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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 March 31, 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 ofMay 23, 2006: 19,568,491 shares of the registrants common stock were outstanding, including 134,009 shares currently held in escrow to be issued in connection with a joint plan of reorganization confirmed by the Bankruptcy Court on September 20, 2001.






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TABLE OF CONTENTS



|                                                          |    |                                                                                       | Page
|--------------------------------------------------------- | -- | ------------------------------------------------------------------------------------- | ----
|CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS | 1 
|                                                          |    |                                                                                       |     
|PART I:                                                   |    | FINANCIAL
        INFORMATION                                                         | 3   
|                                                          |    |                                                                                       |     
|ITEM 1:                                                   |    | Financial Statements                                                                  | 3   
|                                                          |    |                                                                                       |     
|ITEM 2:                                                   |    | Managements Discussion and Analysis of Financial Condition and Results of Operations | 35  
|                                                          |    |                                                                                       |     
|ITEM 3:                                                   |    | Quantitative and Qualitative Disclosures About Market Risk                            | 53  
|                                                          |    |                                                                                       |     
|ITEM 4:                                                   |    | Controls and Procedures                                                               | 53  
|                                                          |    |                                                                                       |     
|PART II:                                                  |    | OTHER INFORMATION                                                                     | 55  
|                                                          |    |                                                                                       |     
|ITEM 1:                                                   |    | Legal Proceedings                                                                     | 55  
|                                                          |    |                                                                                       |     
|ITEM 2:                                                   |    | Unregistered Sales of Equity Securities and Use of Proceeds                           | 55  
|                                                          |    |                                                                                       |     
|ITEM 3:                                                   |    | Defaults Upon Senior Securities                                                       | 55  
|                                                          |    |                                                                                       |     
|ITEM 4:                                                   |    | Submission of Matters to a Vote of Security Holders                                   | 55  
|                                                          |    |                                                                                       |     
|ITEM 5:                                                   |    | Other Information                                                                     | 56  
|                                                          |    |                                                                                       |     
|ITEM 6:                                                   |    | Exhibits                                                                              | 56  
|                                                          |    |                                                                                       |     
|SIGNATURES                                                | 57



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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; our ability to meet our working capital requirements, debt service, and future cash needs; future earnings, capital sources and capital expenditure, debt and lease requirements; our potential extension of credit to our joint venture partners; the expected changes in and effects of government legislation, regulation and funding on our business; estimates in our critical accounting policies, including the adequacy of our allowance for doubtful accounts, any anticipated impact of long-lived asset impairments and our ability to
provide for outstanding losses and loss expenses for our self-insured programs; and the estimated impact of new accounting pronouncements upon adoption;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | statements contained in Quantitative and Qualitative Disclosures About Market Risk; and
| | - | -----------------------------------------------------------------------------------------

| |  | statements contained in the notes to our unaudited condensed consolidated financial statements and in Legal Proceedings regarding the effects of litigation.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| |  | changes in the reimbursement rates or methods of payment from Medicare and Medicaid, including those described herein, or the implementation of other measures to reduce the reimbursement for our services;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the expiration of enactments providing for additional governmental funding;
| | - | ---------------------------------------------------------------------------

| |  | the impact of federal and state regulations;
| | - | --------------------------------------------

| |  | changes in case mix, payor mix and payment methodologies;
| | - | ---------------------------------------------------------

| |  | competition in our businesses;
| | - | ------------------------------

| |  | the capital intensive nature of our inpatient services segment and the need for extensive capital expenditures in order to modernize and improve our physical infrastructure;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an increase in insurance costs and potential liability for losses not covered by, or in excess of, our insurance;
| | - | -----------------------------------------------------------------------------------------------------------------

| |  | competition for, and availability of, qualified staff in the healthcare industry, and risks of potential labor strikes;
| | - | -----------------------------------------------------------------------------------------------------------------------

| |  | our ability to control operating costs and generate sufficient cash flow to meet operational and financial requirements;
| | - | ------------------------------------------------------------------------------------------------------------------------

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| |  | 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

MARCH 31, 2006 AND SEPTEMBER 30, 2005

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)



|                                                                                                                                                                                                                              |  | March
          31, 2006 |           | September
          30, 2005 |           
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | --------- | ---------------------------- | ----------
|                                                                                                                                                                                                                             
|                                                                                                                                                                                                                              |  |                          |           |                              | (Restated)
|Assets:                                                                                                                                                                                                                       |  |                          |           |                              |           
|Current assets:                                                                                                                                                                                                               |  |                          |           |                              |           
|Cash
          and equivalents                                                                                                                                                                                                |  | $                        | 88,643    |                              | $         
|Current
          portion of restricted cash and investments in marketable
          securities                                                                                                                               |  |                          | 37,892    |                              |           
|Accounts
          receivable, net of allowances for doubtful accounts of $24,784 and
          $22,982, at March 31, 2006 and September 30, 2005, respectively                                                               |  |                          | 209,825   |                              |           
|Prepaid
          expenses and other current assets                                                                                                                                                                           |  |                          | 36,223    |                              |           
|Current
          portion of deferred income taxes                                                                                                                                                                            |  |                          | 39,859    |                              |           
|                                                                                                                                                                                                                             
|Total
          current assets                                                                                                                                                                                                |  |                          | 412,442   |                              |           
|                                                                                                                                                                                                                             
|Property
          and equipment, net of accumulated depreciation of $202,814 and $173,714,
          at March 31, 2006 and September 30, 2005, respectively                                                                  |  |                          | 834,922   |                              |           
|Assets
          held for sale                                                                                                                                                                                                |  |                          | 3,911     |                              |           
|Restricted
          cash and investments in marketable securities                                                                                                                                                            |  |                          | 65,492    |                              |           
|Deferred
          income taxes                                                                                                                                                                                               |  |                          | 10,119    |                              |           
|Other
          long-term assets                                                                                                                                                                                              |  |                          | 96,752    |                              |           
|                                                                                                                                                                                                                             
|Total
          assets                                                                                                                                                                                                        |  | $                        | 1,423,638 |                              | $         
|                                                                                                                                                                                                                             
|Liabilities
            and Shareholders Equity:                                                                                                                                                                             |  |                          |           |                              |           
|Current
          liabilities:                                                                                                                                                                                                |  |                          |           |                              |           
|Current installments of long-term
        debt                                                                                                                                                                                |  | $                        | 4,835     |                              | $         
|Accounts payable and other accrued
        expenses                                                                                                                                                                           |  |                          | 152,254   |                              |           
|Current portion of self-insurance
        liability reserves                                                                                                                                                                  |  |                          | 37,892    |                              |           
|                                                                                                                                                                                                                             
|Total
          current liabilities                                                                                                                                                                                           |  |                          | 194,981   |                              |           
|                                                                                                                                                                                                                             
|Long-term
          debt                                                                                                                                                                                                      |  |                          | 441,049   |                              |           
|Self-insurance
          liability reserves                                                                                                                                                                                   |  |                          | 75,833    |                              |           
|Other
          long-term liabilities                                                                                                                                                                                         |  |                          | 46,646    |                              |           
|Commitments
          and contingencies 
		  Shareholders equity:                                                                                                                                                            |  |                          |           |                              |           
|Common
          stock  par $0.01, 45,000,000 shares authorized at March 31, 2006
          and September 30, 2005, 20,544,706 and 20,429,110 shares issued at
          March 31, 2006 and September 30, 2005, respectively |  |                          | 205       |                              |           
|Additional
          paid-in capital                                                                                                                                                                                          |  |                          | 630,785   |                              |           
|Retained
          earnings                                                                                                                                                                                                   |  |                          | 85,175    |                              |           
|Accumulated
          other comprehensive loss                                                                                                                                                                                |  |                          | (673      | )                            |           
|Treasury
          stock at cost, 1,075,742 and 787,337 shares at March 31, 2006 and September
          30, 2005, respectively                                                                                               |  |                          | (42,787   | )                            |           
|Common
          stock held in deferred compensation plan at cost, 200,880 and 163,135
          shares at March 31, 2006 and September 30, 2005, respectively                                                                |  |                          | (7,576    | )                            |           
|                                                                                                                                                                                                                             
|Total
          shareholders equity                                                                                                                                                                                          |  |                          | 665,129   |                              |           
|                                                                                                                                                                                                                             
|Total
          liabilities and shareholders equity                                                                                                                                                                          |  | $                        | 1,423,638 |                              | $         
|                                                                                                                                                                                                                             

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 MARCH 31, 2006 AND 2005

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)



|                                                                                                           |  | Three months ended |           
|---------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------
|                                                                                                           |  |                    |           
|                                                                                                          
|                                                                                                           |  | March 31, 2006     |           
|                                                                                                          
|                                                                                                           |  |                    |           
|Net revenues                                                                                               |  | $                  | 437,448   
|Salaries, wages and benefits                                                                               |  |                    | 268,495   
|Other operating expenses                                                                                   |  |                    | 96,291    
|General and administrative costs                                                                           |  |                    | 29,611    
|Provision for losses on accounts receivable and notes receivable                                           |  |                    | 3,943     
|Loss on early extinguishment of debt                                                                       |  |                    | 188       
|Lease expense                                                                                              |  |                    | 5,620     
|Depreciation and amortization expense                                                                      |  |                    | 15,580    
|Interest expense                                                                                           |  |                    | 6,357     
|Investment income                                                                                          |  |                    | (2,237    
|                                                                                                          
|Income before income tax expense, equity in net income of unconsolidated affiliates and minority interests |  |                    | 13,600    
|Income tax expense                                                                                         |  |                    | 5,517     
|                                                                                                          
|Income before equity in net income of unconsolidated affiliates and minority interests                     |  |                    | 8,083     
|Equity in net income of unconsolidated affiliates                                                          |  |                    | 435       
|Minority interests                                                                                         |  |                    | (323      
|                                                                                                          
|Income from continuing operations                                                                          |  |                    | 8,195     
|Loss from discontinued operations, net of taxes                                                            |  |                    | (127      
|                                                                                                          
|Net income                                                                                                 |  | $                  | 8,068     
|                                                                                                          
|Per common share data:                                                                                     |  |                    |           
|Basic:                                                                                                     |  |                    |           
|Income from continuing operations                                                                          |  | $                  | 0.43      
|Loss from discontinued operations                                                                          |  |                    | (0.01     
|Net income                                                                                                 |  | $                  | 0.42      
|Weighted average shares                                                                                    |  |                    | 19,234,656
|Diluted:                                                                                                   |  |                    |           
|Income from continuing operations                                                                          |  | $                  | 0.42      
|Loss from discontinued operations                                                                          |  |                    | (0.01     
|Net income                                                                                                 |  | $                  | 0.42      
|Weighted average shares                                                                                    |  |                    | 19,434,096

See accompanying notes to unaudited condensed consolidated financial statements.

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

SIX MONTHS ENDED MARCH 31, 2006 AND 2005

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)



|                                                                                                                           |  | Six
        months ended |           
|-------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ----------
|                                                                                                                           |  |                          |           
|                                                                                                                           |  | March
        31, 2006   |           
|                                                                                                                          
|                                                                                                                           |  |                          |           
|Net
        revenues                                                                                                       |  | $                        | 874,430   
|Salaries,
        wages and benefits                                                                                       |  |                          | 537,266   
|Other
        operating expenses                                                                                           |  |                          | 191,963   
|General
        and administrative costs                                                                                   |  |                          | 55,276    
|Provision
        for losses on accounts receivable and notes receivable                                                   |  |                          | 6,883     
|Loss
        on early extinguishment of debt                                                                               |  |                          | 188       
|Lease
        expense                                                                                                      |  |                          | 11,086    
|Depreciation
        and amortization expense                                                                              |  |                          | 30,369    
|Interest
        expense                                                                                                   |  |                          | 12,855    
|Investment
        income                                                                                                  |  |                          | (4,176    
|                                                                                                                          
|Income
        before income tax expense, equity in net income of unconsolidated affiliates
        and minority interests |  |                          | 32,720    
|Income
        tax expense                                                                                                 |  |                          | 13,354    
|                                                                                                                          
|Income
        before equity in net income of unconsolidated affiliates and minority
        interests                     |  |                          | 19,366    
|Equity
        in net income of unconsolidated affiliates                                                                  |  |                          | 969       
|Minority
        interests                                                                                                 |  |                          | (818      
|                                                                                                                          
|Income
        from continuing operations                                                                                  |  |                          | 19,517    
|(Loss)
        income from discontinued operations, net of taxes                                                           |  |                          | (12       
|                                                                                                                          
|Net
        income                                                                                                         |  | $                        | 19,505    
|                                                                                                                          
|Per
        common share data:                                                                                             |  |                          |           
|Basic:                                                                                                                     |  |                          |           
|Income
        from continuing operations                                                                                  |  | $                        | 1.01      
|(Loss)
        income from discontinued operations                                                                         |  |                          | (0.00     
|Net
        income                                                                                                         |  | $                        | 1.01      
|Weighted
        average shares                                                                                            |  |                          | 19,349,678
|Diluted:                                                                                                                   |  |                          |           
|Income
        from continuing operations                                                                                  |  | $                        | 1.00      
|(Loss)
        income from discontinued operations                                                                         |  |                          | (0.00     
|Net
        income                                                                                                         |  | $                        | 1.00      
|Weighted
        average shares                                                                                            |  |                          | 19,599,131

