 2013 from time to time in the open market commencing in March 2005. There were $79.1 million of 8% senior subordinated notes repurchased through June 30, 2006, of which $8.2 million were repurchased in the nine months ended June 30, 2006. The total debt repurchases made to date resulted in prepayment premium charges of $7.9 million and the write-off of unamortized deferred financing fees and other fees of $3.0 million. These charges, along with the write-off of unamortized deferred financing fees, are collectively included in loss on early extinguishment of debt in the unaudited condensed consolidated statements of operations, and were $0.6 million and $0.8 million, respectively, in the three and nine months ended June 30, 2006, and $6.9 million and $11.8
million, respectively, in the three and nine months ended June 30, 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 owned a 50% interest in and managed the operations of each of the three facilities, but upon completion of the transaction on June 1, 2006 owns 100% of each facility and consolidates the related revenues, expenses and net assets. In accordance with FIN 46, GHC had already consolidated the financial statements of one of the facilities and recorded minority interest to reflect its joint venture partners interests. The combined annual revenues and pre tax income of the two unconsolidated facilities is approximately $10.0 million and $1.2 million, respectively.

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Prior Year Recognition of Pennsylvania and New Jersey Provider Assessments

Provider assessments generate additional federal matching funds to the states for Medicaid reimbursement purposes, and implementation of a provider assessment plan requires approval by the Centers for Medicare and Medicaid Services (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.

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 and net income of $42.0 million and $3.7 million, respectively, in the quarter ended March 31, 2005, of which $30.9 million of revenue and $3.3 million of net income related to periods prior to fiscal 2005.

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, 2008, was recognized cumulatively in the quarter ended March 31, 2005. Recognition of the New Jersey provider assessment resulted in increased revenue and net income of $12.8 million and $1.8 million, respectively, in the quarter ended March 31, 2005, of which $4.3 million of revenue and $0.6 million of net income related to periods prior to fiscal 2005.

(4)   Long-Term
  Debt

Long-term debt at June 30, 2006 and September 30, 2005 consisted of the following (in thousands):



|                                                |  | June 30, 2006 |         | September 30, 2005 |  
|----------------------------------------------- |  | ------------- | ------- | ------------------ | -
|                                                |  |               |         |                    |  
|Senior subordinated notes                       |  | $             | 145,935 |                    | $
|Convertible senior subordinated debentures      |  |               | 180,000 |                    |  
|Mortgages and other secured debt (recourse)     |  |               | 38,744  |                    |  
|Capital lease obligations                       |  |               | 35,061  |                    |  
|Mortgages and other secured debt (non recourse) |  |               | 40,201  |                    |  
|                                                |  |               |         |                    |  
|                                                |  |               | 439,941 |                    |  
|Less:                                           |  |               |         |                    |  
|Current installments of long-term debt          |  |               | (4,640  | )                  |  
|                                                |  |               |         |                    |  
|Long-term debt                                  |  | $             | 435,301 |                    | $
|                                                |  |               |         |                    |  

Senior credit facility.GHCs amended and restated senior credit facility provides for a $125.0 million revolving credit facility with monthly interest paid on any outstanding loans at either a base rate plus a margin or at the London Interbank Offered Rate (LIBOR) plus a margin. At June 30, 2006 and September 30, 2005, $123.2 million and $122.1 million, respectively, was available under the revolving credit facility after giving effect to outstanding letters of credit issued under the revolving credit facility.

Senior subordinated notes. In October 2003, GHC issued 8% senior subordinated notes in an aggregate principal amount of $225.0 million due in 2013. Interest is payable semi-annually in April and October.

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Convertible senior subordinated debentures.In March 2005, GHC issued 2.5% convertible senior subordinated debentures in an aggregate principal amount of $180.0 million due in 2025. Interest is payable semi-annually in March and September.

Mortgages and other secured debt (recourse).GHC carries other secured debt consisting principally of revenue bonds and secured bank loans, including loans insured by the Department of Housing and Urban Development. These loans are secured by the underlying real and personal property of individual eldercare centers and have fixed or variable rates of interest ranging from 3.0% to 11.0% at June 30, 2006, with maturity dates ranging from 2008 to 2032. These loans are labeled recourse because GHC or a wholly owned subsidiary is obligated to perform under the respective loan agreements.

Capital lease obligations.These obligations represent the present value of minimum lease payments of a series of capital lease arrangements that bear imputed interest at rates ranging from 5.0% to 7.8% at June 30, 2006 and maturity dates ranging from 2007 to 2012.

Mortgages
  and other secured debt (non-recourse).These loans are
  carried by certain of GHCs less than 51% owned joint ventures consolidated
  pursuant to FIN 46. The loans consist principally of revenue bonds and secured
  bank loans. These loans are secured by the underlying real and personal property
  of individual eldercare centers and have fixed or variable rates of interest
  ranging from4.0% to 8.7%at June 30, 2006, with maturity dates ranging from 2009 to 2038. These loans
  are labeled non-recourse because neither GHC nor a wholly owned
  subsidiary is obligated to perform under the respective loan agreements.

(5)   Investment
  Income

Investment income isearned principally on short-term investments of cash on hand, restricted cash and investments of marketable securities held by GHCs wholly owned insurance captive Liberty Health Corporation (LHC), and assets held in a rabbi trust of GHCs deferred compensation plan. GHC includes investment income in the EBITDA, as defined herein, of its other services and corporate costs segment category (see note 8  Segment Information).

The following table sets forth the components of investment income (in thousands):



|                                          |  | Three months ended June 30, |       | Nine months ended June 30, |  
|----------------------------------------- |  | --------------------------- | ----- | -------------------------- | -
|                                          |  |                             |       |                            |  
|                                          |  | 2006                        |       | 2005                       |  
|                                          |  |                             |       |                            |  
|                                          |  |                             |       | (Restated)                 |  
|Income on cash and short-term investments |  | $                           | 1,020 |                            | $
|Income on restricted investments          |  |                             | 990   |                            |  
|Income on assets held in rabbi trust      |  |                             | 4     |                            |  
|Interest income on notes receivable       |  |                             | 164   |                            |  
|                                          |  |                             |       |                            |  
|Total investment income                   |  | $                           | 2,178 |                            | $
|                                          |  |                             |       |                            |  

(6)   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 GHCs adoption of SFAS
  123R (see note 9  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 and nine months ended June 30, 2006, GHCs outstanding stock
  options yielded 157,297 and 153,462, respectively, potentially dilutive securities
  compared to the three and nine months ended June 30, 2005, in which GHCs
  outstanding stock options yielded 167,660 and 171,425, respectively,
  potentially dilutive securities. For the three and
  nine months ended June 30, 2006, GHCs unvested restricted stock yielded
  an additional 121,801 and 113,946, respectively, potentially dilutive securities
  under the treasury stock method compared to the three and nine months ended
  June 30, 2005, in which GHCs unvested restricted stock yielded an additional
  149,676 and 139,557, respectively, potentially dilutive securities.

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|(7) | Comprehensive Income
|--- | --------------------

The following table sets forth the computation of comprehensive income for the three and nine months ended June 30, 2006 and 2005 (in thousands):



|                                                                              |  | Three months ended June 30, |       | Nine months ended June 30, |  
|----------------------------------------------------------------------------- |  | --------------------------- | ----- | -------------------------- | -
|                                                                              |  |                             |       |                            |  
|                                                                              |  | 2006                        |       | 2005                       |  
|                                                                              |  |                             |       |                            |  
|                                                                              |  |                             |       | (Restated)                 |  
|Net income                                                                    |  | $                           | 9,686 |                            | $
|Net unrealized (loss) gain on restricted investments in marketable securities |  |                             | (192  | )                          |  
|Net increase to minimum pension liability                                     |  |                             |      |                            |  
|Unrealized gain (loss) on interest rate swap agreement                        |  |                             | 71    |                            |  
|                                                                              |  |                             |       |                            |  
|Total comprehensive income                                                    |  | $                           | 9,565 |                            | $
|                                                                              |  |                             |       |                            |  

The unrealized (loss) gain on restricted investments in marketable securities and minimum pension liability are net of income tax (benefits) expenses. The income tax benefit for the three and nine months ended June 30, 2006 was ($0.1) million and ($0.3) million, respectively. The income tax expense (benefit) for the three and nine months ended June 30, 2005 was $0.6 million and ($0.3) million, respectively.

The unrealized gain on interest rate swap agreement represents the change in the fair value of the underlying variable to fixed interest rate swap agreement held by a VIE consolidated by GHC pursuant to FIN 46. The VIE is a limited liability corporation and does not record income taxes at the limited liability corporation level. Therefore, the net unrealized gain on the interest rate swap agreement has not been tax effected. Obligations under the interest rate swap agreement are non-recourse to GHC.

|(8) | Segment Information
|--- | -------------------

GHC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 GHCs internal organization.

GHC includes within inpatient services revenues all room and board charges and ancillary service revenue for its eldercare customers at the eldercare centers which GHC owns, leases or consolidates because it is the primary beneficiary of a VIE pursuant to FIN 46.

GHC includes within 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 GHCs reportable segments is shown in the following table. The All other services and corporate costs category of revenues and EBITDA represents operating information of business units below the prescribed quantitative thresholds that trigger segment reporting requirements, and GHC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 GHCs reportable segments or the All other services and corporate costs category. Investment income is included in the EBITDA of the All other services and corporate
costs category. This approach to segment reporting is consistent with GHCs internal financial reporting and the information used by the chief operating decision maker regarding the performance of GHCs reportable and non-reportable segments.

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|                                                         |  | Three months ended June 30, |         | Nine months ended June 30, |  
|-------------------------------------------------------- |  | --------------------------- | ------- | -------------------------- | -
|                                                         |  |                             |         |                            |  
|(in thousands)                                           |  | 2006                        |         | 2005                       |  
|                                                         |  |                             |         |                            |  
|                                                         |  |                             |         | (Restated)                 |  
|Revenues:                                                |  |                             |         |                            |  
|Inpatient services - external                            |  | $                           | 397,100 |                            | $
|Rehabilitation therapy services:                         |  |                             |         |                            |  
|External                                                 |  |                             | 36,444  |                            |  
|Intersegment                                             |  |                             | 23,603  |                            |  
|All other services:                                      |  |                             |         |                            |  
|External                                                 |  |                             | 8,686   |                            |  
|Intersegment                                             |  |                             | 9,980   |                            |  
|Elimination of intersegment revenues                     |  |                             | (33,583 | )                          |  
|                                                         |  |                             |         |                            |  
|Total net revenues                                       |  |                             | 442,230 |                            |  
|                                                         |  |                             |         |                            |  
|EBITDA (1):                                              |  |                             |         |                            |  
|Inpatient services                                       |  |                             | 52,894  |                            |  
|Rehabilitation therapy services                          |  |                             | 3,963   |                            |  
|All other services and corporate costs                   |  |                             | (17,825 | )                          |  
|Loss on early extinguishment of debt                     |  |                             | (605    | )                          |  
|                                                         |  |                             |         |                            |  
|Total EBITDA                                             |  |                             | 38,427  |                            |  
|                                                         |  |                             |         |                            |  
|Capital and other:                                       |  |                             |         |                            |  
|Depreciation and amortization expense                    |  |                             | (15,843 | )                          |  
|Interest expense                                         |  |                             | (6,387  | )                          |  
|Income tax expense                                       |  |                             | (6,559  | )                          |  
|Equity in net income of unconsolidated affiliates        |  |                             | 540     |                            |  
|Minority interests                                       |  |                             | (621    | )                          |  
|                                                         |  |                             |         |                            |  
|Income from continuing operations                        |  |                             | 9,557   |                            |  
|Income (loss) from discontinued operations, net of taxes |  |                             | 129     |                            |  
|                                                         |  |                             |         |                            |  
|Net income                                               |  | $                           | 9,686   |                            | $
|                                                         |  |                             |         |                            |  

|(1) | GHC defines EBITDA as earnings from continuing operations before equity in net income of unconsolidated affiliates, minority interests, interest expense, income taxes, depreciation and amortization. EBITDA can be calculated through GHCs unaudited condensed consolidated statements of operations by adding back interest expense, income taxes, depreciation and amortization, equity in net income of unconsolidated affiliates and minority interests costs to GHCs income from continuing operations.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The EBITDA of the segments for the three and nine months ended June 30, 2005 previously reported was adjusted to reflect incentive compensation expenses at the segment level. This adjustment was made to conform to the current year presentation, which includes such expenses at the segment level, and is consistent with GHCs current year internal financial reporting. In addition, during the three month period ended March 31, 2006, GHC centralized its professional labor recruiting function, which had historically been a component of the rehabilitation business. The costs associated with this function have been reclassified in the three and nine months ended June 30, 2005 as well as the balance of the nine months ended June 30, 2006 to conform to the current period presentation.

