##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington D.C 20549
 
 Form 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 Commission File Numbers 333-97293 and 333-116927
 EXTENDICARE HEALTH SERVICES, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    111 West Michigan Street
    
    98-0066268(State or other jurisdiction of
    
    Milwaukee, WI 53203
    
    (I.R.S. Employerincorporation or organization)
    
    (Address of principal executive office
    
    Identification Number)including zip code)
 (414) 908-8000
  þ o
  o o þ
  o þ




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##### 



EXTENDICARE HEALTH SERVICES, INC.
 INDEX
 PagePart I Financial Information:Item 1 Financial Statements:Condensed Consolidated Statements of Income for the Three Months Ended
March 31, 2006 and 2005
    
    
    3Condensed Consolidated Balance Sheets, March 31, 2006 and December 31, 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2006 and 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    
    53Item 4 Controls and Procedures
    
    
    54Part II Other Information:Item 1 Legal Proceedings
    
    
    55Item 1A Risk Factors
    
    
    55Item 6 Exhibits
    
    
    55Signatures
    
    
    56Exhibit Index
    
    
    57302 Certification of Chairman of the Board and CEO302 Certification of Sr. VP, CFO and TreasurerWritten Statements
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PART I
FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(In thousands)
 Three Months Ended March 31,2006
    
    

2005REVENUES:Nursing and assisted living facilities
    
    $
    299,484
    
    
    $
    280,862Outpatient therapy
    
    
    2,733
    
    
    
    2,727Other
    
    
    5,116
    
    
    
    4,668307,333
    
    
    
    288,257COSTS AND EXPENSES (INCOME):Operating
    
    
    248,771
    
    
    
    233,587General and administrative
    
    
    12,354
    
    
    
    9,609Lease costs
    
    
    5,699
    
    
    
    4,509Depreciation and amortization
    
    
    11,923
    
    
    
    9,903Accretion of retirement obligations (Note 2)
    
    
    219
    
    
    
    Interest expense, net (Note 7)
    
    
    10,699
    
    
    
    8,184Valuation adjustment on interest rate caps (Note 8)
    
    
    (89
    )
    
    
    1,298Gain on disposal of assets (Note 10)
    
    
    (81
    )
    
    
    (448
    )Loss on refinancing and retirement of debt (Note 7)
    
    
    
    
    
    
    275289,495
    
    
    
    266,917INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES
    
    
    17,838
    
    
    
    21,340Income tax expense
    
    
    6,475
    
    
    
    8,414NET INCOME FROM CONTINUING OPERATIONS
    
    
    11,363
    
    
    
    12,926Loss from discontinued operations before income
taxes (Note 11)
    
    
    (2,269
    )
    
    
    (1,446
    )Income tax benefit on discontinued operations (Note
11)
    
    
    (935
    )
    
    
    (574
    )NET LOSS FROM DISCONTINUED OPERATIONS
    
    
    (1,334
    )
    
    
    (872
    )NET INCOME
    
    $
    10,029
    
    
    $
    12,054
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EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2006 AND DECEMBER 31, 2005
(In thousands except share data)
 March 31,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    15,122
    
    
    $
    13,347Short-term investments
    
    
    2,750
    
    
    
    5,722Accounts receivable, less allowances of $15,143 and $13,813
respectively
    
    
    128,252
    
    
    
    120,982Supplies, inventories and other current assets
    
    
    22,313
    
    
    
    23,173Income taxes receivable
    
    
    1,464
    
    
    
    557Deferred state income taxes
    
    
    5,102
    
    
    
    4,660Due from shareholder and affiliates (Note 9):Federal income taxes receivable
    
    
    6,583
    
    
    
    10,450Deferred federal income taxes
    
    
    17,304
    
    
    
    15,787Total current assets
    
    
    198,890
    
    
    
    194,678Property and equipment, net
    
    
    767,084
    
    
    
    750,075Goodwill and other intangible assets, net
    
    
    87,051
    
    
    
    85,476Other assets
    
    
    29,802
    
    
    