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

SIX MONTHS ENDED MARCH 31, 2006 AND 2005

(IN THOUSANDS)



|                                                                  |  | Six
        months ended |        
|----------------------------------------------------------------- |  | ------------------------ | -------
|                                                                  |  |                          |        
|                                                                  |  | March
        31, 2006   |        
|                                                                 
|                                                                  |  |                          |        
|Cash
        flows from operating activities:                     |  |                          |        
|Net
        income                                                |  | $                        | 19,505 
|Net
        charges included in operations not requiring funds    |  |                          | 52,363 
|Changes
        in assets and liabilities:                        |  |                          |        
|Accounts
        receivable                                       |  |                          | (29,739
|Accounts
        payable and other accrued expenses               |  |                          | (20    
|Other,
        net                                                |  |                          | 5,900  
|                                                                 
|Total
        adjustments                                         |  |                          | 28,504 
|                                                                 
|Net
        cash provided by operating activities                 |  |                          | 48,009 
|                                                                 
|Cash
        flows from investing activities:                     |  |                          |        
|Capital
        expenditures                                      |  |                          | (53,962
|Net
        sales (purchases) of restricted marketable securities |  |                          | 475    
|Net
        change in restricted cash and equivalents             |  |                          | (621   
|Purchase
        of eldercare centers                             |  |                          | (4,823 
|Proceeds
        from sales of eldercare assets                   |  |                          |       
|Other,
        net                                                |  |                          | 6,828  
|                                                                 
|Net
        cash used in investing activities                     |  |                          | (52,103
|                                                                 
|Cash
        flows from financing activities:                     |  |                          |        
|Proceeds
        from issuance of long-term debt                  |  |                          |       
|Repayment
        of long-term debt                               |  |                          | (5,212 
|Debt
        issuance costs and debt prepayment premium           |  |                          | (130   
|Purchase
        of common stock for treasury                     |  |                          | (10,691
|Proceeds
        from exercise of stock options                   |  |                          | 1,108  
|Other,
        net                                                |  |                          | 312    
|                                                                 
|Net
        cash used in financing activities                     |  |                          | (14,613
|                                                                 
|Net
        (decrease) increase in cash and equivalents           |  | $                        | (18,707
|Cash
        and equivalents:                                     |  |                          |        
|Beginning
        of period                                       |  |                          | 107,350
|                                                                 
|End
        of period                                             |  | $                        | 88,643 
|                                                                 
|Supplemental
        disclosure of cash flow information:         |  |                          |        
|Interest
        paid                                             |  | $                        | 12,607 
|Taxes
        paid                                                |  |                          | 4,491  
|Non-cash
        financing activities:                            |  |                          |        
|Capital
        leases                                            |  | $                        |       
|Assumption
        of debt                                        |  |                          |       

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

GHC provides inpatient services through skilled nursing and assisted living centers primarily located in the eastern United States. At March 31, 2006, GHC had 209 owned, leased, managed and jointly owned eldercare centers with 25,683 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 4,900 licensed rehabilitation therapists and assistants employed or contracted at substantially all of the eldercare centers operated by GHC, as well as by contract to healthcare facilities operated by others and through any one of GHCs 13 certified outpatient rehabilitation agencies. After the elimination of intercompany revenues, the rehabilitation therapy services segment constitutes approximately 8% of GHCs revenues.

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

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with 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). Under FIN 46, a VIE
  is created when (i) the equity investment at risk is not sufficient to permit
  the entity to finance its activities without additional subordinated financial
  support from other parties or (ii) equity holders either (a) lack direct or
  indirect ability to make decisions about the entity through voting or similar
  rights, (b) are not obligated to absorb expected losses of the entity or (c)
  do not have the right to receive expected residual returns of the entity if
  they occur. If an entity is deemed to be a VIE, pursuant to FIN 46, an enterprise
  that absorbs a majority of the expected losses or residual returns of the VIE
  is considered the primary beneficiary and must consolidate the VIE. FIN 46 also
  provides guidance with respect to the disclosure of VIEs for which an investor
  is not required to consolidate because the investor is not the primary beneficiary.

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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. In previously issued consolidated financial statements,

  GHC had identified two jointly owned and managed VIEs subject to consolidation
     under FIN 46 and FIN 46R, one of which was subsequently sold. Prior to the
    filing
  of this Quarterly Report on Form 10-Q, GHC reassessed whether certain of the
     transaction structures of its other jointly owned and managed facilities
    create
  VIEs and whether GHC is the primary beneficiary of the VIEs. 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 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 must 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. See Restatement of Unaudited Condensed
  Consolidated  Financial Statements below.

As
  restated, upon adoption of FIN 46 on January 1, 2003, GHC recorded an after-tax
  gain of $2.0 million reflecting the difference between the carrying value of
  GHCs investments in certain of the VIEs and the underlying carrying values
  of the VIEs upon consolidation into GHCs consolidated financial statements.
  The after-tax gain was recorded as a cumulative effect of an accounting change.

In accordance with FIN 46, GHCs investments in variable interest entities in which it is the primary beneficiary are consolidated, while investments in variable interest entities 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 variable interest entities are included in the consolidated financial statements using the equity method of accounting. Prior to the January 1, 2003 adoption of FIN 46, all investments in and the operating results of 20% to 50% owned companies were included in the consolidated financial statements using the equity method of accounting.

In
  total, at March 31, 2006 GHC has consolidated six VIEs, five in connection with
  the restatement and one previously consolidated. At March 31, 2006, total assets
  and debt of the VIEs are $50.8 million and $40.4 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 two VIEs, GHC is not the primary beneficiary and, therefore, the
  VIE is not consolidated into its financial statements. The unconsolidated VIEs
  own and operate two skilled nursing facilities having approximately 300 beds combined.
  GHCs ownership interests in the unconsolidated VIEs is 33.3% and 50% and
  GHC manages the day-to-day operations of the unconsolidated VIEs under management
  agreements. GHCs involvement with the unconsolidated VIEs began in years
  prior to 1991. At March 31, 2006, GHCs maximum exposure to loss associated
  with these two unconsolidated VIEs approximates the aggregate carrying-value
  of its equity method investments of $0.8 million.

Restatement of Unaudited Condensed Consolidated Financial Statements

Prior
  to filing this Quarterly Report on Form 10-Q, 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, results 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.

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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 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.

GHCs
  previously issued unaudited condensed consolidated financial statements (i)
  as of September 30, 2005 and December 31, 2005, (ii) for the three and six months
  ended March 31, 2005 and (iii) for the three months ended December 31,
  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 switch 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 at September 30, 2005 and at December 31, 2005 and for the three and six months ended March 31, 2005 and the three months ended December 31, 2005,  (in thousands, except share and per share data):

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Unaudited Condensed Consolidated Statements of Operations Data:



|                                                                                                           |  | Three months endedMarch 31, 2005 |           
|---------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ----------
|                                                                                                           |  |                                  |           
|                                                                                                           |  | Previously
      Reported        |           
|                                                                                                          
|                                                                                                          
|Net revenues                                                                                               |  | $                                | 454,566   
|Salaries, wages and benefits                                                                               |  |                                  | 254,579   
|Other operating expenses                                                                                   |  |                                  | 123,545   
|General and administrative costs                                                                           |  |                                  | 21,863    
|Provision for losses on accounts receivable and notes receivable                                           |  |                                  | 3,211     
|Loss on early extinguishment of debt                                                                       |  |                                  | 4,289     
|Lease expense                                                                                              |  |                                  | 6,610     
|Depreciation and amortization expense                                                                      |  |                                  | 13,206    
|Interest expense                                                                                           |  |                                  | 6,261     
|Investment income                                                                                          |  |                                  |          
|                                                                                                          
|Income before income tax expense, equity in net income of unconsolidated affiliates and minority interests |  |                                  | 21,002    
|Income tax expense                                                                                         |  |                                  | 7,897     
|                                                                                                          
|Income before equity in net income of unconsolidated affiliates and minority interests                     |  |                                  | 13,105    
|Equity in net income of unconsolidated affiliates                                                          |  |                                  | 679       
|Minority interests                                                                                         |  |                                  | (153      
|                                                                                                          
|Income from continuing operations                                                                          |  |                                  | 13,631    
|(Loss) income from discontinued operations, net of taxes                                                   |  |                                  | (164      
|                                                                                                          
|Net income                                                                                                 |  | $                                | 13,467    
|                                                                                                          
|                                                                                                           |  |                                  |           
|Per common share data:                                                                                     |  |                                  |           
|Basic:                                                                                                     |  |                                  |           
|Income from continuing operations                                                                          |  | $                                | 0.68      
|Loss from discontinued operations                                                                          |  |                                  | (0.01     
|Net income                                                                                                 |  | $                                | 0.67      
|Weighted average shares                                                                                    |  |                                  | 19,985,375
|Diluted:                                                                                                   |  |                                  |           
|Income from continuing operations                                                                          |  | $                                | 0.67      
|Loss from discontinued operations                                                                          |  |                                  | (0.01     
|Net income                                                                                                 |  | $                                | 0.66      
|Weighted average shares                                                                                    |  |                                  | 20,316,822

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|                                                                                                                           |  | Six
        months endedMarch 31, 2005 |           
|-------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------- | ----------
|                                                                                                                           |  |                                        |           
|                                                                                                                           |  | Previously
      Reported              |           
|                                                                                                                          
|Net
        revenues                                                                                                       |  | $                                      | 853,593   
|Salaries,
        wages and benefits                                                                                       |  |                                        | 506,355   
|Other
        operating expenses                                                                                           |  |                                        | 205,865   
|General
        and administrative costs                                                                                   |  |                                        | 42,698    
|Provision
        for losses on accounts receivable and notes receivable                                                   |  |                                        | 5,875     
|Loss
        on early extinguishment of debt                                                                               |  |                                        | 4,832     
|Lease
        expense                                                                                                      |  |                                        | 13,581    
|Depreciation
        and amortization expense                                                                              |  |                                        | 24,525    
|Interest
        expense                                                                                                   |  |                                        | 12,893    
|Investment
        income                                                                                                  |  |                                        |          
|                                                                                                                          
|Income
        before income tax expense, equity in net income of unconsolidated affiliates
        and minority interests |  |                                        | 36,969    
|Income
        tax expense                                                                                                 |  |                                        | 14,379    
|                                                                                                                          
|Income
        before equity in net income of unconsolidated affiliates
        and minority interests                     |  |                                        | 22,590    
|Equity
        in net income of unconsolidated affiliates                                                                  |  |                                        | 1,790     
|Minority
        interests                                                                                                 |  |                                        | (424      
|                                                                                                                          
|Income
        from continuing operations                                                                                  |  |                                        | 23,956    
|Income
        from discontinued operations, net of taxes                                                                  |  |                                        | 359       
|                                                                                                                          
|Net
        income                                                                                                         |  | $                                      | 24,315    
|                                                                                                                          
|                                                                                                                           |  |                                        |           
|Per
        common share data:                                                                                             |  |                                        |           
|Basic:                                                                                                                     |  |                                        |           
|Income
        from continuing operations                                                                                  |  | $                                      | 1.20      
|Income
        from discontinued operations                                                                                |  |                                        | 0.02      
|Net
        income                                                                                                         |  | $                                      | 1.22      
|Weighted
        average shares                                                                                            |  |                                        | 20,004,214
|Diluted:                                                                                                                   |  |                                        |           
|Income
        from continuing operations                                                                                  |  | $                                      | 1.18      
|Income
        from discontinued operations                                                                                |  |                                        | 0.02      
|Net
        income                                                                                                         |  | $                                      | 1.20      
|Weighted
        average shares                                                                                            |  |                                        | 20,304,394