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Total assets by segment at June 30, 2006 and September 30, 2005 were as follows (in thousands):



|                                        |  | June
        30, 2006 |           | September
        30, 2005 |  
|--------------------------------------- |  | --------------------- | --------- | -------------------------- | -
|                                        |  |                       |           |                            |  
|Inpatient
        services              |  | $                     | 1,050,983 |                            | $
|Rehabilitation
        therapy services |  |                       | 42,448    |                            |  
|All
        other                       |  |                       | 322,154   |                            |  
|                                        |  |                       |           |                            |  
|Total
        assets                    |  | $                     | 1,415,585 |                            | $
|                                        |  |                       |           |                            |  



(9)   Stock-Based
  Benefit Plans

Adoption
  of New Accounting Standard

Effective October 1, 2005, GHC 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. GHC 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.

GHC 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

GHC recorded stock-based compensation expense for the three and nine months ended June 30, 2006 and 2005 as follows (in thousands):



|                                                   |  | Three months ended |        | Nine months ended |  
|-------------------------------------------------- |  | ------------------ | ------ | ----------------- | -
|                                                   |  |                    |        |                   |  
|                                                   |  | June 30,2006       |        | June 30,2005      |  
|                                                   |  |                    |        |                   |  
|Stock options                                      |  | $                  | 1,678  |                   | $
|Stock incentive plan                               |  |                    | 1,214  |                   |  
|Stock held in deferred compensation plan           |  |                    | 714    |                   |  
|                                                   |  |                    |        |                   |  
|Total stock-based compensation before income taxes |  |                    | 3,606  |                   |  
|                                                   |  |                    |        |                   |  
|Income tax benefit                                 |  |                    | (1,442 | )                 |  
|                                                   |  |                    |        |                   |  
|Total stock-based compensation after income taxes  |  | $                  | 2,164  |                   | $
|                                                   |  |                    |        |                   |  

GHC
     has revised its estimate with regard to the forfeiture assumptions used
    in evaluating
  the ultimate benefit to be realized by employees who had received option grants.
     In accordance with SFAS 123R, a cumulative adjustment to compensation expense

  is recognized in the period in which such applicable information becomes available
     and future compensation expense relative to the grant(s) is adjusted accordingly.

  In the three months ended June 30, 2006, GHC recorded additional pre tax expense
     of $0.7 million. This change in estimate is not expected to have a material

  affect on GHCs future compensation expense.

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GHCs
  stock option and stock incentive plans are more fully described under their
  respective sections below. Stock held in the 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 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 GHCs obligation under the plan, GHC held 215,953 shares of
  its common stock in the rabbi trust at June 30, 2006. GHC 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), GHC has recorded
  the $8.5 million cost of the shares of common stock as a reduction of shareholders
  equity at June 30, 2006. Also, as prescribed by EITF 97-14, GHC 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 if the plan participants are permitted to diversify
  their investment elections. For the three and nine months ended June 30, 2006,
  GHC recognized $0.7 million and $1.5 million, respectively, of net compensation
  cost from such changes in the fair value of the common stock units of the deferred
  compensation plan compared to the three and nine months ended June 30, 2005,
  in which GHC recognized $0.5 million and $2.5 million, respectively, of net
  compensation cost from such changes in the fair value of the common stock units
  of the deferred compensation plan. Effective June 30, 2006, GHC placed certain
  restrictions on the compensation deferrals of certain members of executive management.
  For these individuals, the restrictions require that deferrals designated in
  GHC common stock units are irrevocable, meaning that such holdings can not be
  diversified within the rabbi trust of the deferred compensation plan and all
  future distributions of such designations must be settled in shares of GHC common
  stock. Accordingly, under EITF 97-14, the portion of the deferred compensation
  obligation that is required to be settled by the delivery of shares of employer
  stock is classified in shareholders equity. At June 30, 2006, there were
  119,658 shares of GHC stock, valued at $5.7 million, held by the rabbi trust
  and presented in the accompanying condensed consolidated balance sheet as an
  equity account. Under EITF 97-14, changes in the fair value of both the employer
  stock held in the rabbi trust and the deferred compensation obligation for those
  shares restricted from diversification and distribution are not recognized through
  earnings.

Prior to October 1, 2005, as permitted by SFAS 123, GHC 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 GHC 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
        monthsendedJune 30,2005 |        | Nine
        monthsendedJune 30,2005 |  
|--------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | ------------------------------------ | -
|                                                                                              |  |                                       |        |                                      |  
|                                                                                              |  | (Restated)                            |        | (Restated)                           |  
|Net
        income, as reported                                                               |  | $                                     | 8,776  |                                      | $
|Adjustments:                                                                                  |  |                                       |        |                                      |  
|Stock-based
        compensation included in net income, net of tax effects                   |  |                                       | 822    |                                      |  
|Stock-based
        compensation determined under fair value based method, net of tax effects |  |                                       | (1,271 | )                                    |  
|                                                                                              |  |                                       |        |                                      |  
|Pro
        forma net income                                                                  |  | $                                     | 8,327  |                                      | $
|                                                                                              |  |                                       |        |                                      |  
|Per
        common share data:                                                                |  |                                       |        |                                      |  
|Basic:                                                                                        |  |                                       |        |                                      |  
|Net
        income as reported                                                                |  | $                                     | 0.45   |                                      | $
|Net
        income pro forma                                                                  |  | $                                     | 0.42   |                                      | $
|Diluted:                                                                                      |  |                                       |        |                                      |  
|Net
        income as reported                                                                |  | $                                     | 0.44   |                                      | $
|Net
        income pro forma                                                                  |  | $                                     | 0.42   |                                      | $

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 53,000 were available for grant at June 30, 2006. 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
GHC, as defined in the option grant. GHC distributes newly issued common shares to satisfy its obligations under the stock option plan.

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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 $18.12 per share for options granted during the nine months ended June 30, 2006, 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 nine months ended June 30, 2005. GHC 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 nine months ended June 30, 2006 and are consistent with those used in prior disclosures in the footnotes to the 2005 GHC Annual Report on Form 10-K/A 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 GHC under SFAS 123R.

Changes to the stock option plan for the nine months ended June 30, 2006 were as follows:



|                               |  | Shares   |   | WeightedAverageExercisePrice |       | IntrinsicValue (inthousands) |   | WeightedAverageRemainingContractualLife | 
|------------------------------ |  | -------- | - | ---------------------------- | ----- | ---------------------------- | - | --------------------------------------- | 
|                               |  |          |   |                              |       |                              |   |                                         | 
|Outstanding at October 1, 2005 |  | 576,976  |   | $                            | 23.71 |                              |   |                                         | 
|                               |  |          |   |                              |       |                              |   |                                         | 
|Granted                        |  | 547,000  |   |                              | 37.80 |                              |   |                                         | 
|Exercised                      |  | (142,619 | ) |                              | 23.90 |                              | $ | 2,953                                   | 
|                               |  |          |   |                              |       |                              |   |                                         | 
|Outstanding at June 30, 2006   |  | 981,357  |   |                              | 31.54 |                              |   | 15,537                                  | 
|                               |  |          |   |                              |       |                              |   |                                         | 
|Exercisable at June 30, 2006   |  | 340,307  |   | $                            | 26.61 |                              | $ | 7,064                                   | 
|                               |  |          |   |                              |       |                              |   |                                         | 

No stock options were forfeited or expired during the nine months ended June 30, 2006. Cash received from stock option exercises totaled $3.3 million and $6.6 million in the nine months ended June 30, 2006 and 2005, respectively.

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The following table summarizes information about stock options outstanding at June 30, 2006:



|                         |  | Stock Options Outstanding |  | Stock Options Exercisable               | 
|------------------------ |  | ------------------------- |  | --------------------------------------- | 
|                         |  |                           |  |                                         | 
|Range of Exercise Prices |  | Number                    |  | WeightedAverageRemainingContractualLife | 
|                         |  |                           |  |                                         | 
|$20.00 - $29.99          |  | 436,441                   |  | 7.62                                    | 
|$30.00 - $39.99          |  | 474,916                   |  | 9.46                                    | 
|$40.00 - $49.99          |  | 70,000                    |  | 9.88                                    | 

The following table presents information regarding non-vested option activity during the nine months ended June 30, 2006:



|                              |  | Non-VestedNumber ofOptions |   | WeightedAverageGrant-DateFair Value |      
|----------------------------- |  | -------------------------- | - | ----------------------------------- | -----
|                              |  |                            |   |                                     |      
|Non-vested at October 1, 2005 |  | 381,263                    |   | $                                   | 13.53
|Granted                       |  | 547,000                    |   |                                     | 18.12
|Vested                        |  | (287,213                   | ) |                                     | 14.25
|                              |  |                            |   |                                     |      
|Non-vested at June 30, 2006   |  | 641,050                    |   | $                                   | 16.84
|                              |  |                            |   |                                     |      

As
  of June 30, 2006, there was $7.7 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 vesting periods as follows: $0.9
  million for the remainder of fiscal 2006, $3.3 million in fiscal 2007, $3.2
  million in fiscal 2008 and $0.3 million in fiscal 2009. The expected recognition
  of compensation expense could differ materially from these estimates as better
  information becomes available regarding the turnover trends of GHCs plan
  participants and forfeiture assumptions are revised accordingly.

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 86,474 shares were available for grant at June 30, 2006. 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. In April 2006, GHC made a grant of restricted
shares to its lead director having a market value of $160,000 as consideration for the assumption of certain expanded responsibilities. 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 nine months ended June 30, 2006, GHC granted 169,051 restricted shares to employees with a weighted average grant date fair value of $40.93 per share. GHC distributes newly issued common shares to satisfy its obligations under the stock incentive plan.

GHC recognizes compensation expense ratably over each quarterly service period at the market value of GHCs common stock on the grant date. GHC recorded compensation expense of $1.2 million and $4.0 million in the three and nine months ended June 30, 2006, respectively, for employee and director restricted stock grants compared to $0.8 million and $2.5 million in the three and nine months ended June 30, 2005, respectively.