    28,563Total Assets
    
    $
    1,082,827
    
    
    $
    1,058,792LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Outstanding checks in excess of bank balance
    
    $
    
    
    
    $
    13,453Current maturities of long-term debt and capital lease
obligations
    
    
    4,196
    
    
    
    4,142Accounts payable
    
    
    27,135
    
    
    
    29,169Accrued liabilities
    
    
    122,859
    
    
    
    117,448Current portion of accrual for self-insured liabilities
    
    
    12,500
    
    
    
    12,500Current portion of amounts due to shareholder and affiliates
    
    
    2,978
    
    
    
    2,975Total current liabilities
    
    
    169,668
    
    
    
    179,687Accrual for self-insured liabilities
    
    
    20,806
    
    
    
    21,691Long-term debt and capital lease obligations (Note 7)
    
    
    536,181
    
    
    
    515,084Deferred state income taxes
    
    
    733
    
    
    
    479Other long-term liabilities
    
    
    33,841
    
    
    
    32,652Due to shareholder and affiliates (Note 9):Deferred federal income taxes
    
    
    12,965
    
    
    
    9,815Other
    
    
    5,044
    
    
    
    5,940Total Liabilities
    
    
    779,238
    
    
    
    765,348Shareholders Equity:Common stock, $1 par value, 1,000 shares
authorized, 947 shares issued and outstanding
    
    
    1
    
    
    
    1Additional paid-in capital
    
    
    209,887
    
    
    
    209,771Retained earnings
    
    
    93,701
    
    
    
    83,672Total Shareholders Equity
    
    
    303,589
    
    
    
    293,444Total Liabilities and Shareholders Equity
    
    $
    1,082,827
    
    
    $
    1,058,792
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EXTENDICARE HEALTH SERVICES, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(In thousands)
 Three Months Ended March 31,2006
    
    
    2005OPERATING ACTIVITIES:Net income
    
    $
    10,029
    
    
    $
    12,054Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    11,973
    
    
    
    10,340Amortization of deferred financing costs
    
    
    513
    
    
    
    470Amortization of purchase accounting adjustments for leases and debt
    
    
    (131
    )
    
    
    (83
    )Amortization of purchase accounting adjustments for below market
resident leases
    
    
    (475
    )
    
    
    Accretion of retirement obligations
    
    
    219
    
    
    
    Provision for self-insured liabilities
    
    
    2,351
    
    
    
    1,995Payment of self-insured liability claims
    
    
    (3,237
    )
    
    
    (4,902
    )Deferred income taxes
    
    
    1,445
    
    
    
    2,518Valuation adjustment on interest rate caps
    
    
    (89
    )
    
    
    1,298(Gain) loss on disposal of assets and impairment of long-lived assets
    
    
    716
    
    
    
    (448
    )Loss on refinancing and retirement of debt
    
    
    
    
    
    
    275Changes in assets and liabilities:Accounts receivable attributable to Indiana and Pennsylvania provider tax
    
    
    (456
    )
    
    
    (18,971
    )Accounts receivable
    
    
    (6,815
    )
    
    
    (8,753
    )Supplies, inventories and other current assets
    
    
    935
    
    
    
    444Accounts payable
    
    
    (2,036
    )
    
    
    (4,392
    )Accrued liabilities attributable to Indiana and Pennsylvania provider tax
    
    
    30
    
    
    
    15,541Accrued liabilities
    
    
    5,166
    
    
    
    4,327Income taxes payable/receivable
    
    
    (895
    )
    
    
    (314
    )Current due to shareholder and affiliates
    
    
    3,049
    
    
    
    11,744Cash provided by operating activities
    
    
    22,292
    
    
    
    23,143INVESTING ACTIVITIES:Payment for acquisition of Assisted Living Concepts, Inc (ALC)
    
    
    
    
    
    
    (144,199
    )Cash balances in ALC as of acquisition
    
    
    
    
    
    
    6,547Payments for other acquisitions
    
    
    (24,723
    )
    
    
    Payments for new construction projects
    
    
    (2,375
    )
    