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

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Unaudited Condensed Consolidated Balance Sheet Data:



|                                                                                      |  | September
          30, 2005 |          
|------------------------------------------------------------------------------------- |  | ---------------------------- | ---------
|                                                                                      |  |                              |          
|                                                                                      |  | Previously
      Reported    |          
|                                                                                     
|Assets:                                                                               |  |                              |          
|Current assets:                                                                       |  |                              |          
|Cash
          and equivalents                                                        |  | $                            | 109,041  
|Current
          portion of restricted cash and investments in marketable securities |  |                              | 39,875   
|Accounts
          receivable, net of allowances                                      |  |                              | 184,616  
|Prepaid
          expenses and other current assets                                   |  |                              | 37,185   
|Current
          portion of deferred income taxes                                    |  |                              | 43,148   
|                                                                                     
|Total
          current assets                                                        |  |                              | 413,865  
|                                                                                     
|Property
          and equipment, net of accumulated depreciation                     |  |                              | 783,359  
|Assets
          held for sale                                                        |  |                              | 3,911    
|Restricted
          cash and investments in marketable securities                    |  |                              | 56,197   
|Deferred
          income taxes                                                       |  |                              | 7,972    
|Other
          long-term assets                                                      |  |                              | 94,850   
|                                                                                     
|Total
          assets                                                                |  | $                            | 1,360,154
|                                                                                     
|Liabilities
            and Shareholders Equity:                                     |  |                              |          
|Current
          liabilities:                                                        |  |                              |          
|Current
          installments of long-term debt                                      |  | $                            | 4,537    
|Accounts
          payable and other accrued expenses                                 |  |                              | 154,917  
|Current
          portion of self-insurance liability reserves                        |  |                              | 39,875   
|                                                                                     
|Total
          current liabilities                                                   |  |                              | 199,329  
|                                                                                     
|Long-term
          debt                                                              |  |                              | 405,633  
|Self-insurance
          liability reserves                                           |  |                              | 58,995   
|Other
          long-term liabilities                                                 |  |                              | 39,548   
|Shareholders equity:                                                                 |  |                              |          
|Common
          stock                                                                |  |                              | 204      
|Additional
          paid-in capital                                                  |  |                              | 632,199  
|Retained
          earnings                                                           |  |                              | 62,673   
|Accumulated
          other comprehensive loss                                        |  |                              | (603     
|Treasury
          stock at cost                                                      |  |                              | (32,096  
|Common
          stock held in deferred compensation plan at cost                     |  |                              | (5,728   
|                                                                                     
|Total
          shareholders equity                                                  |  |                              | 656,649  
|                                                                                     
|Total
          liabilities and shareholders equity                                  |  | $                            | 1,360,154
|                                                                                     

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|                                                                                 |  | December
           31, 2005 |          
|-------------------------------------------------------------------------------- |  | ---------------------------- | ---------
|                                                                                 |  |                              |          
|                                                                                 |  | Previously
     Reported     |          
|                                                                                
|Assets:                                                                          |  |                              |          
|Current
     assets:                                                             |  |                              |          
|Cash
     and equivalents                                                        |  | $                            | 90,363   
|Current
     portion of restricted cash and investments in marketable securities |  |                              | 36,162   
|Accounts
     receivable, net of allowances                                      |  |                              | 205,050  
|Prepaid
     expenses and other current assets                                   |  |                              | 37,344   
|Current
     portion of deferred income taxes                                    |  |                              | 39,478   
|                                                                                
|Total
     current assets                                                        |  |                              | 408,397  
|                                                                                
|Property
     and equipment, net of accumulated depreciation                     |  |                              | 791,209  
|Assets
     held for sale                                                        |  |                              | 3,911    
|Restricted
     cash and investments in marketable securities                    |  |                              | 55,318   
|Deferred
     income taxes                                                       |  |                              | 6,820    
|Other
     long-term assets                                                      |  |                              | 95,252   
|                                                                                
|Total
     assets                                                                |  | $                            | 1,360,907
|                                                                                
|Liabilities
     and Shareholders Equity:                                       |  |                              |          
|Current liabilities:                                                             |  |                              |          
|Current
     installments of long-term debt                                      |  | $                            | 4,163    
|Accounts
     payable and other accrued expenses                                 |  |                              | 154,760  
|Current
     portion of self-insurance liability reserves                        |  |                              | 36,162   
|                                                                                
|Total
     current liabilities                                                   |  |                              | 195,085  
|                                                                                
|Long-term
     debt                                                              |  |                              | 404,839  
|Self-insurance
     liability reserves                                           |  |                              | 59,248   
|Other
     long-term liabilities                                                 |  |                              | 41,287   
|Shareholders equity:                                                            |  |                              |          
|Common
     stock                                                                |  |                              | 205      
|Additional
     paid-in capital                                                  |  |                              | 635,689  
|Retained
     earnings                                                           |  |                              | 74,359   
|Accumulated
     other comprehensive loss                                        |  |                              | (684     
|Treasury
     stock at cost                                                      |  |                              | (42,787  
|Common
     stock held in deferred compensation plan at cost                     |  |                              | (6,334   
|                                                                                
|Total
     shareholders equity                                                  |  |                              | 660,448  
|                                                                                
|Total
     liabilities and shareholders equity                                  |  | $                            | 1,360,907
|                                                                                

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Unaudited Selected Condensed Consolidated Statement of Cash Flows Data:



|                                                 |  | Six months endedMarch 31, 2005 |        
|------------------------------------------------ |  | ------------------------------ | -------
|                                                 |  |                                |        
|                                                 |  | Previously
      Reported      |        
|                                                
|Net cash provided by operating activities        |  | $                              | 58,896 
|Net cash used in investing activities activities |  |                                | (35,951
|Net cash used in financing activities            |  |                                | (22,849
|Cash and equivalents beginning of period         |  |                                | 126,071
|                                                
|Cash and equivalents end of period               |  | $                              | 126,167
|                                                



|                                                 |  | Three months endedDecember 31, 2005 |        
|------------------------------------------------ |  | ----------------------------------- | -------
|                                                 |  |                                     |        
|                                                 |  | Previously
      Reported           |        
|                                                
|Net cash provided by operating activities        |  | $                                   | 18,661 
|Net cash used in investing activities activities |  |                                     | (25,827
|Net cash used in financing activities            |  |                                     | (11,512
|Cash and equivalents beginning of period         |  |                                     | 109,041
|                                                
|Cash and equivalents end of period               |  | $                                   | 90,363 
|                                                

|(1) | To reverse 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.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|(2) | Three months ended March 31, 2005 - $0.3 million represents an accrual adjustment for self-insurance loss reserves and $0.4 million represents other miscellaneous accrual adjustments.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Six
  months ended March 31, 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.

Three months ended December 31, 2005 - 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 six months ended March 31, 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.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Three and six months ended March 31, 2005 - Depreciation expense was also reduced $1.3 million and $1.2 million, respectively, 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 $2.2 million, $4.0 million and $1.9 million for the three and six months ended March 31, 2005 and for the three months ended December 31, 2005, respectively.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | Net revenues were increased to reflect certain zero-margin reimbursements from NCI, GHC’s former parent company, under the transitional services agreement in the amounts of $0.4 million and $1.0 million for the three and six months ended March 31, 2005, respectively.  These amounts were previously classified as an offset to general and administrative costs.
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (iii) | Certain
                reclassifications were made between salaries, wages and benefits
                in the amounts of ($0.1) million, $2.2 million and $2.6 million
                for the three and six months ended March 31, 2005 and for the
                three months ended December 31, 2005, respectively; other operating
                expenses in the amounts of $3.2 million, $2.0 million and $0.5
                million for the three and six months ended March 31, 2005 and
                for the three months ended December 31, 2005, respectively; and
                general and administrative expenses in the amounts of ($3.1)
                million, ($4.2) million and ($3.1) million for the three and
                six months
                ended March 31, 2005 and for the three months ended December
                31, 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 $3.9 million
          and $7.7 million for the three and six months ended March 31, 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 impact to deferred income taxes from the cumulative accounting adjustments.
|--- | ------------------------------------------------------------------------------------------

|(8) | Represents an increase to the estimated accrual for incurred but not reported general and professional liability claims to reflect such amounts on an undiscounted basis.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|(9) | Adjustments to increase self insurance liability reserves reflect
             such amounts on an undiscounted basis. Adjustments to other long-term

        assets increase the amount of estimated insurance claims recoverable
            from  excess insurance carriers.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | Adjustments to additional paid-in-capital represent the cumulative after tax impact of the accounting corrections recognized prior to GHCs December 1, 2003 spin-off. Adjustments to retained earnings represent the cumulative after tax impact of the accounting corrections recognized after GHCs December 1, 2003 spin-off.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(11) | The $7.4 million and $8.0 million reclassification of cash and equivalents at September 30, 2005 and December 31, 2005, respectively, to long-term restricted cash and investments in marketable securities properly classifies restricted cash that was previously reflected in cash and equivalents. The $1.4 million reclassification between property and equipment, net and other long-term liabilities at September 30, 2005 represents the reclassification of certain unfavorable rent balances that should have been applied to capital lease asset balances.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) | 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.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) | 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.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

The following unaudited tables illustrate the impact of the restatement to selected components of previously reported consolidated balance sheets at September 30, 2005 and 2004, and the related consolidated statements of operations and cash flows for each of the years in the three-year period ended September 30, 2005 (in thousands, except share and per share amounts). The restated amounts are adjusted to reflect the corrections and reclassifications previously described. Additionally, GHCs consolidated statements of cash flows were restated in fiscal 2004 and 2003 to reclassify $9.8 million and $2.5 million, respectively, of cash outflows from investing activities to operating activities associated with advanced rent payments made pursuant to certain operating leases.

Unaudited Selected Condensed Consolidated Statements of Operations Data:



|                                                    |  | Years
          ended September 30, |          
|--------------------------------------------------- |  | ----------------------------------- | ---------
|                                                    |  |                                     |          
|                                                    |  | 2005                                |          
|                                                    |  |                                     |          
|                                                    |  | Previously
      Reported           |          
|                                                   
|Revenue                                             |  | $                                   | 1,683,350
|Income
          from continuing operations         |  |                                     | 42,420   
|Net
          income                                |  |                                     | 42,169   
|Per
          common share:                         |  |                                     |          
|Basic
          income from continuing operations   |  | $                                   | 2.15     
|Diluted
          income from continuing operations |  |                                     | 2.12     
|Basic
          net income                          |  |                                     | 2.14     
|Diluted
          net income                        |  |                                     | 2.11     
|                                                   

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Unaudited Selected Condensed Consolidated Balance Sheet Data:



|                                               |  | September 30, 2005 |           | September 30, 2004 |  
|---------------------------------------------- |  | ------------------ | --------- | ------------------ | -
|                                               |  |                    |           |                    |  
|                                               |  | PreviouslyReported |           | Restated           |  
|                                              
|Cash and equivalents                           |  | $                  | 109,041   |                    | $
|Working capital                                |  |                    | 214,536   |                    |  
|Total assets                                   |  |                    | 1,360,154 |                    |  
|Long-term debt, including current installments |  |                    | 410,170   |                    |  
|Shareholders equity                           |  |                    | 656,649   |                    |  
|                                              

Unaudited Selected Condensed Consolidated Statements of Cash Flows Data:



|                                                    |  | Years ended September 30, |        
|--------------------------------------------------- |  | ------------------------- | -------
|                                                    |  |                           |        
|                                                    |  | 2005                      |        
|                                                    |  |                           |        
|                                                    |  | PreviouslyReported        |        
|                                                   
|Net cash provided by operating activities           |  | $                         | 124,978
|Net cash (used in) provided by investing activities |  |                           | (57,134
|Net cash (used in) provided by financing activities |  |                           | (84,874
|Cash and equivalents beginning of period            |  |                           | 126,071
|                                                   
|Cash and equivalents end of period                  |  |                           | 109,041
|                                                   

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
|--- | -----------------------------------

Share Repurchase

In February 2005, GHCs board of directors authorized an increase to the size of its previously established share repurchase program from $25.0 million to $50.0 million of GHCs common stock through December 31, 2005. Share repurchases took place at managements discretion and/or under pre-established, nondiscretionary programs from time to time, depending on market conditions, in the open market, and in privately negotiated transactions. Through March 31, 2006, 1,075,742 shares of common stock were repurchased at a cost of $42.8 million. See also note 13  Subsequent Events.

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 $72.9 million of 8% senior subordinated notes repurchased through March 31, 2006, of which $2.0 million were repurchased in the three months ended March 31, 2006. The total debt repurchases resulted in  prepayment premium charges of $7.5 million and the write-off of unamortized deferred financing fees and other fees of $2.8 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 $0.2 million in the three and six months ended March 31, 2006, and $4.3 million and $4.8 million, respectively, in the three and six
months ended March 31, 2005. See also note 13  Subsequent Events.

Purchase of Joint Venture Interests

In December 2005, GHC deposited into escrow $4.1 million to acquire all of its joint venture partners interests in three skilled nursing facilities located in the State of West Virginia having a combined 208 beds. GHC currently owns a 50% interest in and manages the operations of each of the three facilities, but upon completion of the transaction will own 100% of each facility and will therefore consolidate the related revenues, expenses and net assets. In accordance with FIN 46, GHC already consolidates the financial statements of one of the facilities and records minority interest to reflect its joint venture partners interests. Because GHC extended this partnership mortgage financing, GHC is the primary beneficiary of the partnership, as defined by FIN 46, and is therefore required to consolidate it under FIN 46. The combined annual revenues and pre tax income of the two
unconsolidated facilities is approximately $10.0 million and $1.2 million, respectively. The transaction, which is subject to GHCs receipt of certain state regulatory approvals, is expected to be completed during GHCs third fiscal quarter of 2006.