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The following table presents non-vested restricted stock activity during the nine months ended June 30, 2006:



|                              |  | Non-VestedNumber ofShares |   | WeightedAverageGrant-DateFair Value |      
|----------------------------- |  | ------------------------- | - | ----------------------------------- | -----
|                              |  |                           |   |                                     |      
|Non-vested at October 1, 2005 |  | 492,253                   |   | $                                   | 22.32
|Granted                       |  | 189,886                   |   |                                     | 41.15
|Vested and Distributed        |  | (110,699                  | ) |                                     | 24.15
|Forfeited                     |  | (1,924                    | ) |                                     | 29.07
|                              |  |                           |   |                                     |      
|Non-vested at June 30, 2006   |  | 569,516                   |   | $                                   | 25.37
|                              |  |                           |   |                                     |      

As of June 30, 2006, there was $13.7 million of total unrecognized compensation cost related to future service periods for non-vested restricted stock granted. This unrecognized compensation cost is expected to be recognized over the remaining vesting periods as follows: $1.1 million for the remainder of fiscal 2006, $4.3 million in fiscal 2007, $4.3 million in fiscal 2008, $2.1 million in fiscal 2009, $1.2 million in fiscal 2010, and $0.7 million in fiscal 2011.

|(10) | New Accounting Pronouncements
|---- | -----------------------------

Variable Interest Entities

In
  April 2006, the FASB issued Staff Position No. FIN 46(R)-6, Determining
  the Variability to Be Considered in Applying FASB Interpretation No. 46(R),
  (FIN 46(R)-6). This latest interpretation will significantly change the way
  some companies identify VIEs and how they analyze whether to consolidate those
  they identify. The new requirements discuss how to distinguish between contracts
  or arrangements that create variability in an entity (i.e. its risks and rewards)
  and contracts or arrangements that are exposed to or reduce that variability
  (i.e. variable interests). FIN 46(R)-6 provides guidance on when to consolidate
  an entity based on exposure to risks and rewards, rather than voting control.
  It describes the characteristics of a VIE and how an entity that is involved
  in a VIE should determine whether it shares in the VIEs risks and rewards
  extensively enough to be the VIEs primary beneficiary and
  therefore to consolidate it. FIN 46(R)-6 is to be applied prospectively to all
  entities that the reporting enterprise first becomes involved with beginning
  the first day of the first reporting period that begins after June 15, 2006,
  or July 1, 2006 for GHC. The new requirements need not be applied to entities
  that have previously been analyzed under FIN 46(R) unless a reconsideration
  event occurs.

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 clarifies
  that an entity is required to recognize a liability for the fair value of a
  conditional asset retirement obligation if the fair value can be reasonably
  estimated, even though uncertainty exists about the timing and / or method of
  settlement. Certain of GHCs real estate assets contain asbestos. The asbestos
  is believed to be appropriately contained in accordance with environmental regulations.
  If these properties were demolished or subject to renovation activities that
  disturb the asbestos, certain environmental regulations are in place, which
  specify the manner in which the asbestos must be handled and disposed. FIN 47
  is effective no later than the end of all fiscal years ending after December
  15, 2005, or September 30, 2006 for GHC. GHC is in the process of identifying
  its conditional asset retirement obligations to determine whether it can reasonably
  estimate the timing and / or method of settlement, as well as the fair value
  of each obligation. If GHC can reasonably estimate the fair value of an obligation,
  it will need to recognize a liability for that obligation upon adoption of FIN
  47 as a cumulative effect of a change in accounting principle no later than
  September 30, 2006. Until GHC completes its evaluation of potential asset retirement
  obligations, it cannot predict the impact of adoption on its consolidated financial
  statements.

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Hybrid Financial Instruments

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140 (SFAS 155), to simplify and make more consistent the accounting for certain financial instruments. Specifically, SFAS 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,to permit fair value re-measurement for any hybrid financial instrument with an embedded derivative that otherwise would require bifurcation, provided that the whole instrument is accounted for on a fair value basis. SFAS 155 amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (as amended),to allow a
qualifying special-purpose entity (SPE) to hold a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 applies to all financial instruments acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006, or October 1, 2006 for GHC, with early adoption permitted. The adoption of SFAS 155 is not expected to have a material effect on GHCs financial condition or results of operations.

General Partner Control of Limited Partnerships

In
  June 2005, the Emerging Issues Task Force (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 GHC. GHC continues, but has not completed, evaluating the impact of applying
  the provisions of EITF 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 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 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. GHC does not expect this statement to have a material impact on its consolidated financial statements.

Income Tax Uncertainties

In June 2006, the FASB issued Interpretation No.48,Accounting for Uncertainty in Income Taxes, (FIN 48), which prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprises financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxes.Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. FIN 48 will be effective for fiscal years beginning after December 15, 2006, or October 1, 2007 for GHC, and the provisions of FIN 48 will be applied to all tax positions accounted for under Statement No. 109 upon initial adoption. The cumulative
effect of applying the provisions of this interpretation will be reported as an adjustment to the opening balance of retained earnings for that fiscal year. GHC is currently evaluating the potential impact of FIN 48 on its consolidated financial statements.

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|(11) | 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, even if the outcome is unfavorable, would have a material adverse effect on the results of operations, financial position or cash flows of GHC.

At
  June 30, 2006, GHC:

| |  | extended $3.9 million in working capital lines of credit to certain jointly owned and managed companies, including certain consolidated VIEs, of which $2.1 million was unused; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | posted $1.8 million of outstanding letters of credit to guarantee the performance to third parties of various trade activities.
| | - | -------------------------------------------------------------------------------------------------------------------------------

|(12) | 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 under Rule 144A of the Securities Act of 1933, as amended. In June 2005, GHC 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 LHC, certain separately mortgaged eldercare centers and VIEs consolidated by GHC pursuant to FIN 46 (Non-guarantors).

The
  following tables present the unaudited condensed consolidating financial statements
  of GHC (Parent), the Guarantors and the Non-guarantors:

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS

JUNE 30, 2006

(IN THOUSANDS)



|                                                   |  | Parent |           | Guarantors |   | Non-guarantors |  | Eliminations |         | Consolidated |  
|-------------------------------------------------- |  | ------ | --------- | ---------- | - | -------------- |  | ------------ | ------- | ------------ | -
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|Assets:                                            |  |        |           |            |   |                |  |              |         |              |  
|Current
        assets                             |  | $      | 101,529   |            | $ | 244,187        |  | $            | 57,846  |              | $
|Property
        and equipment, net                |  |        | 27,601    |            |   | 779,912        |  |              | 42,183  |              |  
|Other
        long-term assets                     |  |        | 105,633   |            |   | 22,281         |  |              | 78,472  |              |  
|Investments
        in subsidiaries                |  |        | 443,948   |            |   |               |  |              |        |              |  
|Intercompany
        receivables                   |  |        | 434,872   |            |   |               |  |              |        |              |  
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|Total
        assets                               |  | $      | 1,113,583 |            | $ | 1,046,380      |  | $            | 178,501 |              | $
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|Liabilities
        and shareholders equity:      |  |        |           |            |   |                |  |              |         |              |  
|Current
        liabilities                        |  | $      | 42,996    |            | $ | 91,704         |  | $            | 47,911  |              | $
|Intercompany
        payables                      |  |        |          |            |   | 427,811        |  |              | 7,061   |              |  
|Long-term
        debt                             |  |        | 328,816   |            |   | 59,584         |  |              | 49,629  |              |  
|Other
        long-term liabilities                |  |        | 52,511    |            |   | 555            |  |              | 59,599  |              |  
|Shareholders
        equity                       |  |        | 689,260   |            |   | 466,726        |  |              | 14,301  |              |  
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|Total
        liabilities and shareholders equity |  | $      | 1,113,583 |            | $ | 1,046,380      |  | $            | 178,501 |              | $
|                                                   |  |        |           |            |   |                |  |              |         |              |  

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   |            | $ | 211,737        |  | $            | 57,154  |              | $
|Property
        and equipment, net                |  |        | 25,048    |            |   | 749,615        |  |              | 43,475  |              |  
|Other
        long-term assets                     |  |        | 111,869   |            |   | 25,741         |  |              | 76,275  |              |  
|Investments
        in subsidiaries                |  |        | 423,262   |            |   |               |  |              |        |              |  
|Intercompany
        receivables                   |  |        | 388,093   |            |   |               |  |              |        |              |  
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|Total
        assets                               |  | $      | 1,098,359 |            | $ | 987,093        |  | $            | 176,904 |              | $
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|Liabilities
        and shareholders equity:      |  |        |           |            |   |                |  |              |         |              |  
|Current
        liabilities                        |  | $      | 56,057    |            | $ | 98,202         |  | $            | 54,565  |              | $
|Intercompany
        payables                      |  |        |          |            |   | 387,771        |  |              | 322     |              |  
|Long-term
        debt                             |  |        | 338,780   |            |   | 59,185         |  |              | 54,883  |              |  
|Other
        long-term liabilities                |  |        | 52,709    |            |   | 177            |  |              | 61,546  |              |  
|Shareholders
        equity                       |  |        | 650,813   |            |   | 441,758        |  |              | 5,588   |              |  
|                                                   |  |        |           |            |   |                |  |              |         |              |  
|Total
        liabilities and shareholders equity |  | $      | 1,098,359 |            | $ | 987,093        |  | $            | 176,904 |              | $
|                                                   |  |        |           |            |   |                |  |              |         |              |  

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2006

(IN THOUSANDS)



|                                                                                                                                            |  | Parent |         | Guarantors |   | Non-guarantors |   | Eliminations |        | Consolidated |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ | ------- | ---------- | - | -------------- | - | ------------ | ------ | ------------ | -
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Net
        revenues                                                                                                                        |  | $      | 279     |            | $ | 456,341        |   | $            | 19,946 |              | $
|Equity
        in net income of subsidiaries                                                                                                |  |        | 34,404  |            |   |               |   |              |       |              |  
|Operating
        expenses                                                                                                                  |  |        | 34,956  |            |   | 380,211        |   |              | 17,652 |              |  
|Lease
        expense                                                                                                                       |  |        | 468     |            |   | 4,949          |   |              | 28     |              |  
|Depreciation
        and amortization expense                                                                                               |  |        | 3,277   |            |   | 11,979         |   |              | 587    |              |  
|Interest
        expense                                                                                                                    |  |        | 4,383   |            |   | 1,089          |   |              | 1,126  |              |  
|Investment
        income                                                                                                                   |  |        | (1,147  | )          |   | (2             | ) |              | (1,029 | )            |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Income
        (loss) before income tax (benefit) expense, equity in net income of unconsolidated
        affiliates and minority interests |  |        | (7,254  | )          |   | 58,115         |   |              | 1,582  |              |  
|Income
        tax (benefit) expense                                                                                                        |  |        | (15,931 | )          |   | 23,216         |   |              | 648    |              |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Income
        before equity in net income of unconsolidated affiliates and minority
        interests                                      |  |        | 8,677   |            |   | 34,899         |   |              | 934    |              |  
|Equity
        in net income of unconsolidated affiliates                                                                                   |  |        | 1,070   |            |   |               |   |              |       |              |  
|Minority
        interests                                                                                                                  |  |        |        |            |   |               |   |              |       |              |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Income
        from continuing operations                                                                                                   |  |        | 9,747   |            |   | 34,899         |   |              | 934    |              |  
|(Loss)
        income from discontinued operations, net of taxes                                                                            |  |        | (61     | )          |   | 190            |   |              |       |              |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Net
        income                                                                                                                          |  | $      | 9,686   |            | $ | 35,089         |   | $            | 934    |              | $
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  

GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED
  CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
  THREE MONTHS ENDED JUNE 30, 2005