    
    (5,699
    )Payments for purchase of property and equipment
    
    
    (6,583
    )
    
    
    (6,340
    )Proceeds from sale of investments
    
    
    3,054
    
    
    
    Proceeds from sale of assets held for sale
    
    
    1,232
    
    
    
    Proceeds from sale of property and equipment
    
    
    
    
    
    
    1,878Changes in other non-current assets
    
    
    (248
    )
    
    
    (243
    )Cash used in investing activities
    
    
    (29,643
    )
    
    
    (148,056
    )FINANCING ACTIVITIES:Proceeds from Revolving Credit Facility to finance ALC acquisition
    
    
    
    
    
    
    60,000Proceeds from 6% EHI Term Note to finance ALC acquisition
    
    
    
    
    
    
    55,000Payments of long-term debt
    
    
    (817
    )
    
    
    (19,280
    )Payments on line of credit
    
    
    (7,000
    )
    
    
    (12,000
    )Proceeds from issuance of long-term debt
    
    
    29,000
    
    
    
    10,000Payment of deferred financing costs
    
    
    
    
    
    
    (125
    )Outstanding checks in excess of bank balance
    
    
    (13,453
    )
    
    
    10,091Other long-term liabilities
    
    
    1,396
    
    
    
    867Cash provided by financing activities
    
    
    9,126
    
    
    
    104,553Increase (decrease) in cash and cash equivalents
    
    
    1,775
    
    
    
    (20,360
    )Cash and cash equivalents, beginning of period
    
    
    13,347
    
    
    
    29,612Cash and cash equivalents, end of period
    
    $
    15,122
    
    
    $
    9,252
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EXTENDICARE HEALTH SERVICES, INC.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(In thousands)
 Three Months Ended March 31,2006
    
    
    2006Supplemental schedule of cash flow information:Cash paid during the period for:Interest
    
    $
    11,329
    
    
    $
    7,554Income tax payments, net of refunds
    
    
    1,352
    
    
    
    889Supplemental schedule of noncash investing and financing activities:The Company acquired all of the capital stock of Assisted Living
Concepts, Inc. for $144,199. In connection with the acquisition,
liabilities were assumed as follows:Fair value of assets acquired
    
    $
    
    
    
    $
    310,136Cash paid
    
    
    
    
    
    
    (144,199
    )Liabilities assumed
    
    $
    
    
    
    $
    165,937Capital lease obligations incurred to purchase properties
    
    $
    
    
    
    $
    12,822
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EXTENDICARE HEALTH SERVICES, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Summary of Significant Accounting Policies
  Basis of Presentation
     2. New Accounting Policies
 Asset Retirement Obligations
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(In thousands)Cumulative effect of accounting change, net of
income taxes
    
    $
    6,414Property and equipment, net
    
    
    1,671Deferred state income taxes
    
    
    535Due to shareholder and affiliates:Deferred federal income taxes
    
    
    3,741Total asset retirement obligation
    
    $
    12,361
   Three Months EndedMarch
31, 2005(in thousands)Net income, as reported
    
    $
    12,054Effect of adoption of FIN No. 47 on prior year:Income before income taxes
    
    
    (229
    )Income tax expense (benefit)
    
    
    (92
    )Net income
    
    
    (137
    )Adjusted net income after effect of adoption
of FIN No. 47
    
    $
    11,917
 3. Extendicares Strategic Initiative
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4. Acquisition of Assisted Living Concepts, Inc.
    Three Months EndedMarch 31, 2005( in thousands)Total revenues
    
    $
    309,024Income before income taxes
    
    
    19,037Net income
    
    
    11,533
 5. Other Acquisitions and New Construction
 a) Acquisition in Pennsylvania
  (in thousands)Cash used to finance the acquisition
    
    $
    (24,723
    )Other current assets
    
    
    99Total current assets
    
    
    (24,624
    )Property, plant and equipment
    
    
    22,685Resident relationships intangible
    
    
    149Goodwill
    
    
    2,221Total assets
    
    $
    431Current liabilities
    
    $
    431
  b) New Construction
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6. Approval of Pennsylvania State Plan and Amendment Relating to Medicaid Revenues
  7. Line of Credit and Long-term Debt
 Summary of Long-term Debt
  Interest
    