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.

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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 relates 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, 2006, 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 relates to periods prior to fiscal 2005.

|(4) | Long-Term Debt
|--- | --------------

Long-term debt at March 31, 2006 and September 30, 2005 consists of the following (in thousands):



|                                                |  | March
        31, 2006 |         | September
        30, 2005 |  
|----------------------------------------------- |  | ---------------------- | ------- | -------------------------- | -
|                                                |  |                        |         |                            |  
|                                                |  |                        |         | (Restated)                 |  
|Senior subordinated notes                       |  | $                      | 152,150 |                            | $
|Convertible senior subordinated debentures      |  |                        | 180,000 |                            |  
|Mortgages and other secured debt (recourse)     |  |                        | 37,900  |                            |  
|Capital lease obligations                       |  |                        | 35,472  |                            |  
|Mortgages and other secured debt (non recourse) |  |                        | 40,362  |                            |  
|                                                |  |                        |         |                            |  
|                                                |  |                        | 445,884 |                            |  
|Less:                                           |  |                        |         |                            |  
|Current installments of long-term debt          |  |                        | (4,835  | )                          |  
|                                                |  |                        |         |                            |  
|Long-term debt                                  |  | $                      | 441,049 |                            | $
|                                                |  |                        |         |                            |  

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 March 31, 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.

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 March 31, 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.

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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 3.1% to 7.8% at March 31, 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 from 3.2% to 8.7% at March 31, 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 March 31, |       | Six months ended March 31, |  
|--------------------------------------------------------- |  | ---------------------------- | ----- | -------------------------- | -
|                                                          |  |                              |       |                            |  
|                                                          |  | 2006                         |       | 2005                       |  
|                                                         
|                                                          |  |                              |       | (Restated)                 |  
|Income
                on cash and short-term investments |  | $                            | 940   |                            | $
|Income on restricted investments                          |  |                              | 631   |                            |  
|Income
        on assets held in rabbi trust              |  |                              | 576   |                            |  
|Interest income on notes receivable                       |  |                              | 90    |                            |  
|                                                         
|Total investment income                                   |  | $                            | 2,237 |                            | $
|                                                         

|(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 six months ended March 31, 2006, GHCs outstanding stock options yielded 102,483 and 143,205, respectively, potentially dilutive securities compared to the three and six months ended March 31, 2005, in which GHCs outstanding stock options yielded 186,172 and 166,525, respectively, potentially dilutive securities. For the three and six months ended March 31, 2006, GHCs unvested restricted stock yielded an additional 96,957 and 106,248, respectively, potentially dilutive securities under the treasury stock method compared to the three and six months ended March 31, 2005, in which GHCs unvested restricted stock yielded an additional 145,275 and 133,655, 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 six months ended March 31, 2006 and 2005 (in thousands):



|                                                                       |  | Three months ended March 31, |       | Six months ended March 31, |  
|---------------------------------------------------------------------- |  | ---------------------------- | ----- | -------------------------- | -
|                                                                       |  |                              |       |                            |  
|                                                                       |  | 2006                         |       | 2005                       |  
|                                                                      
|                                                                       |  |                              |       | (Restated)                 |  
|Net income                                                             |  | $                            | 8,068 |                            | $
|Net unrealized loss on restricted investments in marketable securities |  |                              | (193  | )                          |  
|Net
                increase to minimum pension liability              |  |                              |      |                            |  
|Unrealized gain on interest rate swap agreement                        |  |                              | 100   |                            |  
|                                                                      
|Total comprehensive income                                             |  | $                            | 7,975 |                            | $
|                                                                      

The unrealized loss on restricted investments in marketable securities and minimum pension liability are net of income tax benefits. The income tax benefit for the three and six months ended March 31, 2006 was $0.1 million and $0.1 million, respectively. The income tax benefit for the three and six months ended March 31, 2005 was $0.7 million and $0.9 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 March 31, |         | Six months ended March 31, |  
|-------------------------------------------------------- |  | ---------------------------- | ------- | -------------------------- | -
|                                                         |  |                              |         |                            |  
|(in thousands)                                           |  | 2006                         |         | 2005                       |  
|                                                        
|                                                         |  |                              |         | (Restated)                 |  
|Revenues:                                                |  |                              |         |                            |  
|Inpatient services - external                            |  | $                            | 393,230 |                            | $
|Rehabilitation therapy services:                         |  |                              |         |                            |  
|External                                                 |  |                              | 35,459  |                            |  
|Intersegment                                             |  |                              | 22,755  |                            |  
|All other services:                                      |  |                              |         |                            |  
|External                                                 |  |                              | 8,759   |                            |  
|Intersegment                                             |  |                              | 17,710  |                            |  
|Elimination of intersegment revenues                     |  |                              | (40,465 | )                          |  
|                                                        
|Total net revenues                                       |  |                              | 437,448 |                            |  
|                                                        
|EBITDA (1):                                              |  |                              |         |                            |  
|Inpatient services                                       |  |                              | 51,627  |                            |  
|Rehabilitation therapy services                          |  |                              | 3,375   |                            |  
|All other services and corporate costs                   |  |                              | (19,277 | )                          |  
|Loss on early extinguishment of debt                     |  |                              | (188    | )                          |  
|                                                        
|Total EBITDA                                             |  |                              | 35,537  |                            |  
|                                                        
|Capital and other:                                       |  |                              |         |                            |  
|Depreciation and amortization expense                    |  |                              | (15,580 | )                          |  
|Interest expense                                         |  |                              | (6,357  | )                          |  
|Income tax expense                                       |  |                              | (5,517  | )                          |  
|Equity in net income of unconsolidated affiliates        |  |                              | 435     |                            |  
|Minority interests                                       |  |                              | (323    | )                          |  
|                                                        
|Income from continuing operations                        |  |                              | 8,195   |                            |  
|(Loss) income from discontinued operations, net of taxes |  |                              | (127    | )                          |  
|                                                        
|Net income                                               |  | $                            | 8,068   |                            | $
|                                                        

|(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 six months ended March 31, 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 for the change in GHCs internal financial reporting during the year. 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 six months ended March 31, 2005 as well as the balance of the six months ended March 31, 2006 to conform to the current period presentation.

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Total assets by segment at March 31, 2006 and September 30, 2005 were as follows (in thousands):



|                                        |  | March
        31, 2006 |           | September
        30, 2005
        (Restated) |  
|--------------------------------------- |  | ---------------------- | --------- | --------------------------------------------- | -
|                                       
|Inpatient
        services              |  | $                      | 1,027,772 |                                               | $
|Rehabilitation
        therapy services |  |                        | 40,787    |                                               |  
|All
        other                       |  |                        | 355,079   |                                               |  
|                                       
|Total
        assets                    |  | $                      | 1,423,638 |                                               | $
|                                       

|(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 six months ended March 31, 2006 and 2005 as follows (in thousands):



|                                         |  | Three months ended |       | Six months ended |  
|---------------------------------------- |  | ------------------ | ----- | ---------------- | -
|                                         |  |                    |       |                  |  
|                                         |  | March 31,2006      |       | March 31,2005    |  
|                                        
|Stock options                            |  | $                  | 964   |                  | $
|Stock incentive plan                     |  |                    | 1,058 |                  |  
|Stock held in deferred compensation plan |  |                    | 1,475 |                  |  
|                                        
|Total                                    |  | $                  | 3,497 |                  | $
|                                        

The
    stock-based compensation expenses in the table above are presented before
    the effect of income taxes which were a benefit of $1.4 million and $2.1
    million for the three and six months ended March 31, 2006, respectively,
    and a benefit of $0.9 million and $1.5 million for the three and six months
    ended March 31, 2005, respectively. Net income was reduced $2.1 million and
    $3.1 million for the three and six months ended March 31, 2006, respectively,
    and reduced $1.4 million and $2.2 million for the three and six months ended
    March 31, 2005, respectively, as a result of stock-based compensation expenses.

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GHCs stock option and stock incentive plans are more fully described under their respective sections below. Stock held in deferred compensation plan is associated with a non-qualified deferred compensation plan established in fiscal 2004 for certain employees. Under the provisions of the plan, a rabbi trust was established to 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 200,880 shares of its common stock in the rabbi trust at March 31, 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 $7.6 million cost of the shares of common stock as a reduction of shareholders equity at March 31, 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. For the three and six months ended March 31, 2006, GHC recognized $1.5 million and $0.8 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 six months ended March 31, 2005, in which GHC recognized $1.5 million and $2.0 million, respectively, of net compensation cost from such changes in the fair value of the common stock units of the deferred compensation plan.

Prior to October 1, 2005, as permitted by SFAS 123, 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
        monthsendedMarch 31,2005 |        | Six
        monthsendedMarch 31,2005 |  
|--------------------------------------------------------------------------------------------- |  | -------------------------------------- | ------ | ------------------------------------ | -
|                                                                                             
|                                                                                              |  | (Restated)                             |        | (Restated)                           |  
|Net
        income, as reported                                                               |  | $                                      | 13,189 |                                      | $
|Adjustments:                                                                                  |  |                                        |        |                                      |  
|Stock-based
        compensation included in net income, net of tax effects                   |  |                                        | 1,403  |                                      |  
|Stock-based
        compensation determined under fair value based method, net of tax effects |  |                                        | (1,962 | )                                    |  
|                                                                                             
|Pro
        forma net income                                                                  |  | $                                      | 12,630 |                                      | $
|                                                                                             
|Per
        common share data:                                                                |  |                                        |        |                                      |  
|Basic:                                                                                        |  |                                        |        |                                      |  
|Net
        income as reported                                                                |  | $                                      | 0.66   |                                      | $
|Net
        income pro forma                                                                  |  | $                                      | 0.63   |                                      | $
|Diluted:                                                                                      |  |                                        |        |                                      |  
|Net
        income as reported                                                                |  | $                                      | 0.65   |                                      | $
|Net
        income pro forma                                                                  |  | $                                      | 0.62   |                                      | $
|                                                                                             

Stock Option Plan

GHC has a stock option plan that provides for the grant of incentive stock options and non-qualified stock options for officers, key employees and non-employee directors. A total of 1,500,000 shares of GHC common stock were reserved for issuance under the stock option plan, of which 123,000 were available for grant at March 31, 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 $17.47 per share for options granted during the six months ended March 31, 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 six months ended March 31, 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 six months ended March 31, 2006 and are consistent with those used in prior disclosures in the footnotes to the 2005 GHC Annual Report on Form 10-K for the year ended September 30, 2005. Estimates of fair value are not intended to predict actual
future events or the value ultimately realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by GHC under SFAS 123R.

Changes to the stock option plan for the six months ended March 31, 2006 were as follows:



|                               |  | Shares    |   | WeightedAverageExercisePrice |       | IntrinsicValue (inthousands) |   | WeightedAverageRemainingContractualLife | 
|------------------------------ |  | --------- | - | ---------------------------- | ----- | ---------------------------- | - | --------------------------------------- | 
|                              
|Outstanding at October 1, 2005 |  | 576,976   |   | $                            | 23.72 |                              |   |                                         | 
|                              
|Granted                        |  | 477,000   |   |                              | 36.40 |                              |   |                                         | 
|Exercised                      |  | (46,893   | ) |                              | 24.17 |                              | $ | 780                                     | 
|                              
|Outstanding at March 31, 2006  |  | 1,007,083 |   |                              | 29.70 |                              |   | 14,341                                  | 
|                              
|Exercisable at March 31, 2006  |  | 334,203   |   | $                            | 25.11 |                              | $ | 6,294                                   | 
|                              

No stock options were forfeited or expired during the six months ended March 31, 2006. Cash received from stock option exercises totaled $1.1 million and $3.1 million in the six months ended March 31, 2006 and 2005, respectively.