(IN THOUSANDS)



|                                                                                                                            |  | (Restated) |        
|--------------------------------------------------------------------------------------------------------------------------- |  | ---------- | -------
|                                                                                                                            |  |            |        
|                                                                                                                            |  | Parent     |        
|                                                                                                                            |  |            |        
|Net revenues                                                                                                                |  | $          | 720    
|Equity in net income of subsidiaries                                                                                        |  |            | 31,918 
|Operating expenses                                                                                                          |  |            | 33,036 
|Lease expense                                                                                                               |  |            | 347    
|Depreciation and amortization expense                                                                                       |  |            | 2,479  
|Interest expense                                                                                                            |  |            | 4,554  
|Investment income                                                                                                           |  |            | (773   
|                                                                                                                            |  |            |        
|Income (loss) before income tax (benefit) expense, equity in net income of unconsolidated affiliates and minority interests |  |            | (7,005 
|Income tax (benefit) expense                                                                                                |  |            | (15,024
|                                                                                                                            |  |            |        
|Income (loss) before equity in net income of unconsolidated affiliates and minority interests                               |  |            | 8,019  
|Equity in net income of unconsolidated affiliates                                                                           |  |            | 757    
|Minority interests                                                                                                          |  |            |       
|                                                                                                                            |  |            |        
|Income (loss) from continuing operations                                                                                    |  |            | 8,776  
|Loss from discontinued operations, net of taxes                                                                             |  |            |       
|                                                                                                                            |  |            |        
|Net income (loss)                                                                                                           |  | $          | 8,776  
|                                                                                                                            |  |            |        

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

NINE MONTHS ENDED JUNE 30, 2006

(IN THOUSANDS)



|                                                                                                                                            |  | Parent |         | Guarantors |   | Non-guarantors |   | Eliminations |        | Consolidated |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ | ------- | ---------- | - | -------------- | - | ------------ | ------ | ------------ | -
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Net
        revenues                                                                                                                        |  | $      | 1,509   |            | $ | 1,357,387      |   | $            | 67,932 |              | $
|Equity
        in net income of subsidiaries                                                                                                |  |        | 97,148  |            |   |               |   |              |       |              |  
|Operating
        expenses                                                                                                                  |  |        | 97,846  |            |   | 1,140,434      |   |              | 61,241 |              |  
|Lease
        expense                                                                                                                       |  |        | 1,393   |            |   | 15,053         |   |              | 85     |              |  
|Depreciation
        and amortization expense                                                                                               |  |        | 9,130   |            |   | 35,337         |   |              | 1,745  |              |  
|Interest
        expense                                                                                                                    |  |        | 13,317  |            |   | 3,202          |   |              | 3,427  |              |  
|Investment
        income                                                                                                                   |  |        | (3,257  | )          |   | (784           | ) |              | (2,313 | )            |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Income
        (loss) before income tax (benefit) expense, equity in net income of unconsolidated
        affiliates and minority interests |  |        | (19,772 | )          |   | 164,145        |   |              | 3,747  |              |  
|Income
        tax (benefit) expense                                                                                                        |  |        | (46,217 | )          |   | 66,632         |   |              | 1,540  |              |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Income
        before equity in net income of unconsolidated affiliates and minority
        interests                                      |  |        | 26,445  |            |   | 97,513         |   |              | 2,207  |              |  
|Equity
        in net income of unconsolidated affiliates                                                                                   |  |        | 2,653   |            |   |               |   |              |       |              |  
|Minority
        interests                                                                                                                  |  |        |        |            |   |               |   |              |       |              |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Income
        from continuing operations                                                                                                   |  |        | 29,098  |            |   | 97,513         |   |              | 2,207  |              |  
|Income
        (loss) from discontinued operations, net of taxes                                                                            |  |        | 93      |            |   | (85            | ) |              | 109    |              |  
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  
|Net
        income                                                                                                                          |  | $      | 29,191  |            | $ | 97,428         |   | $            | 2,316  |              | $
|                                                                                                                                            |  |        |         |            |   |                |   |              |        |              |  

GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

NINE MONTHS ENDED JUNE 30, 2005

(IN THOUSANDS)



|                                                                                                                            |  | (Restated) |        
|--------------------------------------------------------------------------------------------------------------------------- |  | ---------- | -------
|                                                                                                                            |  |            |        
|                                                                                                                            |  | Parent     |        
|                                                                                                                            |  |            |        
|Net revenues                                                                                                                |  | $          | 3,081  
|Equity in net income of subsidiaries                                                                                        |  |            | 97,947 
|Operating expenses                                                                                                          |  |            | 88,147 
|Lease expense                                                                                                               |  |            | 1,184  
|Depreciation and amortization expense                                                                                       |  |            | 6,849  
|Interest expense                                                                                                            |  |            | 16,314 
|Investment income                                                                                                           |  |            | (2,350 
|                                                                                                                            |  |            |        
|Income (loss) before income tax (benefit) expense, equity in net income of unconsolidated affiliates and minority interests |  |            | (9,116 
|Income tax (benefit) expense                                                                                                |  |            | (41,172
|                                                                                                                            |  |            |        
|Income (loss) before equity in net income of unconsolidated affiliates and minority interests                               |  |            | 32,056 
|Equity in net income of unconsolidated affiliates                                                                           |  |            | 3,060  
|Minority interests                                                                                                          |  |            |       
|                                                                                                                            |  |            |        
|Income (loss) from continuing operations                                                                                    |  |            | 35,116 
|Loss from discontinued operations, net of taxes                                                                             |  |            |       
|                                                                                                                            |  |            |        
|Net income (loss)                                                                                                           |  | $          | 35,116 
|                                                                                                                            |  |            |        

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED JUNE 30, 2006

(IN THOUSANDS)



|                                                    |  | Parent |          | Guarantors |   | Non-guarantors |   | Consolidated |       
|--------------------------------------------------- |  | ------ | -------- | ---------- | - | -------------- | - | ------------ | ------
|                                                    |  |        |          |            |   |                |   |              |       
|Net cash (used in) provided by operating activities |  | $      | (130,465 | )          | $ | 173,627        |   | $            | 4,626 
|Net cash used in investing activities               |  |        | (10,081  | )          |   | (63,946        | ) |              | (24   
|Net cash (used in) provided by financing activities |  |        | (52,675  | )          |   | 32,735         |   |              | (1,153
|                                                    |  |        |          |            |   |                |   |              |       
|Net (decrease) increase in cash and equivalents     |  | $      | (193,221 | )          | $ | 142,416        |   | $            | 3,449 
|                                                    |  |        |          |            |   |                |   |              |       

GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED JUNE 30, 2005

(IN THOUSANDS)



|                                                            |  | (Restated) |        
|----------------------------------------------------------- |  | ---------- | -------
|                                                            |  |            |        
|                                                            |  | Parent     |        
|                                                            |  |            |        
|Net
        cash (used in) provided by operating activities |  | $          | (84,651
|Net
        cash (used in) provided by investing activities |  |            | (3,490 
|Net
        cash provided by (used in) financing activities |  |            | 25,733 
|                                                            |  |            |        
|Net
        (decrease) increase in cash and equivalents     |  | $          | (62,408
|                                                            |  |            |        

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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/A for the fiscal year ended September 30, 2005. The following discussion and analysis of our results of operations and financial condition for the three and nine months ended June 30, 2006 and 2005 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/A for the fiscal year ended September 30, 2005.

Restatement of Unaudited Condensed Consolidated Financial Statements

Prior to filing the Quarterly Report on Form 10-Q for the three and six months ended March 31, 2006, certain accounting errors were identified requiring the restatement of our previously issued consolidated financial statements.

Our policy with respect to discounting self-insured outstanding losses and loss expenses for both general and professional liability and workers compensation liability claims was reassessed, and it was determined that such discounting was not in accordance with U.S. generally accepted accounting principles. In connection with the evaluation of our accounting for self-insurance loss reserves, we also identified an accounting error that, upon correction, resulted in an increase to self-insurance loss reserves and related expenses of $2.4 million in fiscal 2004 and corresponding decreases in fiscal 2005.

We reassessed whether certain of the transaction structures of our jointly owned and managed facilities create variable interest entities (VIEs) and whether we are the primary beneficiary of the VIEs, within the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin (ARB) 51 ( FIN 46). Upon re-examination of the interests at January 1, 2003 of all parties associated with all 12 of our previously unconsolidated jointly owned and managed facilities, we have concluded that nine of the transaction structures are or were VIEs, seven of which we are the primary beneficiary. Of these seven, we subsequently acquired 100% of the interests of one of the VIEs (the acquired VIE) and the conditions that caused one of the
facilities to be a VIE were extinguished in May 2004 (the former VIE). Consequently, we consolidate the financial statements of five previously unconsolidated VIEs beginning January 1, 2003, the acquired VIE from January 1, 2003 through December 31, 2004 and the former VIE from January 1, 2003 through May 31, 2004.

Also, as disclosed in our previously issued Annual Report on Form 10-K, prior to restatement, for the fiscal year ended September 30, 2005, certain additional errors were identified and corrected by us in our fiscal 2005 consolidated financial statements. These errors involved accounting for operating lease expense on a straight-line basis, the classification of certain leases, accounting for our stock held in a deferred compensation plan, the useful lives assigned to certain fixed assets and unaccrued costs resulting from errors in purchasing cut-off. Based upon an evaluation conducted in fiscal 2005, we previously concluded that the errors were not material to our consolidated financial statements taken as a whole and adjusted for the errors in the period such errors were identified.

Our previously issued unaudited condensed consolidated financial statements for the three and nine months ended June 30, 2005 have been restated herein to correct all of the errors previously described. These corrections, along with certain other immaterial errors that were identified and corrected in the appropriate periods, are illustrated in more detail under note 1  Organization and Basis of Presentation  Principals of Consolidation and Restatement of Unaudited Condensed Consolidated Financial Statements, to the unaudited condensed consolidated financial statements included herein.



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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 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 27, 2006, the Centers for Medicare and Medicaid Services (CMS) released the final fiscal 2007 skilled nursing facility prospective payment rules. Effective October 1, 2006, the current skilled nursing facility prospective payment rates will increase by a 3.1% annual inflation factor. The new prospective payment rules also include revisions to geographic wage index factors, which also influence overall Medicare payment rates. We have not yet quantified the impact of the wage index factors to our overall Medicare payment rates effective October 1, 2006.

On
  July 28, 2005, 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 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 an additional 3.1% annual inflation
  factor, and after considering the distribution of our Medicare patient population
  under the new system, we previously expected RUGs refinement to reduce our Medicare
  payment rates approximately $9 per patient day beginning January 1, 2006. However,
  as a result of continuing shifts in the mix of our Medicare admissions toward
  higher acuity cases, and a higher percentage of patients qualifying for the
  new nine RUG categories than initially projected, our average Medicare payment
  rate increased approximately $5 per patient following the January 1, 2006 implementation
  of RUGs refinement.

In February 2006, the Deficit Reduction Act of 2005 (DRA) was signed into law. Under the DRA, effective for cost report years beginning on or after October 1, 2005, the amount that Medicare reimburses skilled nursing facilities and other non-hospital providers for bad debts arising from uncollectible accounts receivable with non-government payors was reduced by 30%. The impact of this provision of the DRA is not expected to have a material impact on our financial condition and results of operations.