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The following table summarizes information about stock options outstanding at March 31, 2006:



|                         |  | Stock Options Outstanding |  | Stock Options Exercisable               | 
|------------------------ |  | ------------------------- |  | --------------------------------------- | 
|                         |  |                           |  |                                         | 
|Range of Exercise Prices |  | Number                    |  | WeightedAverageRemainingContractualLife | 
|                        
|$20.00 - $29.99          |  | 530,083                   |  | 7.87                                    | 
|$30.00 - $39.99          |  | 477,000                   |  | 9.71                                    | 
|                        

The following table presents information regarding non-vested option activity during the six months ended March 31, 2006:



|                              |  | Non-VestedNumber ofOptions |   | WeightedAverageGrant-DateFair Value |      
|----------------------------- |  | -------------------------- | - | ----------------------------------- | -----
|                             
|Non-vested at October 1, 2005 |  | 381,263                    |   | $                                   | 13.53
|Granted                       |  | 477,000                    |   |                                     | 17.47
|Vested                        |  | (185,383                   | ) |                                     | 14.02
|                             
|Non-vested at March 31, 2006  |  | 672,880                    |   | $                                   | 15.96
|                             

As of March 31, 2006, there was $7.2 million of total unrecognized compensation cost related to non-vested stock options granted under the plan. That cost is expected to be recognized over the remaining vesting periods as follows:  $1.7 million for the remainder of fiscal 2006, $2.8 million in fiscal 2007 and $2.7 million in fiscal 2008.

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 160,449 shares were available for grant at March 31, 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. 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 six months ended March 31, 2006, GHC granted 157,051 restricted shares to employees with a weighted average grant date fair value of $40.44 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 vesting period at the market value of GHCs common stock on the grant date. GHC recorded compensation expense of $1.1 million and $2.8 million in the three and six months ended March 31, 2006, respectively, for employee and director restricted stock grants compared to $0.8 million and $1.7 million in the three and six months ended March 31, 2005, respectively.

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The following table presents non-vested restricted stock activity during the six months ended March 31, 2006:



|                              |  | Non-VestedNumber ofShares |   | WeightedAverageGrant-DateFair Value |      
|----------------------------- |  | ------------------------- | - | ----------------------------------- | -----
|                             
|Non-vested at October 1, 2005 |  | 492,253                   |   | $                                   | 22.32
|Granted                       |  | 174,386                   |   |                                     | 40.63
|Vested and Distributed        |  | (68,703                   | ) |                                     | 22.93
|Forfeited                     |  | (650                      | ) |                                     | 21.95
|                             
|Non-vested at March 31, 2006  |  | 597,286                   |   | $                                   | 25.07
|                             

As of March 31, 2006, there was $14.5 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:  $2.1 million for the remainder of fiscal 2006, $4.2 million in fiscal 2007, $4.2 million in fiscal 2008, $2.3 million in fiscal 2009, $1.1 million in fiscal 2010, and $0.6 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 variable-interest entities (VIE) and how they analyze whether to consolidate those they identify. The new requirements regarding 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.

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.

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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.

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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|(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 March 31, 2006 GHC has:

| |  | extended $4.1 million in working capital lines of credit to certain jointly owned and managed companies, including certain consolidated VIEs, of which $2.4 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

MARCH 31, 2006

(IN THOUSANDS)



|                                                     |  | Parent |           | Guarantors |   | Non-guarantors |  | Eliminations |         | Consolidated |  
|---------------------------------------------------- |  | ------ | --------- | ---------- | - | -------------- |  | ------------ | ------- | ------------ | -
|                                                    
|Assets:                                              |  |        |           |            |   |                |  |              |         |              |  
|Current
          assets                             |  | $      | 125,995   |            | $ | 231,317        |  | $            | 56,088  |              | $
|Property
          and equipment, net                |  |        | 26,663    |            |   | 764,935        |  |              | 43,324  |              |  
|Other
          long-term assets                     |  |        | 119,882   |            |   | 22,499         |  |              | 78,662  |              |  
|Investments
          in subsidiaries                |  |        | 387,306   |            |   |               |  |              |        |              |  
|Intercompany
          receivables                   |  |        | 458,105   |            |   |               |  |              |        |              |  
|                                                    
|Total
          assets                               |  | $      | 1,117,951 |            | $ | 1,018,751      |  | $            | 178,074 |              | $
|                                                    
|                                                     |  |        |           |            |   |                |  |              |         |              |  
|Liabilities
          and shareholders' equity:      |  |        |           |            |   |                |  |              |         |              |  
|Current
          liabilities                        |  | $      | 57,487    |            | $ | 96,172         |  | $            | 47,324  |              | $
|Intercompany
          payables                      |  |        |          |            |   | 453,872        |  |              | 4,233   |              |  
|Long-term
          debt                             |  |        | 335,512   |            |   | 58,453         |  |              | 54,256  |              |  
|Other
          long-term liabilities                |  |        | 59,823    |            |   | 1,162          |  |              | 62,868  |              |  
|Shareholders'
          equity                       |  |        | 665,129   |            |   | 409,092        |  |              | 9,393   |              |  
|                                                    
|Total
          liabilities and shareholders' equity |  | $      | 1,117,951 |            | $ | 1,018,751      |  | $            | 178,074 |              | $
|                                                    



GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS

SEPTEMBER 30, 2005

(IN THOUSANDS)



|                                                     |  | (Restated) |          
|---------------------------------------------------- |  | ---------- | ---------
|                                                     |  |            |          
|                                                     |  | Parent     |          
|                                                    
|Assets:                                              |  |            |          
|Current
          assets                             |  | $          | 150,087  
|Property
          and equipment, net                |  |            | 25,048   
|Other
          long-term assets                     |  |            | 111,869  
|Investments
          in subsidiaries                |  |            | 423,262  
|Intercompany
          receivables                   |  |            | 388,093  
|                                                    
|Total
          assets                               |  | $          | 1,098,359
|                                                    
|                                                     |  |            |          
|Liabilities
          and shareholders' equity:      |  |            |          
|Current
          liabilities                        |  | $          | 56,057   
|Intercompany
          payables                      |  |            |         
|Long-term
          debt                             |  |            | 338,780  
|Other
          long-term liabilities                |  |            | 52,709   
|Shareholders'
          equity                       |  |            | 650,813  
|                                                    
|Total
          liabilities and shareholders' equity |  | $          | 1,098,359
|                                                    



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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2006

(IN THOUSANDS)



|                                                                                                                                            |  | Parent |         | Guarantors |   | Non-guarantors |   | Eliminations |        | Consolidated |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ | ------- | ---------- | - | -------------- | - | ------------ | ------ | ------------ | -
|                                                                                                                                           
|Net
        revenues                                                                                                                        |  | $      | 659     |            | $ | 451,982        |   | $            | 25,272 |              | $
|Equity
        in net income of subsidiaries                                                                                                |  |        | 30,883  |            |   |               |   |              |       |              |  
|Operating
        expenses                                                                                                                  |  |        | 33,318  |            |   | 384,216        |   |              | 21,057 |              |  
|Lease
        expense                                                                                                                       |  |        | 479     |            |   | 5,112          |   |              | 29     |              |  
|Depreciation
        and amortization expense                                                                                               |  |        | 3,064   |            |   | 11,936         |   |              | 580    |              |  
|Interest
        expense                                                                                                                    |  |        | 4,405   |            |   | 1,052          |   |              | 1,152  |              |  
|Investment
        income                                                                                                                   |  |        | (991    | )          |   | (576           | ) |              | (670   | )            |  
|                                                                                                                                           
|Income
        (loss) before income tax (benefit) expense, equity in net income of unconsolidated
        affiliates and minority interests |  |        | (8,733  | )          |   | 50,242         |   |              | 3,124  |              |  
|Income
        tax (benefit) expense                                                                                                        |  |        | (16,055 | )          |   | 20,612         |   |              | 1,376  |              |  
|                                                                                                                                           
|Income
        before equity in net income of unconsolidated affiliates
        and minority interests                                      |  |        | 7,322   |            |   | 29,630         |   |              | 1,748  |              |  
|Equity
        in net income of unconsolidated affiliates                                                                                   |  |        | 678     |            |   |               |   |              |       |              |  
|Minority
        interests                                                                                                                  |  |        |        |            |   |               |   |              |       |              |  
|                                                                                                                                           
|Income
        from continuing operations                                                                                                   |  |        | 8,000   |            |   | 29,630         |   |              | 1,748  |              |  
|Income
        (loss) from discontinued operations, net of taxes                                                                            |  |        | 68      |            |   | (247           | ) |              | 52     |              |  
|                                                                                                                                           
|Net
        income                                                                                                                          |  | $      | 8,068   |            | $ | 29,383         |   | $            | 1,800  |              | $
|                                                                                                                                           

GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2005

(IN THOUSANDS)



|                                                                                                                                            |  | (Restated) |        
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------- | -------
|                                                                                                                                            |  |            |        
|                                                                                                                                            |  | Parent     |        
|                                                                                                                                           
|Net
        revenues                                                                                                                        |  | $          | 1,177  
|Equity
        in net income of subsidiaries                                                                                                |  |            | 34,188 
|Operating
        expenses                                                                                                                  |  |            | 29,986 
|Lease
        expense                                                                                                                       |  |            | 332    
|Depreciation
        and amortization expense                                                                                               |  |            | 2,345  
|Interest
        expense                                                                                                                    |  |            | 5,723  
|Investment
        income                                                                                                                   |  |            | (830   
|                                                                                                                                           
|Income
        (loss) before income tax (benefit) expense, equity in net income of unconsolidated
        affiliates and minority interests |  |            | (2,191 
|Income
        tax (benefit) expense                                                                                                        |  |            | (14,444
|                                                                                                                                           
|Income
        (loss) before equity in net income of unconsolidated
        affiliates and minority interests                               |  |            | 12,253 
|Equity
        in net income of unconsolidated affiliates                                                                                   |  |            | 936    
|Minority
        interests                                                                                                                  |  |            |       
|                                                                                                                                           
|Income
        (loss) from continuing operations                                                                                            |  |            | 13,189 
|Loss
        from discontinued operations, net of taxes                                                                                     |  |            |       
|                                                                                                                                           
|Net
        income (loss)                                                                                                                   |  | $          | 13,189 
|                                                                                                                                           

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

SIX MONTHS ENDED MARCH 31, 2006

(IN THOUSANDS)



|                                                                                                                                                     |  | Parent |         | Guarantors |   | Non-guarantors |   | Eliminations |        | Consolidated |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ | ------- | ---------- | - | -------------- | - | ------------ | ------ | ------------ | -
|                                                                                                                                                    
|Net revenues                                                                                                                                         |  | $      | 1,230   |            | $ | 901,046        |   | $            | 47,986 |              | $
|Equity in net income of subsidiaries                                                                                                                 |  |        | 62,744  |            |   |               |   |              |       |              |  
|Operating expenses                                                                                                                                   |  |        | 62,890  |            |   | 760,223        |   |              | 43,589 |              |  
|Lease expense                                                                                                                                        |  |        | 925     |            |   | 10,104         |   |              | 57     |              |  
|Depreciation and amortization expense                                                                                                                |  |        | 5,853   |            |   | 23,358         |   |              | 1,158  |              |  
|Interest expense                                                                                                                                     |  |        | 8,934   |            |   | 2,113          |   |              | 2,301  |              |  
|Investment income                                                                                                                                    |  |        | (2,110  | )          |   | (782           | ) |              | (1,284 | )            |  
|                                                                                                                                                    
|Income before
                income tax (benefit) expense, equity in net income of unconsolidated
                affiliates and minority interests |  |        | (12,518 | )          |   | 106,030        |   |              | 2,165  |              |  
|Income tax (benefit) expense                                                                                                                         |  |        | (30,286 | )          |   | 43,416         |   |              | 892    |              |  
|                                                                                                                                                    
|Income before equity in net income of unconsolidated affiliates and minority interests                                                               |  |        | 17,768  |            |   | 62,614         |   |              | 1,273  |              |  
|Equity in net income of unconsolidated affiliates                                                                                                    |  |        | 1,583   |            |   |               |   |              |       |              |  
|Minority interests                                                                                                                                   |  |        |        |            |   |               |   |              |       |              |  
|                                                                                                                                                    
|Income from continuing operations                                                                                                                    |  |        | 19,351  |            |   | 62,614         |   |              | 1,273  |              |  
|Income (loss) from discontinued operations, net of taxes                                                                                             |  |        | 154     |            |   | (275           | ) |              | 109    |              |  
|                                                                                                                                                    
|Net income                                                                                                                                           |  | $      | 19,505  |            | $ | 62,339         |   | $            | 1,382  |              | $
|                                                                                                                                                    

GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

SIX MONTHS ENDED MARCH 31, 2005

(IN THOUSANDS)



|                                                                                                                            |  | (Restated) |        
|--------------------------------------------------------------------------------------------------------------------------- |  | ---------- | -------
|                                                                                                                            |  |            |        
|                                                                                                                            |  | Parent     |        
|                                                                                                                           
|Net revenues                                                                                                                |  | $          | 2,361  
|Equity in net income of subsidiaries                                                                                        |  |            | 66,029 
|Operating expenses                                                                                                          |  |            | 55,111 
|Lease expense                                                                                                               |  |            | 837    
|Depreciation and amortization expense                                                                                       |  |            | 4,370  
|Interest expense                                                                                                            |  |            | 11,760 
|Investment income                                                                                                           |  |            | (1,577 
|                                                                                                                           
|Income (loss) before income tax (benefit) expense, equity in net income of unconsolidated affiliates and minority interests |  |            | (2,111 
|Income tax (benefit) expense                                                                                                |  |            | (26,148
|                                                                                                                           
|Income
                before equity in net income of unconsolidated affiliates and
            minority interests          |  |            | 24,037 
|Equity in net income of unconsolidated affiliates                                                                           |  |            | 2,303  
|Minority interests                                                                                                          |  |            |       
|                                                                                                                           
|Income from continuing operations                                                                                           |  |            | 26,340 
|Income (loss) from discontinued operations, net of taxes                                                                    |  |            |       
|                                                                                                                           
|Net income                                                                                                                  |  | $          | 26,340 
|                                                                                                                           

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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED MARCH 31, 2006

(IN THOUSANDS)



|                                                    |  | Parent |          | Guarantors |   | Non-guarantors |   | Consolidated |      
|--------------------------------------------------- |  | ------ | -------- | ---------- | - | -------------- | - | ------------ | -----
|                                                   
|Net cash (used in) provided by operating activities |  | $      | (71,918  | )          | $ | 116,922        |   | $            | 3,005
|Net
          cash used in investing activities     |  |        | (6,718   | )          |   | (44,710        | ) |              | (675 
|Net cash (used in) provided by financing activities |  |        | (79,380  | )          |   | 65,409         |   |              | (642 
|                                                   
|Net (decrease) increase in cash and equivalents     |  | $      | (158,016 | )          | $ | 137,621        |   | $            | 1,688
|                                                   

GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED MARCH 31, 2005

(IN THOUSANDS)



|                                                    |  | (Restated) |        
|--------------------------------------------------- |  | ---------- | -------
|                                                    |  |            |        
|                                                    |  | Parent     |        
|                                                   
|Net cash (used in) provided by operating activities |  | $          | (62,112
|Net cash used in investing activities               |  |            | (2,451 
|Net cash provided by (used in) financing activities |  |            | 9,939  
|                                                   
|Net (decrease) increase in cash and equivalents     |  | $          | (54,624
|                                                   

|(13) | Subsequent
        Events
|---- | -------------------------

In April 2006, GHC repurchased $6.2 million of 8% senior subordinated notes resulting in a prepayment premium charge of $0.4 million and the write-off of unamortized deferred financing fees and other fees of $0.2 million.

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 March 31, 2006 is $14.4 million.

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 assume 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 debt balance 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.

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

For a description of our material challenges and risks, including an analysis of industry trends and the effect of recent legislation on our operations, see Risk Factors  Risks Related to Our Business included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2005. The following discussion and analysis of our results of operations and financial condition for the three and six months ended March 31, 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 for the fiscal year ended September 30, 2005.

Restatement of Unaudited Condensed Consolidated Financial Statements

Prior
  to filing this Quarterly Report on Form 10-Q, 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, results in an increase
   to self-insurance loss reserves and related expenses of $2.2 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 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 must 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 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
    (i)
  as of September 30, 2005 and December 31, 2005, (ii) for the three and
   six months ended March 31, 2005 and (iii) for the three months ended

  December 31, 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.

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.

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

On July 28, 2005, the Centers for Medicare and Medicaid Services (CMS) released the final fiscal 2006 skilled nursing facility prospective payment rules, including refinement to the resource utilization group (RUG) classification system (RUGs refinement). Effective October 1, 2005, the skilled nursing facility prospective payment rates were increased by a 3.1% annual inflation update factor. Effective January 1, 2006, the rules established nine new payment classifications, altered the case-mix weights for the remaining 44 RUG payment categories and adjusted upward the nursing component of most RUG payment categories. Excluding the additional 3.1% annual inflation factor, and after considering the distribution of our Medicare patient population under the new system, 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 day in the three months ended March 31, 2006 compared to the immediately preceding quarter.

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.

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.

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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 at 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%. We anticipate Congress to consider changes in the fee schedule formula later this year before it adjourns.

In February 2006, the White House transmitted to Congress the proposed fiscal 2007 federal budget. We believe that preliminary evaluation suggests 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.

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Medicaid
  funding is set annually. States have completed legislative actions on their
  fiscal year 2006 state budgets. We expect our average Medicaid rate per patient
  day to increase between approximately 2% to 3% in our fiscal 2006. Generally,
  state fiscal 2007 budgets will be finalized by mid calendar year. The governors
  in a number of states where we operate have announced proposed fiscal 2007 budgets
  and state legislatures are beginning the process of review and ratification.
  In the states that have completed fiscal year 2007 budgets, final decisions
  on nursing home funding have been in line with the increases during fiscal year
  2006. However, in several of the states most important to us, budget considerations
  are still underway, and we can make no assurances as to the outcome of final
  state budgets.

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

Nursing home provider assessments have been implemented in eight states where we operate (Massachusetts, West Virginia, Rhode Island, North Carolina, New Hampshire, Pennsylvania, New Jersey and Connecticut). Three of these plans received federal approval during the past year and impacted our results in the periods reported herein as compared to the comparative periods, most notably was recognition of the Pennsylvania and New Jersey provider assessments. See  Significant Transactions and Events  Prior Year Recognition of Pennsylvania and New Jersey Provider Assessments included herein.

The Commonwealth of Pennsylvania reduced the reimbursement allowance under its provider assessment program effective July 1, 2005 through June 30, 2006 (the recapture provision). The reduction causes the amount we must pay the Commonwealth under this program to approximate the amount we are reimbursed resulting in a reduction of our fiscal 2006 revenue and EBITDA of approximately $2.4 million and a reduction in our fiscal 2006 net income of approximately $1.4 million, or $0.08 per diluted share, compared to the provider assessment in place prior to July 1, 2005. In his fiscal 2007 budget address, the Governor of the Commonwealth of Pennsylvania has proposed a modification of the recapture provisions. This change and a proposed supplemental appropriation for fiscal year 2006 is under consideration as part of the Commonwealths fiscal year 2007 budget process. Additionally, the
Commonwealth has a mandate to re-design its nursing home payment system before the beginning of its next fiscal year, July 1, 2006. We are unable to predict the outcome of the payment system re-design and its impact on our financial condition and results of operations, if any.

As indicated above, the Presidents proposed fiscal 2007 Federal Budget proposed 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 law permits states to receive federally matched funds for up to 6% of aggregate outlays for state Medicaid nursing home services. The Federal Budget proposes to reduce the acceptable percentage to 3%. A similar proposal was advanced in the fiscal year 2006 proposed Federal Budget and rejected by the Congress. 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. 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. It is impossible to predict the outcome of the legislative and regulatory processes. We cannot at this time predict the extent to which these proposals will be adopted or, if adopted and implemented, what effect, if any, such proposals and existing new legislation and regulation will have on us. It is not possible to quantify fully the effect of legislative changes, the interpretation or administration of such legislation or other governmental initiatives on our business and the business of the customers served by our rehabilitation services business. Accordingly, there can be no assurance that the impact of any future healthcare legislation or regulation will not further adversely affect our business. There can be no assurance that payments under
governmental and private third-party payor programs will be timely, will remain at levels similar to present levels or will, in the future, be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs. Our financial condition and results of operations will be affected by the reimbursement process, which in the healthcare industry is complex and can involve lengthy delays between the time that revenue is recognized and the time that reimbursement amounts are settled.

Significant Transactions and Events

Share Repurchase

In February 2005, our board of directors authorized an increase to the size of our previously established share repurchase program from $25.0 million to $50.0 million of our common stock through December 31, 2005. Share repurchases took place at managements discretion and/or under pre-established, nondiscretionary programs from time to time, depending on market conditions, in the open market, and in privately negotiated transactions. Through March 31, 2006, 1,075,742 shares of common stock were repurchased at a cost of $42.8 million.

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 $72.9 million of 8% senior subordinated notes repurchased through March 31, 2006, of which $2.0 million were repurchased in the three months ended March 31, 2006. The total debt repurchases resulted in  prepayment premium charges of $7.5 million and the write-off of unamortized deferred financing fees and other fees of $2.8 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 $0.2 million and $0.2 million, respectively, in the three and six months ended March 31, 2006, and $4.3 million and $4.8 million, respectively, in the
three and six months ended March 31, 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 currently own a 50% interest in and manage the operations of each of the three facilities, but upon completion of the transaction will own 100% of each facility and will therefore consolidate the related revenues, expenses and net assets. In accordance with FASB Interpretation No. 46, Consolidation of Variable Interest Entities  an Interpretation of ARB No. 51 (FIN46), we already consolidate the financial statements of one of the facilities and record minority interest to reflect our joint venture partners interests. Because we extended this partnership mortgage financing, we are the primary beneficiary
of the partnership, as defined by FIN 46, and are therefore required to consolidate it under FIN 46. The combined annual revenues and pre tax income of the two unconsolidated facilities is approximately $10.0 million and $1.2 million, respectively. The transaction, which is subject to our receipt of certain state regulatory approvals, is expected to be completed during our third fiscal quarter of 2006.

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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 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 relates 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, 2006, 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 relates 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.

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.

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We recorded stock-based compensation expense for the three and six months ended March 31, 2006 and 2005 as follows (in thousands):



|                                         |  | Three months ended |       | Six months ended |  
|---------------------------------------- |  | ------------------ | ----- | ---------------- | -
|                                         |  |                    |       |                  |  
|                                         |  | March 31,2006      |       | March 31,2005    |  
|                                        
|Stock options                            |  | $                  | 964   |                  | $
|Stock incentive plan                     |  |                    | 1,058 |                  |  
|Stock held in deferred compensation plan |  |                    | 1,475 |                  |  
|                                        
|Total                                    |  | $                  | 3,497 |                  | $
|                                        

The adoption of SFAS 123R is expected to reduce fiscal 2006 diluted earnings per share approximately $0.10. As of March 31, 2006, there was $7.2 million of total unrecognized compensation cost related to non-vested stock options granted under our stock option plan, which is expected to be recognized over the remaining vesting periods as follows:  $1.7 million for the remainder of fiscal 2006, $2.8 million in fiscal 2007, and $2.7 million in fiscal 2008. As of March 31, 2006, there was $14.5 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:  $2.1 million for the remainder of fiscal 2006, $4.2 million in fiscal 2007, $4.2 million in fiscal 2008, $2.3 million in fiscal 2009, $1.1 million in fiscal 2010, and
$0.6 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. 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.

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
| | - | -----------------------------------------------------------------------------------------------------------------------------------

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| |  | 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 other of our 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 in. 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.

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

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



|                                                         |  | Three months ended March 31, |        | Six months ended March 31, |  
|-------------------------------------------------------- |  | ---------------------------- | ------ | -------------------------- | -
|                                                         |  |                              |        |                            |  
|(in thousands)                                           |  | 2006                         |        | 2005                       |  
|                                                        
|                                                         |  |                              |        | (Restated)                 |  
|Net income                                               |  | $                            | 8,068  |                            | $
|Add back:                                                |  |                              |        |                            |  
|Loss (income) from discontinued operations, net of taxes |  |                              | 127    |                            |  
|Equity in net income of unconsolidated affiliates        |  |                              | (435   | )                          |  
|Minority interests                                       |  |                              | 323    |                            |  
|Income tax expense                                       |  |                              | 5,517  |                            |  
|Interest expense                                         |  |                              | 6,357  |                            |  
|Depreciation and amortization expense                    |  |                              | 15,580 |                            |  
|                                                        
|EBITDA                                                   |  | $                            | 35,537 |                            | $
|                                                        

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.

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Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005

In the current quarter, revenues were $437.4 million, a decrease of $21.8 million, or 4.8%, over the same period in the prior year. Inpatient services revenue decreased by $25.3 million while external rehabilitation therapy services revenue increased by $2.9 million and other businesses revenue increased by $0.6 million.

The inpatient services segment revenue decline of $25.3 million includes $45.0 of retroactive New Jersey and Pennsylvania provider tax assessments recognized in the prior year quarter that pertained to prior periods. Exclusive of the retroactive provider assessments, revenues increased by $19.7 million primarily due to increased payor rates. In the aggregate, payor rates increased by $15.9 million versus the prior year with $8.4 million of such increase occurring in the Medicare payor category. Medicare rates increased by 8.3% 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 $4.8 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 $0.3 million versus the prior year quarter. The $3.2 million balance of Medicaid rate increases, which equate to a 1.6% increase, resulted from both increased acuity levels and legislated increases. Increases in private pay and insurance rates of 4.5% and 4.5%, respectively, were the primary reasons for the $2.7 million remainder of the overall rate increase. 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 91.7% in the current quarter from 90.2% in the same period in the prior year, resulting in a $3.1 million revenue increase. Total patient days increased 9,634 to 1,715,237 in the current year quarter compared to 1,705,603 in the same period of the prior year. Remaining net revenue increases
of $0.7 million were primarily due to increased other revenues.