Included in the DRA is a provision that directed CMS to develop an exceptions process for medically necessary physical, speech and occupational therapy services for beneficiaries that exceed a $1,740 annual reimbursement cap. The provision establishes a 10-day exceptions request process. In connection with the DRA, on February 13, 2006 CMS issued three program transmittals instructing its contractors on implementing the exceptions process. Under the instructions, a two-tier process is established providing for automatic exceptions based upon diagnoses and patient condition, and a manual exceptions process for other claims that are not automatically exempt. These changes are retroactive to January 1, 2006. While initially there were delays in processing claims, most of the implementation issues are being resolved. We expect that most nursing home therapy claims will fall within the automatic
exceptions group, and, therefore, we do not anticipate a disruption of services. However, the delayed communication and implementation of the exceptions process negatively impacted Medicare Part B therapy utilization during the three months ended March 31, 2006. There continues to be uncertainty regarding how the Medicare Part B therapy cap will be addressed in future reimbursement policy.

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.

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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. 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 specified by CMS. Currently, under contract, Omnicare, Inc., through its wholly
 owned subsidiary, provides services required for our residents. Under Medicare Part D, reimbursement for such services is provided through such plans being the primary payor for prescription drugs. Effective
January 1, 2006, 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 continue to receive medically necessary medication on a timely basis.

Because of concerns that the MMA shifts prescription drug coverage from Medicaid to Medicare through private plans, CMS established an initial 30-day transition period for those persons transitioning to the Part D program that was extended to 90-days. This transition period expired on April 1, 2006. 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 automatically enrolled in 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 and guidance 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. In November 2005, CMS published
  final payment rules for calendar year 2006 implementing a 4.4% reduction in
  fee schedules. Through the DRA, Congress restored fee schedules to their calendar
  year 2005 level. Once the legislation was signed into law, CMS issued instructions
  to its contractors rescinding the rate reduction and restoring the Medicare
  Part B fee schedules consistent with calendar year 2005 fee schedules retroactive
  to January 1, 2006. On April 7, 2006, CMS released a press statement indicating
  that it anticipates calendar year 2007 physician fee schedules will be reduced
  by 4.6% effective January 1, 2007. We anticipate Congress to consider changes
  in the fee schedule formula later this year before it adjourns. In late June
  2006, CMS issued proposed changes to payment rules for physician and non-physician
  services. The proposed payment rules define the methodology for payment of most
  Medicare Part B services. The comment period on these proposed rules will extend
  through August 21, 2006. Final calendar year 2007 physician payment rules and
  confirmation of the calendar year 2007 rate structure are expected to be published
  by November 1, 2006. We are unable to predict the outcome of final rules and
  their impact on our financial condition and results of operations, if any.



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In
  February 2006, the White House transmitted to Congress the proposed fiscal 2007
  federal budget. Preliminary evaluation suggests that the President recommends
  curtailing the growth of outlays for Medicare and Medicaid. The 2007 budget
  also proposes legislative changes in Medicaid that would reduce federal Medicaid
  matching funding by $1.5 billion over five years as well as regulatory changes
  that would reduce federal funding by an additional $12.2 billion over five years.
  A substantial majority of these changes could result in costs being shifted
  to the states. Both chambers of the Congress have begun consideration of their
  versions of the federal budget. At this time, we have insufficient information
  to predict the eventual 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 2007 budgets. While the rate changes for states may vary, we expect
  our average Medicaid rate per patient day to increase approximately 2.5% to
  3.5%.

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 nine states where we operate (Massachusetts, West Virginia, Rhode Island, North Carolina, New Hampshire, Vermont, Pennsylvania, New Jersey and Connecticut). Of these nine states, all but one has provider assessment taxes of 6%.

As
  indicated above, the Presidents proposed fiscal 2007 federal budget recommended
  spending reductions for both Medicare and Medicaid. One of the specific changes
  advanced by the President is a change in current law to phase-down the level
  of Federal matching under Medicaid for provider assessments. Current regulations
  permit states to receive federally matched funds for up to 6% of aggregate outlays
  for state Medicaid nursing home services. The Presidents federal budget
  proposes to reduce the acceptable percentage to 3%. A similar proposal was submitted
  in the fiscal year 2006 proposed federal budget and rejected by the Congress.
  The Secretary of Health and Human Services has affirmed that rather than to
  wait for the Congress to make this policy change, the Department is considering
  implementing the provider assessment changes through the administrative process.
  Given the initial 6% was set by regulation rather than law, the agency appears
  to have authority to implement such a change. Because of the potential negative
  impact of the change, there has been considerable opposition to this reduction
  from certain members of the Congress, Governors and trade organizations. We
  are unable to predict the outcome of this proposal and its impact on our financial
  condition and results of operations.

The DRA reduced projected Medicaid outlays by $6.9 billion over 5 years. The President signed this legislation into law on February 8, 2006. Among the provisions of the final legislation were requirements that extend the Medicaid look-back period for asset transfers from three years to five years, a change in the manner that annuities are considered and a change in the date for calculating the look-back penalty from the date of transfer to the date that Medicaid nursing home services are delivered. It is our understanding that CMS will be issuing specific guidance regarding the changes in the asset transfer rules. These changes may affect the number of people potentially eligible for Medicaid funding. We are unable to predict what impact this provision of the DRA will have on our financial condition and results of operations, if any.

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Under the DRA, states may be allowed to reduce the benefits provided to certain Medicaid enrollees, which could affect the services that states contract for with us. On July 12, 2006 CMS issued interim final regulations implementing the requirement that Medicaid recipients must be able to show proof of citizenship. We are unable to predict the outcome of these potential changes and their impact on our financial condition and results of operations, if any.

The federal government and state governments continue to focus on efforts to curb spending on healthcare programs such as Medicare and Medicaid. Among the ideas receiving active consideration in the Congress are revisions to the federal budget process that would establish an Entitlement Commission empowered to alter future outlays for all entitlement programs including 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

Lease and Purchase Option Agreements

In May 2006, we announced that we signed an agreement to enter into lease and purchase option agreements with an unrelated provider of long-term care that operates 11 facilities with a combined total of approximately 970 skilled nursing and assisted living facility beds located in the State of Maine. The most significant terms of the transaction assume we will enter into 11 separate agreements to lease the facilities over a 10-year term, with two five year renewal options. We will also obtain an option to purchase all 11 properties in 2026 for $53.0 million. We expect to account for the transaction as a capital lease. We would pay approximately $16.0 million of cash consideration and the related capital lease obligation is expected to approximate $40.0 million. The 11 facilities currently generate approximately $65.0 million of annual revenue. The closing of the transaction, which is
expected to occur in the last calendar quarter of 2006, is subject to receipt of regulatory approvals and various other customary conditions. Accordingly, no assurances can be given that the transaction will be consummated or, if it is, what the final terms will be or what its ultimate impact will be on our financial condition or results of operations.

Share Repurchase

In
  April 2006, our board of directors authorized the repurchase of up to $150.0
  million of our common stock, with such repurchases to take place at our managements
  discretion and/or under pre-established, non-discretionary programs from time
  to time, depending on market conditions, in the open market and in privately
  negotiated transactions, subject to any covenants or restrictions contained
  in agreements governing our indebtedness. Repurchases of common stock are restricted
  by our debt agreements, the most restrictive of which is our 8% senior subordinated
  notes. Such restrictions preclude repurchases of common stock above 50% of our
  net income since July 1, 2003. After considering common stock repurchases made
  to date and other repurchase provisions, our maximum common stock repurchasing
  capacity at June 30, 2006 was $19.4 million. In total, 1,075,745 shares of common
  stock have been repurchased under current and past common stock repurchase programs
  at a cost of $42.8 million, of which 288,408 shares at a cost of $10.7 million
  were repurchased during the nine months ended June 30, 2006.



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Debt Repurchase

In February 2005, our board of directors authorized the repurchase of a portion of our 8% senior subordinated notes due 2013 from time to time in the open market commencing in March 2005. There were $79.1 million of 8% senior subordinated notes repurchased through June 30, 2006, of which $8.2 million were repurchased in the nine months ended June 30, 2006. The total debt repurchases made to date resulted in prepayment premium charges of $7.9 million and the write-off of unamortized deferred financing fees and other fees of $3.0 million. These charges, along with the write-off of unamortized deferred financing fees, are collectively included in loss on early extinguishment of debt in the unaudited condensed consolidated statements of operations, were $0.6 million and $0.8 million, respectively, in the three and nine months ended June 30, 2006, and $6.9 million and $11.8 million,
respectively, in the three and nine months ended June 30, 2005.

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 owned a 50% interest in and manage the operations of each of the three facilities, but upon completion of the transaction on June 1, 2006 own 100% of each facility and 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 had already consolidated the financial statements of one of the facilities and recorded minority interest to reflect our joint venture partners interests. The combined annual revenues and pre tax income of the two unconsolidated facilities was
approximately $10.0 million and $1.2 million, respectively.

Prior Year Recognition of Pennsylvania and New Jersey Provider Assessments

Provider assessments 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.

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 and net income of $42.0 million and $3.7 million, respectively, in the quarter ended March 31, 2005, of which $30.9 million of revenue and $3.3 million of net income related to periods prior to fiscal 2005.

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, 2008, was recognized cumulatively in the quarter ended March 31, 2005. Recognition of the New Jersey provider assessment resulted in increased revenue and net income of $12.8 million and $1.8 million, respectively, in the quarter ended March 31, 2005, of which $4.3 million of revenue and $0.6 million of net income related to periods prior to fiscal 2005.

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.



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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 and nine months ended June 30, 2006 and 2005 as follows (in thousands):



|                                                   |  | Three months ended |        | Nine months ended |  
|-------------------------------------------------- |  | ------------------ | ------ | ----------------- | -
|                                                   |  |                    |        |                   |  
|                                                   |  | June 30,2006       |        | June 30,2005      |  
|                                                   |  |                    |        |                   |  
|Stock options                                      |  | $                  | 1,678  |                   | $
|Stock incentive plan                               |  |                    | 1,214  |                   |  
|Stock held in deferred compensation plan           |  |                    | 714    |                   |  
|                                                   |  |                    |        |                   |  
|Total stock-based compensation before income taxes |  |                    | 3,606  |                   |  
|                                                   |  |                    |        |                   |  
|Income tax benefit                                 |  |                    | (1,442 | )                 |  
|                                                   |  |                    |        |                   |  
|Total stock-based compensation after income taxes  |  | $                  | 2,164  |                   | $
|                                                   |  |                    |        |                   |  

The
  adoption of SFAS 123R is expected to reduce fiscal 2006 diluted earnings per
  share approximately $0.11. As of June 30, 2006, there was $7.7 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
  vesting periods as follows: $0.9 million for the remainder of fiscal 2006, $3.3
  million in fiscal 2007, $3.2 million in fiscal 2008 and $0.3 million in fiscal
  2009.The expected recognition of compensation expense could
  differ materially from these estimates as better information becomes available
  regarding the turnover trends of our plan participants and forfeiture assumptions
  are revised accordingly.As of June 30, 2006, there was
  $13.7 million of total unrecognized compensation cost related to future service
  periods for non-vested restricted stock granted under the stock incentive plan,
  which is expected to be recognized over the remaining vesting periods as follows:
  $1.1 million for the remainder of fiscal 2006, $4.3 million in fiscal 2007,
  $4.3 million in fiscal 2008, $2.1 million in fiscal 2009, $1.2 million in fiscal
  2010, and $0.7 million in fiscal 2011.

A detailed description of the components of stock-based compensation and the assumptions and methodologies used to determine fair value are described in note 9  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. 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. 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 U.S. generally accepted accounting principles. 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.