The $2.9 million increase in external rehabilitation therapy services revenue resulted from net increased business volume of $4.3 million from new and existing contracts partially offset by a net $1.4 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 $0.6 million increase in other business revenue primarily resulted from increased external business volume in our non-core respiratory health services and physician services businesses.

For the current year quarter, net income decreased to $8.1 million from $13.2 million in the same period in the prior year. The net income decline resulted from revenue decreases of $21.8 million, as previously discussed, as well as $13.5 million of increased salaries, wages and benefits, partially offset by $31.7 million of decreased other operating expenses. Of the $13.5 million of increased salaries, wages and benefits, approximately $0.9 million is attributed to the replacement of higher cost temporary agency nurses with internally employed nurses, with the balance of the increase due to normal inflationary growth in wage and benefits in both our inpatient services segment and rehabilitation therapy services segment, increased occupancy within our inpatient segment, increased inpatient nursing hours per patient day resulting from servicing higher acuity patients and increased
rehabilitation therapy services business volume. The $31.7 million of decreased other operating expenses is net of the $37.3 million retroactive portion of New Jersey and Pennsylvania provider assessment taxes recognized in the prior year quarter that pertained to prior periods. Exclusive of retroactive provider taxes, other operating expenses increased by $5.6 million. Of the $5.6 million increase, $1.2 million is attributed to the recognition of newly implemented provider assessment taxes in Connecticut, $1.7 million is attributed to an increase in pharmacy and medical supply costs incurred to treat a higher acuity patient population and $1.8 million is due to increased natural gas and electricity costs. These increases were offset by approximately $1.1 million of reduced costs attributed to the replacement of higher cost temporary agency nurses with internally employed nurses and $0.4 million of reduced grounds maintenance (primarily snow-removal) costs. The balance of the increase
in other operating expenses of approximately $2.4 million is largely attributed to normal inflationary increases in cost. The provision for losses on accounts receivable and notes receivable increased by $0.7 million as compared with the prior year period primarily due to notes receivable recoveries recognized in the prior year period. General and administrative costs increased by $5.6 million due to increased payroll costs resulting from both wage inflation and additional resources to support multiple operational and system improvement initiatives, incremental stock based compensation associated with the October 1, 2005 adoption of SFAS 123R and increased marketing and recruiting costs. Net income was further reduced by increases in depreciation and amortization expense and lower earnings of less than 100% owned subsidiaries as further discussed below. Net income was increased due to lower early extinguishment of debt costs, interest expense and income tax expense, each of which is
further discussed below.

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For the current quarter, EBITDA decreased $5.9 million to $35.5 million compared with $41.4 million in the same period of the prior year. Inpatient services EBITDA decreased $6.3 million, of which $7.7 million is due to retroactive New Jersey and Pennsylvania provider tax assessments recognized in the prior year quarter that pertained to prior periods, $1.8 million is due to increased natural gas and electricity costs, $1.7 million is due to an increase in pharmacy and medical supply costs incurred to treat a higher acuity patient population and $0.3 million is due to decreased Medicaid revenue settlements and adjustments, partially offset by $0.7 million of provider tax assessments in Connecticut. The prior year quarter contained no provider tax assessments in Connecticut. The remaining $4.5 million increase resulted from the previously discussed other increases in payor rates, increased
occupancy levels, decreased grounds maintenance costs and reduced utilization of agency labor offset by the impact of increased nursing hours per patient day, marketing costs and inflationary increases in cost. The rehabilitation services segment combined external and intersegment revenues increased by $5.1 million, while EBITDA as a percentage of combined external and intersegment revenues (EBITDA margin) decreased to 5.8% of revenues in the current quarter from 8.5% in the same period in the prior year. The resulting $1.4 million contraction of EBITDA margin was the primary reason for the $1.1 million decline in EBITDA of the rehabilitation services segment versus the same period in the prior year, partially offset by $0.3 million of increased EBITDA generated by increased revenues. The margin contraction of $1.4 million primarily resulted from a $1.4 million decline in revenue mix as discussed above. Increased rates for both internal wages and temporary agencies were offset by
increased therapist productivity in the current quarter versus the same period in the prior year. The increase in rates for both internal wages and temporary agencies is primarily being driven by high market demand for a limited pool of qualified therapists. Decreased loss on early extinguishment of debt in the current quarter increased EBITDA by $4.1 million, with the current quarter loss of $0.2 million resulting from the write-off of deferred financing fees and other costs related to the repayment of $2.0 million of 8% subordinated debt. The $4.3 million recognized in the prior year quarter is comprised of the write-off of unamortized financing fees on the fully repaid term loan component of our senior credit facility ($1.3 million) and the repayment of 8% subordinated debt ($0.7 million). In addition, prepayment premiums approximating 10% of the $23.5 million of repaid 8% subordinated debt resulted in $2.3 million of charges. 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 as well as increased recruiting costs.

Capital Costs and Other

Depreciation and amortization expense increased by $2.6 million to $15.6 million in the current quarter compared to $13.0 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 $1.3 million in the current quarter to $6.3 million, compared to $7.6 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 was flat at $2.2 million in the current quarter compared to the same period in the prior year. Investment income was reduced by levels of interest bearing assets, offset by higher investment yields.

Our effective tax rate approximated 40.2% for the quarter ended March 31, 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.

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Operating results of our less than 100% owned subsidiaries in the current year quarter approximated prior year results, resulting in net combined equity in net income of unconsolidated affiliates and minority interests of $0.1 million in both the current and prior year periods.

Six Months Ended March 31, 2006 Compared to Six Months Ended March 31, 2005

In the current year to date period, revenues were $874.4 million, an increase of $7.7 million, or 0.9%, over the same period in the prior year. Of this growth, inpatient services revenue increased by $2.7 million, external rehabilitation therapy services revenue increased by $6.8 million and other businesses revenue decreased by $1.8 million.

The $2.7 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 $37.9 million primarily due to increased payor rates. In the aggregate, payor rates increased by $30.9 million versus the prior year with $15.2 million of such increase occurring in the Medicare payor category. Medicare rates increased by 7.7% 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 $10.0 million of payor rate increases occurred in the Medicaid payor category of which $3.8 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 $1.7 million versus the prior year quarter. The $7.9 million balance of Medicaid rate increases, which equate to a 2.0% increase, resulted from both increased acuity levels and legislative increases. Increases in private and insurance rates of 4.5% and 5.0%, respectively, were the primary reasons for the $5.7 million remainder of the overall rate increase. 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 91.6% in the current year to date period from 90.3% in the same period in the prior year, resulting in a $4.2 million revenue increase. Total patient days increased 12,478 to 3,465,259 in the current year to date period compared to 3,452,781 in the same period of the prior year.
Remaining net revenue increases of $2.8 million were primarily due to increased Medicare Part B volume.

The $6.8 million increase in external rehabilitation therapy services revenue resulted from net increased business volume of $8.9 million from new and existing contracts partially offset by a net $2.1 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 $1.8 million decrease in other business revenue was the net result of $1.6 million of revenue decreases primarily resulting from decreased external business volume in our non-core hospitality and staffing services businesses and a $1.0 million decrease resulting from decreased billing for certain shared services to our former parent company prior to December 1, 2003, NeighborCare Inc., partially offset by $0.8 million of increased external business volume in our non-core respiratory health services business.

For the current year to date period, net income decreased to $19.5 million from $26.3 million in the same period in the prior year. A $26.3 million increase in salaries, wages and benefits was partially offset by the previously discussed revenue increases of $7.7 million as well as $14.7 million of decreased other operating expenses. Of the $26.3 million of increased salaries, wages and benefits, approximately $1.4 million is attributed to the replacement of higher cost temporary agency nurses with internally employed nurses, with the balance of the increase due to normal inflationary growth in wage and benefits in both our inpatient services segment and rehabilitation therapy services segment, increased occupancy within our inpatient segment, increased inpatient nursing hours per patient day resulting from servicing higher acuity patients and increased rehabilitation therapy services
business volume. The $14.7 million of decreased other operating expenses is 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 $14.1 million. Of the $14.1 million increase, $2.5 million is attributed to the recognition of newly implemented provider assessment taxes in Connecticut, $2.9 million is attributed to an increase in pharmacy and medical supply costs incurred to treat a higher acuity patient population, $2.8 million is due to increased natural gas and electricity costs and $4.2 million is due to increased general and property liability insurance costs. These increases were offset by approximately $2.0 million of reduced costs attributed to the replacement of higher cost temporary agency nurses with internally employed nurses, $0.3 million of reduced grounds maintenance
(primarily snow removal) costs and $1.7 million of reduced costs resulting from decreased business volume in our non-core businesses as discussed above. The balance of the increase in other operating expenses of approximately $5.7 million is 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 notes receivable recoveries recognized in the prior year period. General and administrative costs increased by $6.6 million 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 and increased marketing and recruiting costs. Net income was further reduced from increases in depreciation and amortization expense, lower earnings of
less than 100% owned subsidiaries and lower after-tax gains from discontinued operations, each of which is further discussed below. Net income increased due to lower early extinguishment of debt costs, interest expense, lease expense and income tax expense, each of which is further discussed below.

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For
    the current year to date period, EBITDA decreased $6.4 million to $75.9 million
    compared with $82.3 million in the same period of the prior year. Inpatient
    services EBITDA decreased $5.8 million, of which $6.4 million is due to the
    retroactive New Jersey and Pennsylvania provider tax assessments recognized
    in the prior year to date period that pertained to prior periods, $2.8 million
    is due to increased natural gas and electricity costs, $2.9 million is due
    to an increase in pharmacy and medical supply costs incurred to treat a higher
    acuity patient population and $1.7 million is due to decreased Medicaid revenue
    settlements and adjustments, partially offset by $1.2 million of provider
    tax assessments in Connecticut. The prior year to date period contained no
    provider tax assessments in Connecticut. The remaining $6.8 million increase
    resulted from the previously discussed other increases in payor rates, increased
    Medicare Part B volume, increased occupancy levels, decreased grounds maintenance
    costs and reduced utilization of agency labor offset by the impact of increased
    nursing hours per patient day, marketing costs and inflationary increases
    in cost. The rehabilitation services segment combined external and intersegment
    revenues increased by $11.3 million, while EBITDA as a percentage of combined
    external and intersegment revenues (EBITDA margin) decreased to 6.9% of revenues
    in the current year to date period from 7.4% in the same period in the prior
    year. Consequently, rehabilitation services EBITDA increased by $0.3 million
    versus the same period in the prior year due to $0.8 million of increased
    EBITDA generated by increased revenues offset by a $0.5 million decrease
    resulting from EBITDA margin contraction. The margin contraction of $0.5
    million primarily resulted from a $2.1 million decline in revenue mix as
    discussed above partially offset by the
$1.6 million net impact of an increase in therapist productivity in the current
    year to date period versus the same period in the prior year and increased
    rates for both internal wages and temporary agencies. The increase in rates
    for both internal wages and temporary agencies is primarily being driven
    by high market demand for a limited pool of qualified therapists. Decreased
    loss on early extinguishment of debt in the current year to date period increased
    EBITDA by $4.6 million, with the current year to date period loss of $0.2
    million resulting from the write-off of deferred financing fees and other
    costs related to the repayment of $2.0 million of 8% subordinated debt. The
    $4.8 million recognized in the prior year to date period is comprised of
    the write-off of unamortized financing fees for several repaid mortgages
    ($0.4 million), the full write-off of the term loan component of our senior
    credit facility ($1.3 million) and the repayment of 8% subordinated debt
    ($0.7 million). In  addition, prepayment premiums approximating 10% of the
    $23.5 million of repurchased 8% subordinated debt resulted in $2.4 million
    of charges. The remaining decrease in EBITDA of $5.5 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 increased recruiting costs.

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 $4.8 million to $30.4 million in the current year to date period compared to $25.6 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.

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Interest expense decreased $2.8 million in the current year to date period to $12.9 million, compared to $15.7 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 was up slightly to $4.2 million in the current year to date period compared to $4.1 million for the same period in the prior year. Investment income was reduced by lower levels of interest bearing assets, offset by higher investment yields.

Our effective tax rate approximated 40.6% for the year to date period ended March 31, 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.

Income (loss) from discontinued operations, net of taxes, was de minimis in the current year to date period versus income of $0.5 million in the prior year to date period. The decrease is primarily due to favorable claims development recognized on self-insured Florida policies in the prior year to date period that did not recur in the current year to date period.

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 $0.4 million in equity in net income of unconsolidated affiliates and minority interests.