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Management believes that the presentation of EBITDA provides useful information to investors regarding our results of operations because these financial measures are useful for trending, analyzing and benchmarking the performance and value of our business. By excluding certain expenses and other items that may not be indicative of our core business operating results, this non-GAAP financial measure:

| |  | allows investors to evaluate our performance from managements perspective, resulting in greater transparency with respect to supplemental information used by us in our financial and operational decision making;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | facilitates comparisons with prior periods and reflects the principal basis on which management monitors financial performance; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------

| |  | facilitates comparisons with the performance of others in the long-term care services industry.
| | - | -----------------------------------------------------------------------------------------------

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 that 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 the 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. The presentation of this non-GAAP financial measure is consistent with our past practice and we believe this measure further enables investors and analysts to compare current non-GAAP measures with non-GAAP measures presented in prior periods.

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.

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



|                                                                  |  | Three months ended June 30, |        | Nine months ended June 30, |  
|----------------------------------------------------------------- |  | --------------------------- | ------ | -------------------------- | -
|                                                                  |  |                             |        |                            |  
|(in thousands)                                                    |  | 2006                        |        | 2005                       |  
|                                                                  |  |                             |        |                            |  
|                                                                  |  |                             |        | (Restated)                 |  
|Net income                                                        |  | $                           | 9,686  |                            | $
|Add back:(Income) loss from discontinued operations, net of taxes |  |                             | (129   | )                          |  
|Equity in net income of unconsolidated affiliates                 |  |                             | (540   | )                          |  
|Minority interests                                                |  |                             | 621    |                            |  
|Income tax expense                                                |  |                             | 6,559  |                            |  
|Interest expense                                                  |  |                             | 6,387  |                            |  
|Depreciation and amortization expense                             |  |                             | 15,843 |                            |  
|                                                                  |  |                             |        |                            |  
|EBITDA                                                            |  | $                           | 38,427 |                            | $
|                                                                  |  |                             |        |                            |  

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Factors Affecting Comparability of Financial Information

In March 2005, we recognized revenues and operating expenses resulting from the approval of retroactive provider assessments. See  Significant Transactions and Events  Prior Year Recognition of Pennsylvania and New Jersey Provider Assessments included herein.

Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

In the current quarter, revenues were $442.2 million, an increase of $24.7 million, or 5.9%, over the same period in the prior year. Inpatient services revenue increased by $21.4 million while external rehabilitation therapy services revenue increased by $4.2 million and external other businesses revenue decreased by $0.9 million.

The inpatient services segment revenue increase was primarily due to increased payor rates. In the aggregate, payor rates increased by $13.9 million versus the prior year with $8.1 million of such increase occurring in the Medicare payor category. Medicare rates increased by 8.1% due to the October 1, 2005 upward Medicare rate adjustment of 3.1%, higher Medicare patient acuity levels and the positive impact of the Medicare programs RUGs refinement reimbursement regulations that took effect on January 1, 2006. Approximately $3.4 million of payor rate increases occurred in the Medicaid payor category of which $1.9 million was due to newly implemented provider tax assessments in Connecticut. The prior year quarter contained no provider tax assessments in Connecticut. Medicaid revenue settlements and adjustments decreased by $4.4 million versus the prior year quarter. The $5.9 million
balance of Medicaid rate increases, which equate to a 3.0% increase, resulted from both increased acuity levels and legislated increases. Increases in private pay and insurance rates of 5.2% and 1.5%, respectively, were the primary reasons for the $2.4 million remainder of the overall rate increase. Approximately $0.9 million of the overall revenue increase was due to the step acquisition of two previously unconsolidated eldercare centers, which we previously jointly owned and managed. We purchased our joint venture partners ownership interest in the centers and, beginning in June 2006, we owned and consolidated 100% of the operations. Overall occupancy, including the 0.9% increase in occupancy resulting from 206 licensed beds being taken out of service over the past 12 months, increased to 90.9% in the current quarter from 89.4% in the same period in the prior year, resulting in a $4.3 million revenue increase. Total patient days increased 21,552 to 1,730,671 in the current
year quarter compared to 1,709,119 in the same period of the prior year. Of the total increase in patient days, 3,605 days was attributed to the step acquisitions of two eldercare centers with the 17,947 patient day balance of the increase attributed to occupancy growth at our same facility centers which were included in both reporting periods. Remaining net revenue increases of $2.3 million were primarily due to increased Medicare Part B volume and other revenues.

The $4.2 million increase in external rehabilitation therapy services revenue resulted from net increased business volume of $4.5 million from new and existing contracts partially offset by a net $0.3 million decline primarily resulting from revenue mix caused by Medicare Part B revenues representing a lower percentage of overall revenues in the current year quarter versus the same period in the prior year.

The $0.9 million decrease in other business revenue was the net result of $0.5 million of revenue decreases primarily resulting from decreased external business volume in our non-core hospitality and staffing services businesses and a $0.4 million decrease resulting from decreased billing for certain shared services to our former parent company prior to our spin-off, partially offset by $0.8 million of increased external business volume in our respiratory health services business.

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For
  the current year quarter, net income increased to $9.7 million from $8.8 million
  in the same period in the prior year. The increase in net income resulted from
  revenue increases of $24.7 million, as previously discussed, partially offset
  by $14.9 million of increased salaries, wages and benefits and $9.3 million
  of increased other operating expenses. The $14.9 million of increased salaries,
  wages and benefits was 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 $9.3 million increase
  in other operating expenses, $1.3 million was attributed to the recognition
  of newly implemented provider assessment taxes in Connecticut, $2.5 million
  was due to provider assessment tax increases in other states (primarily Pennsylvania
  and New Jersey), $2.8 million was attributed to an increase in pharmacy and
  medical supply costs incurred to treat a higher acuity patient population, $0.9
  million was due to increased natural gas and electricity costs and $0.3 million
  was due to the step acquisition of two previously unconsolidated eldercare centers.
  These increases were offset by approximately $0.3 million of reduced costs attributed
  to the replacement of higher cost temporary agency nurses with internally employed
  nurses. The balance of the increase in other operating expenses of approximately
  $1.8 million was largely attributed to normal inflationary increases in cost.
  The provision for losses on accounts and notes receivable was comparable to
  the prior year period, decreasing by $0.1 million. General and administrative
  costs increased by $3.4 million primarily due to increased payroll costs resulting
  from both wage inflation and additional resources to support multiple operational
  and system improvement initiatives and incremental stock-based compensation
  associated with the October 1, 2005 adoption of SFAS 123R. Net income was further
  reduced by increases in depreciation and amortization expense, income tax expense,
  lower earnings of less than 100% owned subsidiaries and reduced investment income,
  as further discussed below. Net income was increased due to lower early extinguishment
  of debt costs, interest expense and increased income from discontinued operations,
  each of which is further discussed below.

For the current quarter, EBITDA increased $2.9 million to $38.4 million compared with $35.5 million in the same period of the prior year. Inpatient services EBITDA decreased $1.6 million, of which $0.9 million was due to increased natural gas and electricity costs, $2.8 million was due to an increase in pharmacy and medical supply costs incurred to treat a higher acuity patient population and $4.4 million was due to decreased Medicaid revenue settlements and adjustments, partially offset by $0.1 million due to the step acquisition of two previously unconsolidated eldercare centers  and $0.6 million of provider tax assessments in Connecticut. The prior year quarter contained no provider tax assessments in Connecticut. The remaining $5.8 million increase resulted from the previously discussed other increases in payor rates, increased Medicare Part B volume, increased occupancy levels and
reduced utilization of agency labor offset by the impact of increased nursing hours per patient day, provider assessment tax expense increases in other states (primarily Pennsylvania and New Jersey) and inflationary increases in cost. The rehabilitation services segment combined external and intersegment revenues increased by $7.2 million, while EBITDA as a percentage of combined external and intersegment revenues (EBITDA margin) increased to 6.6% of revenues in the current quarter from 6.0% in the same period in the prior year. Consequently EBITDA of the rehabilitation services segment increased by $0.8 million in total, of which $0.3 million was due to margin expansion with the remaining $0.5 million of increased EBITDA generated by increased revenues. The margin expansion of $0.3 million primarily resulted from increased therapist productivity, partially offset by increased rates for both internal wages and temporary agencies and the decline in revenue mix as discussed above. The
increase in rates for both internal wages and temporary agencies was primarily 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 $6.3 million, with the current quarter loss of $0.6 million primarily resulting from the write-off of deferred financing fees and other costs related to the repayment of $6.2 million of 8% subordinated debt. The $6.9 million recognized in the prior year quarter was comprised of $1.5 million of  write-offs of unamortized financing fees on the repayment of 8% subordinated debt and $0.4 million of commissions paid relative to such debt retirement, with the remaining  $5.0 million of debt extinguishment charges resulting from  prepayment premiums on the repaid 8% subordinated debt. The remaining decrease in EBITDA of $2.6 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 and system initiatives and incremental stock-based compensation associated with the October 1, 2005 adoption of SFAS 123R.

Capital Costs and Other

Depreciation and amortization expense increased by $2.0 million to $15.8 million in the current quarter compared to $13.8 million for the same period in the prior year. The increase was primarily attributed to additional depreciation expense on incremental capital additions, principally in computer hardware related to the deployment of new computer systems.

Interest expense decreased $0.1 million in the current quarter to $6.4 million, compared to $6.5 million for the same period in the prior year, principally due to repurchases of our 8% senior subordinated notes.

Investment
  income decreased by $0.6 million in the current quarter to $2.2 million compared
  to the same period in the prior year. Investment income was reduced by lower
  investment earnings on assets held in our rabbi trust, offset by overall higher
  interest income on cash and short-term investments.



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Our effective tax rate approximated 40.7% for the quarter ended June 30, 2006. 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%. Income tax expense in the prior year quarter was estimated using an effective tax rate of approximately 39.8%, which was then 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.

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

Income (loss) from discontinued operations, net of taxes, was $0.1 million in the current quarter versus a loss of $(1.3) million in the prior year quarter. The improvement was primarily due to more favorable claims development recognized on self-insured Florida liability policies in the current year quarter combined with certain asset write-downs recognized in the prior year quarter.

Nine Months Ended June 30, 2006 Compared to Nine Months Ended June 30, 2005

In the current year to date period, revenues were $1,316.7 million, an increase of $32.4 million, or 2.5%, over the same period in the prior year. Of this growth, inpatient services revenue increased by $24.0 million, external rehabilitation therapy services revenue increased by $11.0 million and other businesses revenue decreased by $2.6 million.

The $24.0 million of revenue growth in our inpatient services segment is net of $35.2 million of New Jersey and Pennsylvania provider tax assessments recognized in the prior year to date period that pertained to prior periods. Exclusive of the retroactive provider assessments, revenues increased by $59.2 million primarily due to increased payor rates. In the aggregate, payor rates increased by $44.7 million versus the prior year with $23.3 million of such increase occurring in the Medicare payor category. Medicare rates increased by 7.8% due to the October 1, 2005 upward Medicare rate adjustment of 3.1%, higher Medicare patient acuity levels and the positive impact of the Medicare programs RUGs refinement reimbursement regulations that took effect on January 1, 2006.  Approximately $13.3 million of payor rate increases occurred in the Medicaid payor category of which $5.7 million was
due to newly implemented provider tax assessments in Connecticut. The prior year to date period contained no provider tax assessments in Connecticut. Medicaid revenue settlements and adjustments decreased by $6.1 million versus the prior year to date period. The $13.7 million balance of Medicaid rate increases, which equate to a 2.3% increase, resulted from both increased acuity levels and legislative increases. Increases in private and insurance rates of 4.7% and 3.8%, respectively, were the primary reasons for the $8.1 million remainder of the overall rate increase. Approximately $0.9 million of the overall revenue increase was due to the step acquisition of two previously unconsolidated eldercare centers, which we previously jointly owned and managed. We purchased our joint venture partners ownership interest in the centers and, beginning in June 2006, we own and consolidate 100% of the operations. Overall occupancy, including the 0.9% increase in occupancy resulting from 206
licensed beds being taken out of service over the past 12 months, increased to 91.4% in the current year to date period from 90.0% in the same period in the prior year, resulting in an $8.6 million revenue increase. Total patient days increased 34,030 to 5,195,930 in the current year to date period compared to 5,161,900 in the same period of the prior year. Of the total increase in patient days, 3,605 days was attributed to the step acquisitions of two eldercare centers with the 30,425 patient day balance of the increase attributed to occupancy growth at our same facility centers which were included in both reporting periods. Remaining net revenue increases of $5.0 million were primarily due to increased Medicare Part B volume and other revenues.

The $11.0 million increase in external rehabilitation therapy services revenue resulted from net increased business volume of $13.0 million from new and existing contracts partially offset by a net $2.0 million decline primarily resulting from a decline in revenue mix caused by Medicare Part B revenues representing a lower percentage of overall revenues in the current year to date period versus the same period in the prior year.

The $2.6 million decrease in other business revenue was the net result of $1.8 million of revenue decreases primarily resulting from decreased external business volume in our non-core hospitality and staffing services businesses and a $1.4 million decrease resulting from decreased billing for certain shared services to our former parent company prior to our spin-off, with the remaining net $0.6 million increase primarily resulting from increased external business volume in our respiratory health services business.

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For the current year to date period, net income decreased to $29.2 million from $35.1 million in the same period in the prior year. A $41.2 million increase in salaries, wages and benefits was partially offset by the previously discussed revenue increases of $32.4 million as well as $5.4 million of decreased other operating expenses. Of the $41.2 million of increased salaries, wages and benefits, approximately $1.6 million was 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. The $5.4 million of decreased other operating expenses was net of the $28.8 million retroactive portion of New Jersey and Pennsylvania provider assessment taxes recognized in the prior year to date period that pertained to prior periods. Exclusive of retroactive provider taxes, other operating expenses increased by $23.4 million. Of the $23.4 million increase, $3.8 million was attributed to the recognition of newly implemented provider assessment taxes in Connecticut, $2.2 million was due to provider assessment tax increases in other states,  $5.7 million was attributed to an increase in pharmacy and medical supply costs incurred to treat a higher acuity patient population, $3.6 million was due to increased natural gas and electricity costs and $0.3 million was due to the step acquisition of two previously unconsolidated eldercare centers. These increases were offset by approximately $2.1 million of reduced costs attributed to the replacement of higher cost temporary
agency nurses with internally employed nurses. The balance of the increase in other operating expenses of approximately $9.9 million was largely attributed to normal inflationary increases in cost. The provision for losses on accounts receivable and notes receivable increased by $0.9 million as compared with the same period in the prior year primarily due to increased expense in our inpatient segment. General and administrative costs increased by $10.1 million primarily due to increased payroll costs resulting from both wage inflation and additional resources to support multiple operational improvement and system initiatives, incremental stock-based compensation associated with the October 1, 2005 adoption of SFAS 123R. Net income was further reduced from increases in depreciation and amortization expense, lower earnings of less than 100% owned subsidiaries and reduced investment income, each of which is further discussed below. Net income increased due to lower early extinguishment
of debt costs, interest expense, lease expense, income tax expense and higher after-tax gains from discontinued operations, each of which is further discussed below.

For
  the current year to date period, EBITDA decreased $3.4 million to $114.4 million
  compared with $117.8 million in the same period of the prior year. Inpatient
  services EBITDA decreased $7.4 million, of which $6.4 million was due to the
  retroactive New Jersey and Pennsylvania provider tax assessments recognized
  in the prior year to date period that pertained to prior periods, $3.6 million
  was due to increased natural gas and electricity costs, $5.7 million was due
  to an increase in pharmacy and medical supply costs incurred to treat a higher
  acuity patient population and $6.1 million was due to decreased Medicaid revenue
  settlements and adjustments, partially offset by $0.1 million due to the step
  acquisition of two previously unconsolidated eldercare centers and $1.8 million
  of provider tax assessments in Connecticut. The prior year to date period contained
  no provider tax assessments in Connecticut. The remaining $12.5 million increase
  resulted from the previously discussed other increases in payor rates, increased
  Medicare Part B volume, increased occupancy levels and reduced utilization of
  agency labor offset by the impact of increased nursing hours per patient day,
  provider assessment tax expense increases in other states, increased provision
  for losses on accounts and notes receivable and inflationary increases in cost.
  The rehabilitation services segment combined external and intersegment revenues
  increased by $18.5 million, while EBITDA as a percentage of combined external
  and intersegment revenues (EBITDA margin) decreased to 6.8% of revenues in the
  current year to date period from 7.0% in the same period in the prior year.
  Consequently, rehabilitation services EBITDA increased by $1.0 million versus
  the same period in the prior year due to $1.2 million of increased EBITDA generated
  by increased revenues offset by a $0.2 million decrease resulting from EBITDA
  margin contraction. The margin contraction of $0.2 million primarily resulted
  from the decline in revenue mix as discussed above and increased rates for both
  internal wages and temporary agencies partially offset by an increase in therapist
  productivity in the current year to date period versus the same period in the
  prior year. The increase in rates for both internal wages and temporary agencies
  was primarily being driven by high market demand for a limited pool of qualified
  therapists. Decreased loss on early extinguishment of debt in the current year
  to date period increased EBITDA by $11.0 million, with the current year to date
  period loss of $0.8 million primarily resulting from the write-off of deferred
  financing fees and other costs related to the repayment of $8.2 million of 8%
  subordinated debt. Of the $11.8 million loss on early extinguishment of debt
  recognized in the prior year to date period, $0.4 million was due to the write-off
  of unamortized financing fees for several repaid mortgages, $1.3 million was
  due to the full write-off of unamortized financing fees for the term loan component
  of our senior credit facility, $2.3 million was due to the write-off of unamortized
  financing fees from the repayment of 8% subordinated debt, $0.4 million was
  due to commissions paid relative to the 8% subordinated debt, with the remaining
  $7.4 million of debt extinguishment charges resulting from prepayment premiums
  on the repaid 8% subordinated debt. The remaining decrease in EBITDA of $8.0
  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 and system initiatives and incremental stock-based
  compensation associated with the October 1, 2005 adoption of SFAS 123R.

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Capital Costs and Other

Lease expense decreased by $0.4 million primarily due to the January 2005 acquisition of the land and building of a skilled nursing facility that we previously leased.

Depreciation and amortization expense increased by $6.8 million to $46.2 million in the current year to date period compared to $39.4 million for the same period in the prior year. The increase is primarily attributed to additional depreciation expense on incremental capital additions, principally in computer hardware related to the deployment of new computer systems.

Interest expense decreased $3.0 million in the current year to date period to $19.2 million, compared to $22.2 million for the same period in the prior year, due to repurchases of our 8% senior subordinated notes and the restructuring of our debt portfolio in the quarter ended March 31, 2005 resulting in a decline in our overall weighted average interest rate.

Investment
  income decreased $0.5 million to $6.4 million in the current year to date period
  compared to $6.9 million for the same period in the prior year. Investment income
  was reduced by lower investment earnings on assets held in our rabbi trust,
  offset by higher interest income on cash and short-term investments.

Our effective tax rate approximated 40.6% for the year to date period ended June 30, 2006. 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 were reinstated retroactively, we would expect our full fiscal year effective tax rate to approximate 40%. Income tax expense in the prior year to date period was estimated using an effective tax rate of approximately 39.8%, which was then 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.

Operating results of our less than 100% owned subsidiaries in the current year to date period declined compared to the same period in the prior year, resulting in a combined decrease of $0.8 million in equity in net income of unconsolidated affiliates and minority interests.

Income (loss) from discontinued operations, net of taxes, was $0.1 million in the current year to date period versus a loss of $(0.8) million in the prior year to date period. The improvement is primarily due to more favorable claims development recognized on self-insured Florida liability policies in the current year to date period combined with certain asset write-downs recognized in the prior year quarter.

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 nine months ended June 30, 2006 and 2005 were $47.8 million and $113.6
    million, respectively. The $65.8 million decline in cash flow from operations
    in the nine months ended June 30, 2006 primarily resulted from reduced net
    income previously discussed herein, $31.2 million in decreased cash flows
    from the timing of payments to vendors and employees,  and decreased cash
    flows of $15.8 million in accounts receivable. Approximately $12.0 million
    of the accounts receivable fluctuation is attributed to a change in the Pennsylvania
    Medicaid payment schedule.

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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 $77.5 million and $40.8 million for the nine months ended June 30, 2006
     and 2005, respectively. For fiscal 2006, capital expenditures are anticipated

  to be within the range of $90.0 million to $100.0 million. Investing activities
     for the nine months ended June 30, 2006 included $2.4 million of net cash
    used
  to purchase our joint venture partners interests in three skilled nursing
   facilities and $0.7 million to purchase a tract of land. Investing activities

  for the nine months ended June 30, 2005 included proceeds received from the
   sale of eldercare centers of $6.7 million, principally from the sale of eldercare

  centers located in the State of Wisconsin. In the nine months ended June 30,
   2005, approximately $8.9 million of net cash was used for center acquisitions

  principally to purchase a previously leased skilled nursing facility. We do
   not expect to receive significant cash proceeds from asset sales in fiscal
  2006.
  Investing activities for the nine months ended June 30, 2006 also included
  $0.6  million of net sales of restricted cash and marketable securities held
  by our
  wholly owned insurance captive compared to $1.4 million of net purchases of
   restricted cash and marketable securities for the nine months ended June 30,
  2005.

Cash flows from financing activities were a net use of cash of $21.1 million and $78.3 million for the nine months ended June 30, 2006 and 2005, respectively. Cash flows from financing activities for the nine months ended June 30, 2005 are reflective of several financing transactions that occurred in the second fiscal quarter of 2005. In March 2005, we issued $180.0 million of 2.5% convertible senior subordinated debentures due 2025. After paying financing fees of approximately $5.5 million, we used (i) approximately $20.1 million of the net proceeds of the offering to repurchase shares of our common stock from the initial purchasers of the debentures in negotiated transactions concurrently with the offering, (ii) approximately $119.7 million of the net proceeds to repay the remaining outstanding borrowings under the term loan portion of our senior credit facility, and (iii) the balance for
general corporate purposes, including $23.5 million of repurchases of our 8% senior subordinated notes due 2013. The debt repurchases resulted in a prepayment premium of $2.4 million, which is included in loss on early extinguishment of debt. Also 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 $150.0 million of our common stock, 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. Repurchases of common stock are restricted by our debt
  agreements, the most restrictive of which is our 8% senior subordinated notes.
  Such restrictions preclude repurchases of common stock above 50% of our net
  income since July 1, 2003. After considering common stock repurchases made to
  date and other repurchase provisions, our maximum common stock repurchasing
  capacity at June 30, 2006 was $19.4 million. For the nine months ended June
  30, 2006, 288,408 shares of common stock were repurchased at a cost of $10.7
  million, and $8.2 million principal amount of our 8% senior subordinated notes
  were repurchased. Cumulatively through June 30, 2006, 1,075,745 shares of common
  stock were repurchased at a cost of $42.8 million and $79.1 million principal
  amount of our 8% senior subordinated notes were repurchased. The debt repurchases
  resulted in a prepayment premium charge of $7.9 million and the write-off of
  unamortized deferred financing fees and other fees of $3.0 million. These charges
  are recorded as loss on early extinguishment of debt in the unaudited condensed
  consolidated statements of operations in the period in which the repurchases
  are made.