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 six
    months ended March
  31, 2006 and 2005 were $48.0 million and $60.8 million, respectively. The $12.8
     million decline in cash flow from operations in the six months ended March
    31,
  2006 primarily resulted from reduced net income previously discussed herein,
     $38.0 million in decreased cash flows from the timing of payments to vendors

  and employees, offset with increased cash flows of $30.0 million in accounts
     receivable. These unusually large fluctuations in cash flows of working
    capital
  accounts are due to the prior year period recognition of receivables and payables
     associated with the implementation of the Pennsylvania and New Jersey provider

  assessments that were accrued, but not yet received or disbursed as of March
     31, 2005.

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 $54.0 million and $23.6 million for the six months ended March 31, 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 six months ended March 31, 2006 include $4.1 million of cash used to fund into escrow a proposed purchase of our joint venture partners interests in three skilled nursing facilities and $0.7 million to purchase a tract of land. Investing
activities for the six months ended March 31, 2005 include proceeds received from the sale of eldercare centers of $5.3 million, principally from the sale of eldercare centers located in the state of Wisconsin. In the six months ended March 31, 2005, approximately $7.0 million of net cash was used 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 six months ended March 31, 2006 also includes $0.5 million of net sales of restricted marketable securities held by our wholly owned insurance captive compared to $14.2 million of net purchases of restricted marketable securities for the six months ended March 31, 2005.

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Cash
    flows from financing activities were a net use of cash of $14.6 million and
    $23.6 million for the six months ended March 31, 2006 and 2005, respectively.
    Cash flows from financing activities for the six months ended March 31, 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 March 31, 2006 is $14.4 million. For
    the six
    months
    ended March
    31, 2006,
    288,405 shares of common stock were repurchased at a cost of $10.7 million,
    and $2.0 million principal amount of our 8% senior subordinated notes were
    repurchased. Cumulatively through March 31, 2006, 1,075,742 shares of common
    stock were repurchased at a cost of $42.8 million and $72.9 million principal
    amount of our 8% senior subordinated notes were repurchased. The debt repurchases
    resulted in a prepayment premium charge of $7.5 million and the write-off
    of unamortized deferred financing fees and other fees of $2.8 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. Subsequent to
    March 31, 2006, we repurchased an additional $6.2 million principal amount
    of 8% senior subordinated notes resulting in a prepayment premium charge
    of $0.4 million and the write-off of unamortized deferred financing fees
    and other fees of $0.2 million.

In April 2006, we entered into a series of letters of intent with unrelated third parties to acquire the real estate and business activities of nine assisted living and skilled nursing facilities. The aggregate purchase price of these transactions of approximately $61.0 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, which are expected to close through the end of calendar year 2006, 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.

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.

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We believe that the net cash provided by our operating activities, supplemented as necessary with cash reserves and borrowings available under our revolving credit facility, will provide sufficient resources to meet our working capital requirements, debt service and other liquidity needs over the next 12 months. At March 31, 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 March 31, 2006, we had restricted cash equivalents and restricted investments in marketable securities of $103.4 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.

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 $4.1 million in working capital lines of credit to certain jointly owned and managed companies, of which $2.4 million were unused at March 31, 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.

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

We have exited a commitment to purchase land with an aggregate purchase price of approximately $3.0 million. The $0.2 million deposit that was disbursed into escrow at December 31, 2005 was refunded during the three months ended March 31, 2006.

Income Taxes

As of March 31, 2006, we had net operating loss carryforwards available of $105.9 million, which can be utilized to offset future taxable income subject to an annual limitation of $33.1 million. The net operating loss carryforwards serve to reduce the amount of cash payments we make for income tax obligations. We regularly assess our ability to realize the tax benefit from our net operating loss carryforwards.

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Critical Accounting Policies

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

| | Allowance for Doubtful Accounts;
|- | --------------------------------

| | Loss
        Reserves for Certain Self-Insured Programs;
|- | --------------------------------------------------------

| | Revenue
        Recognition / Contractual Allowances; and
|- | ---------------------------------------------------------

| | Long-Lived
        Asset Impairments.
|- | -------------------------------------

During the three months ended March 31, 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, with exception to the following matter. Historically, we recorded outstanding losses and loss expenses for both general and professional liability and workers compensation liability based on the estimates of the amount of reported losses together with a provision for losses incurred but not reported, based on the recommendations of an independent actuary, and our judgment using our past experience and industry experience. General and professional liability and workers compensation claims were discounted at a rate of 4.5%. This rate estimated the present value of funds required to pay losses at a future date. After review and consultation with our Audit Committee and KPMG LLP, our independent
registered public accounting firm, we determined that our loss reserves in connection with our self-insured programs should be reported on an undiscounted basis to comply with U.S. generally accepted accounting principles. Accordingly, we and our Audit Committee have determined we will restate our historical financial statements. See note 1  Organization and Basis of Presentation - Restatement of Unaudited Condensed Consolidated Financial Statements, to the unaudited condensed consolidated financial statements included herein.

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 regarding 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.

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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 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.

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.

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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.

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 March 31, 2006, we had $7.8 million of debt with recourse to GHC 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
     March 31, 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
    March 31, 2006, we had $98.0 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 $1.0 million annually.

At March 31, 2006, we held $22.6 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 $0.2 million annually.

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

| | (a) | Effectiveness of disclosure controls and procedures.
| | --- | ----------------------------------------------------

Restatement
  of Financial Statements

In
    connection with our response to review letters from the Securities and Exchange
    Commission (SEC) relating to our Annual Report on Form 10-K for the fiscal
    year ended September 30, 2005 and Quarterly Report for the fiscal quarter
    ended December 31, 2005, and after review and consultation with our Audit
    Committee and KPMG LLP, our independent registered public accounting firm,
    we determined that our policy with respect to discounting self-insured outstanding
    losses and loss expenses for both general and professional liability and
    workers compensation
    liability claims and our conclusions
    regarding the consolidation of certain joint venture partnerships in accordance
    with FIN 46 were not in accordance with U.S. generally accepted accounting
    principles.

Our
     consolidated financial statements for the fiscal years ended September 30,
    2003,
  2004 and 2005 and the fiscal quarter ended December 31, 2005 will be restated
     to reflect self-insured general and professional liability claims and workers compensation
      claims on an undiscounted basis and to consolidate certain joint venture
     partnerships
  in accordance with FIN 46. In addition, the restatements will include changes
     in certain account classifications to conform with U.S. generally accepted
     accounting
  principles and to correct all previously reported errors to include them in
      the appropriate period. See note 1 to the Notes to Unaudited Condensed
     Consolidated
  Financial Statements contained in this Quarterly Report on Form 10-Q for more
      information regarding the restatement.

In
    light of the determination that certain of our accounting policies were not
    in accordance with U.S. generally accepted accounting principles, our management,
    including our chief executive officer and chief financial officer re-evaluated
    our internal control over financial reporting as of September 30, 2005. Management
    has concluded that the errors described
    above resulted from a material weakness in
    internal
  control over financial reporting related to the misapplication of U.S. genereally
    accepted accounting principles. We are also evaluating other deficiencies
    in connection with the restatements. Readers are therefore cautioned not
    to
  rely on managements conclusion set forth in Item 9A: Controls and Procedures
   Managements Annual Report on Internal Control over Financial Reporting,
   included in our Annual Report on Form 10-K for the fiscal year ended September

  30, 2005, that our internal control over financial reporting was effective
  as  of September 30, 2005. We have been advised by KPMG LLP that its report
  on internal
  control over financial reporting as of September 30, 2005 should not be relied
   upon.

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Conclusion Regarding 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 March 31, 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 March 31, 2006, our disclosure controls and procedures were not effective because of the material weakness described above. In addition, our chief executive officer and chief financial officer have reevaluated the conclusions regarding our disclosure controls and procedures for prior periods and have concluded that our disclosure controls and procedures were not effective for the interim periods during the fiscal years ended September 30, 2003, 2004 and 2005, and the fiscal quarter ended December 31, 2005.

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

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

In
     order to conform to U.S. generally accepted accounting principles, we are
    in the process of evaluating our policies and procedures to ensure proper

  accounting for self-insured outstanding losses and loss expenses for both general
    and professional liability and workers compensation liability claims
    and the proper application of FIN 46 under U.S. generally accepted accounting
    principles.

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|PART
        II: | OTHER INFORMATION
|---------------- | -----------------

|ITEM
        1: | Legal Proceedings
|--------------- | -----------------

Haskell et al. v. Goldman Sachs & Co. et al.

NeighborCare, Inc., our former parent, is a defendant in an action brought by former investors in NeighborCare, Inc. on January 27, 2004 in the Supreme Court of New York, County of New York. The plaintiffs collectively held over $205.0 million in subordinated debentures prior to the filing by NeighborCare, Inc. and substantially all of our subsidiaries of a Chapter 11 bankruptcy petition in 2000. The claim alleges fraud and grossly negligent misrepresentation by defendants NeighborCare, Inc., Goldman Sachs & Co., Mellon Bank, N.A., Highland Capital Management, LP, and George V. Hager, Jr., our Chief Executive Officer (and former Chief Financial Officer of NeighborCare, Inc. prior to the spin-off), in connection with the Bankruptcy Courts approval of the plan of reorganization confirmed by the Bankruptcy Court in 2001 which canceled the subordinated debentures. The plaintiffs seek
to recover $200.0 million plus interest costs and fees. The action was removed to the United States Bankruptcy Court for the District of Delaware. In July 2004, we received notice from NeighborCare, Inc. indicating that it believes we are responsible for 50% of the legal fees related to this matter. In addition, Mellon Bank, N.A. has asserted a claim against NeighborCare, Inc. for indemnification for expenses and damages related to the former investors claim. On March 28, 2005, the Bankruptcy Court ruled that NeighborCare, Inc. would be obligated to reimburse Mellon Bank, N.A. for expenses and damages relating to the claim, other than any expenses or damages determined by the Bankruptcy Court to have resulted from Mellon Banks gross negligence or willful misconduct. On April 27, 2005, the Bankruptcy Court dismissed the plaintiffs complaint against all named defendants and the plaintiffs appealed. On March 29, 2006, the U.S. District Court for the District of Delaware
affirmed the Bankruptcy Courts Order as to NeighborCare, Inc. and remanded the matter for further proceedings as to the remaining defendants. While we have advanced NeighborCare, Inc. 50% of the deductible under the insurance policy related to the former investors claim, we have not made a determination with respect to our ultimate liability, if any, relative to this case.

|ITEM
        2: | Unregistered
        Sales of Equity Securities and Use of Proceeds None
|--------------- | -------------------------------------------------------------------------

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

|ITEM
        4: | Submission of Matters to a Vote of Security Holders
|--------------- | ---------------------------------------------------

Pursuant to the 2006 Annual Meeting of Shareholders discussed below, Robert H. Fish, Charles W. McQueary and Charlene Connolly Quinn were each elected as Class II directors to serve until the 2009 Annual Meeting of Shareholders and until their successors are duly elected and qualified. George V. Hager, Jr. and Kevin M. Kelley continue to serve as Class I directors to serve until the 2008 Annual Meeting of Shareholders and John F. DePodesta, J. Michael Gallagher and Terry Allison Rappuhn continue to serve as Class III directors to serve until the 2007 Annual Meeting of Shareholders, each until their successors are duly elected and qualified.

On February 22, 2006, we held our 2006 Annual Meeting of Shareholders. Proxies were solicited for the meeting pursuant to Regulation 14A of the Securities Exchange Act of 1934.

At the meeting, the following matter was voted on:

| |  | the election of Robert H. Fish, Charles W. McQueary and Charlene Connolly Quinn to hold office for a term of three years and until each of their successors are duly elected and qualified.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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A summary of the voting results follows:



|                                            |  | Votes
        For |  | Votes
        Against |  | Votes
        Withheld |  | Broker
        Non-Vote | 
|------------------------------------------- |  | ----------------- |  | --------------------- |  | ---------------------- |  | ----------------------- | 
|                                            |  |                   |  |                       |  |                        |  |                         | 
|Election
        of Robert H. Fish          |  | 17,608,848        |  |                      |  | 355,751                |  |                        | 
|Election
        of Charles W. McQueary     |  | 17,500,670        |  |                      |  | 463,929                |  |                        | 
|Election
        of Charlene Connolly Quinn |  | 17,942,266        |  |                      |  | 22,333                 |  |                        | 

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

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

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

| | 31.1 | Certification of George V. Hager, Jr., Chief Executive Officer, of the Company dated May 30, 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
            May 30, 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 May 30, 2006 pursuant to 18 U.S.C. Section 1350.
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 32.2 | Certification
                of James V. McKeon, Chief Financial Officer, of the Company dated
            May 30, 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: May 30, 2006
        
        
        /s/ James V. McKeonJames V. McKeon,Chief Financial Officer


Date: May 30, 2006
        
        
        /s/ George V. Hager, Jr.George V. Hager, Jr.,Chief Executive Officer and Chairman of the Board


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