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In June 2006, we acquired a 49% limited partnership interest in a joint venture for $1.9 million. The joint venture is engaged in the construction of an office building. Upon completion of construction, we intend to lease office space from the joint venture to house certain of our corporate support functions.

In
  May 2006, we announced that we signed an agreement to enter into lease and purchase
  option agreements with an unrelated provider of long-term care that operates
  11 facilities with a combined total of approximately 970 skilled nursing and
  assisted living facility beds located in the State of Maine. The most significant
  terms of the transaction assume we will enter into 11 separate agreements to
  lease the facilities over a 10 year term, with two five year renewal options.
  We will also assume an option to purchase all 11 properties in 2026 for $53.0
  million. We expect to account for the transaction as a capital lease. We would
  pay approximately $16.0 million of cash consideration and the related capital
  lease debt balance is expected to approximate $40.0 million. The 11 facilities
  generate approximately $65.0 million of annual revenue. The closing of the transaction,
  which is expected to occur in the last calendar quarter of 2006, is subject
  to receipt of regulatory approvals and various other customary conditions. Accordingly,
  no assurances can be given that the transaction will be consummated or, if it
  is, what the final terms will be or what its ultimate impact will be on our
  financial condition or results of operations.

We
  have entered into a series of non-binding letters of intent with unrelated third
  parties to acquire the real estate and business activities of ten skilled nursing
  and assisted living facilities. The aggregate purchase price of these transactions
  of approximately $80.0 million is expected to be financed by us with cash on
  hand or available borrowings under our revolving credit facility. The closing
  of these transactions are subject to due diligence, the execution of definitive
  agreements, receipt of state regulatory approvals and various other customary
  conditions. Accordingly, no assurances can be given that the transactions will
  be consummated or, if they are, what the final terms will be or what its ultimate
  impact will be on our financial condition or results of operations.

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 June 30, 2006, $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 June 30, 2006, we had restricted cash equivalents and restricted investments in marketable securities of $102.5 million, which are held by Liberty Health Corporation (LHC), our wholly owned captive insurance subsidiary incorporated under the laws of Bermuda. The cash equivalents and 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.

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Off-Balance Sheet Commitments and Commitments to Consolidated VIEs

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 $3.9 million in working capital lines of credit to certain jointly owned and managed companies, of which $2.1 million were unused at June 30, 2006. 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.

As of June 30, 2006, we 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.

Income Taxes

As of June 30, 2006, we had net operating loss carryforwards available of $91.1 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.

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/A 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 three months ended June 30, 2006, we did not make any material changes to our estimates or methods by which estimates are derived with regard to our critical accounting policies.

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New Accounting Pronouncements

Variable Interest Entities

In
  April 2006, the Financial Accounting Standards Board (FASB) issued Staff Position
  No. FIN 46(R)-6, Determining the Variability to
  Be Considered in Applying FASB Interpretation No. 46(R),
  (FIN 46(R)-6). This latest interpretation will significantly change the way
  some companies identify variable interest entities (VIE) and how they analyze
  whether to consolidate those they identify. The new requirements discuss how
  to distinguish between contracts or arrangements that create variability in
  an entity (i.e. its risks and rewards) and contracts or arrangements that are
  exposed to or reduce that variability (i.e. variable interests). FIN 46(R)-6
  provides guidance on when to consolidate an entity based on exposure to risks
  and rewards, rather than voting control. It describes the characteristics of
  a VIE and how an entity that is involved in a VIE should determine whether it
  shares in the VIEs risks and rewards extensively enough to be the VIEs
  primary beneficiary and therefore to consolidate it. FIN 46(R)-6
  is to be applied prospectively to all entities that the reporting enterprise
  first becomes involved with beginning the first day of the first reporting period
  that begins after June 15, 2006, or July 1, 2006 for us. The new requirements
  need not be applied to entities that have previously been analyzed under FIN
  46(R) unless a reconsideration event occurs.

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 clarifies that
  an entity is required to recognize a liability for the fair value of a conditional
  asset retirement obligation if the fair value can be reasonably estimated, even
  though uncertainty exists about the timing and / or method of settlement. Certain
  of our real estate assets contain asbestos. The asbestos is believed to be appropriately
  contained in accordance with environmental regulations. If these properties
  were demolished or subject to renovation activities that disturb the asbestos,
  certain environmental regulations are in place which specify the manner in which
  the asbestos must be handled and disposed. FIN 47 is effective no later than
  the end of all fiscal years ending after December 15, 2005, or September 30,
  2006 for us. We are in the process of identifying our conditional asset retirement
  obligations to determine whether we can reasonably estimate the timing and /
  or method of settlement, as well as the fair value of each obligation. If we
  can reasonably estimate the fair value of an obligation, we will need to recognize
  a liability for that obligation upon adoption of FIN 47 as a cumulative effect
  of a change in accounting principle no later than September 30, 2006. Until
  we complete our evaluation of potential asset retirement obligations, we cannot
  predict the impact of adoption on our consolidated financial statements.

Hybrid Financial Instruments

In
  February 2006, the FASB issued SFAS No. 155, Accounting
  for Certain Hybrid Financial Instruments - an amendment of FASB Statements No.
  133 and 140 (SFAS 155), to simplify and make more
  consistent the accounting for certain financial instruments. Specifically, SFAS
  155 amends SFAS No. 133, Accounting for Derivative
  Instruments and Hedging Activities, to permit
  fair value re-measurement for any hybrid financial instrument with an embedded
  derivative that otherwise would require bifurcation, provided that the whole
  instrument is accounted for on a fair value basis. SFAS 155 amends SFAS No.
  140, Accounting for Transfers and Servicing of
  Financial Assets and Extinguishments of Liabilities (as amended),
  to allow a qualifying special-purpose entity (SPE) to hold a derivative financial
  instrument that pertains to a beneficial interest other than another derivative
  financial instrument. SFAS 155 applies to all financial instruments acquired
  or issued after the beginning of an entitys first fiscal year that begins
  after September 15, 2006, or October 1, 2006 for us, with earlier adoption permitted.
  The adoption of SFAS 155 is not expected to have a material effect on our financial
  condition or results of operations.

General Partner Control of Limited Partnerships

In June 2005, the Emerging Issues Task Force (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 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.

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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 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 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.

Income Tax Uncertainties

In June 2006, the FASB issued Interpretation No.48,Accounting for Uncertainty in Income Taxes, (FIN 48), which prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprises financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxes.Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. FIN 48 will be effective for fiscal years beginning after December 15, 2006, or October 1, 2007 for us, and the provisions of FIN 48 will be applied to all tax positions accounted for under Statement No. 109 upon initial adoption. The cumulative
effect of applying the provisions of this interpretation will be reported as an adjustment to the opening balance of retained earnings for that fiscal year. We are currently evaluating the potential impact of FIN 48 on our consolidated 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.

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

We are exposed to the impact of interest rate changes.

At June 30, 2006, we had $7.8 million of debt with recourse to us 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
  June 30, 2006, we had $13.0 million of non-recourse debt subject to variable
  rates of interest held by two of our consolidated VIEs pursuant to FIN 46. A
  one percent change in the rate of interest would result in a change to our interest
  expense of $0.1 million annually.

At June 30, 2006, we had $74.9 million of cash and equivalents, including restricted cash and equivalents, that were affected by market rates of interest. A one percent change in the rate of interest would result in a change in interest income of $0.7 million annually.

At
  June 30, 2006, we held $11.5 million of restricted investments in marketable
  securities that were affected by market rates of interest. A one percent change
  in the rate of interest would result in a change in interest income of $0.1
  million annually.

|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 June 30, 2006. 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 recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in
the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosures. 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 June 30, 2006, our disclosure controls and procedures were not effective because of the material weaknesses described in Item 9A of our Annual Report on Form 10-K/A for the fiscal year ended September 30, 2005 (the 2005 Form 10-K/A), which are still in the process of remediation. Investors are directed to Managements Report on Internal Control over Financial Reporting in Item 9A of the 2005 Form 10-K/A for a full description of these weaknesses and our planned remediation efforts. Although our remediation efforts are underway, the material weaknesses will not be considered remediated until our new internal controls are fully implemented and operational for a period of time and are operating effectively.
Notwithstanding the material weaknesses described in Item 9A of the 2005 Form 10-K/A, we believe our condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for all periods presented herein.

| | (b) | Changes in internal control over financial reporting.
| | --- | -----------------------------------------------------

Except for steps taken in our ongoing remediation efforts discussed in Item 9A of the 2005 Form 10-K/A, which commenced during the three months ended June 30, 2006, 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
        1A: | Risk
        Factors
|---------------- | --------------------

In addition to the other information set forth in this report, you should carefully consider the factors discussed in our Annual Report on Form 10-K/A for the year ended September 30, 2005, which could materially affect our business, financial condition or future results. The risk factors in our Annual Report on Form 10-K/A have not materially changed. The risks described in our Annual Report on Form 10-K/A are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

|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 June 30, 2006:



|Issuer
        Purchases of Equity Securities | 
|--------------------------------------------- | 
|                                              | 
|Period                                        | 
|                                              | 
|4/1/06
        - 4/30/06                      | 
|5/1/06
        - 5/31/06                      | 
|6/1/06
        - 6/30/06                      | 
|                                              | 
|Total                                         | 
|                                              | 

|(1) | In
        April 2006, our board of directors authorized the repurchase of up to
        $150.0 million of our common stock, with such repurchases to take place
        at managements discretion and/or under pre-established, non-discretionary
        programs from time to time, depending on market conditions, in the open
        market and in privately negotiated transactions, subject to any covenants
        or restrictions contained in agreements governing our indebtedness. Repurchases
        of common stock are restricted by our debt agreements, the most restrictive
        of which is our 8% senior subordinated notes. Such restrictions preclude
        repurchases of common stock above 50% of our net income since July 1,
        2003. After considering common stock repurchases made to date and other
        repurchase provisions, our maximum common stock repurchasing capacity
        at June 30, 2006 was $19.4 million.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|ITEM
        3: | Defaults
        Upon Senior Securities None
|--------------- | ---------------------------------------------

|ITEM
        4: | Submission
        of Matters to a Vote of Security Holders None
|--------------- | -----------------------------------------------------------------

|ITEM
        5: | Other
        Information None
|--------------- | -------------------------------

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|ITEM
        6: | Exhibits
|--------------- | --------

| | (a) | Exhibits
| | --- | --------

| | 31.1 | Certification of George V. Hager, Jr., Chief Executive Officer, of the Company dated August 8, 2006 pursuant to Rule 13a  14(a) of the Securities Exchange Act of 1934, as amended.
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 31.2 | Certification of James V. McKeon, Chief Financial Officer, of the Company dated August 8, 2006 pursuant to Rule 13a  14(a) of the Securities Exchange Act of 1934, as amended.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 32.1 | Certification of George V. Hager, Jr., Chief Executive Officer, of the Company dated August 8, 2006 pursuant to 18 U.S.C. Section 1350.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------

| | 32.2 | Certification of James V. McKeon, Chief Financial Officer, of the Company dated August 8, 2006 pursuant to 18 U.S.C. Section 1350.
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------

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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 CorporationDate: August 8, 2006
        
        
        /s/ James V. McKeonJames V. McKeon,Chief Financial Officer




Date: August 8, 2006
        
        
        /s/ George V. Hager, Jr.George V. Hager, Jr.,Chief Executive Officer and Chairman of the Board


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