    
    March 31,
    
    
    December 31,Rate (1)
    
    
    2006
    
    
    2005(in thousands)9.50% Senior Notes due 2010
    
    
    9.54
    %
    
    $
    149,767
    
    
    $
    149,7566.875% Senior Subordinated Notes due 2014
    
    
    7.23
    %
    
    
    122,316
    
    
    
    122,255Term Loan due 2010, at variable interest rates
    
    
    6.31
    %
    
    
    85,355
    
    
    
    85,5706.00% EHI Term Note due 2010
    
    
    6.00
    %
    
    
    55,000
    
    
    
    55,0006.00% EI Term Note due 2010
    
    
    6.00
    %
    
    
    8,900
    
    
    
    8,900Other mortgage notes payable, interest rates ranging
from 0% to 8.0%, maturing through 2008
    
    
    6.66
    %
    
    
    3,750
    
    
    
    3,8366.25% Industrial Development Revenue Bond, maturing 2008
    
    
    6.25
    %
    
    
    735
    
    
    
    735Credit Facility Revolver
    
    
    6.64
    %
    
    
    22,000
    
    
    
    ALC Debt:6.24% Red Mortgage Capital Note due 2014
    
    
    6.51
    %
    
    
    36,367
    
    
    
    36,533DMG Mortgage notes payable, interest rates ranging from
5.98% to 6.06%, due 2008
    
    
    6.01
    %
    
    
    26,981
    
    
    
    27,263Capital lease obligations, interest rates ranging from
2.84% to 13.54%, maturing through 2009
    
    
    6.36
    %
    
    
    12,126
    
    
    
    12,222Oregon Trust Deed Notes, interest rates ranging from
6.63% to 6.77%, maturing from 2020 through 2026
    
    
    6.75
    %
    
    
    9,425
    
    
    
    9,483HUD Insured Mortgages, interest rates ranging from
7.40% to 7.55%, due 2036
    
    
    6.89
    %
    
    
    7,655
    
    
    
    7,673Long-term debt before current maturities
    
    
    
    
    
    
    540,377
    
    
    
    519,226Less current maturities
    
    
    
    
    
    
    4,196
    
    
    
    4,142Total long-term debt
    
    
    
    
    
    $
    536,181
    
    
    $
    515,084
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2010 Senior Notes
      Year
    
    Redemption Price2006
    
    
    104.750
    %2007
    
    
    102.375
    %2008 and thereafter
    
    
    100.000
    %
 2014 Notes
 .
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Year
    
    Redemption Price2009
    
    
    103.438
    %2010
    
    
    102.292
    %2011
    
    
    101.146
    %2012 and thereafter
    
    
    100.000
    %
 Amended and Restated Credit Facility
   
    
    the credit extended to the Company under the Amended and Restated Credit Facility
includes a Term Loan for $86.0 million. The principal balance of the Term Loan is payable
in equal quarterly installments of $215,000 over the first four years of the Amended and
Restated Credit Facility, equal quarterly installments of $20.6 million over the first three
quarters of the last year of the Amended and Restated Credit Facility, and a final principal
installment of $20.6 million due on the maturity date.
    
    the revolving credit limit under the Amended and Restated Credit Facility reflects a
reduction by $41.0 million from the $155.0 million limit under the former Revolving Credit
Facility to $114.0 million under the Amended and Restated Credit Facility. The Company may
request an increase in the credit extended or available under the Amended and Restated
Credit Facility by up to $15.0 million, but such request must be approved by one or more
participating lenders. The increase may be in the form of additional term loans or in the
form of an increase in the revolving credit limit.
    
    the maturity date of the Amended and Restated Credit Facility is July 31, 2010,
reflecting an extension of more than one year from the maturity date of the former Revolving
Credit Facility.
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
    
    the interest rate margins over the Eurodollar rate or the base rate, as applicable,
have been reduced and fixed at 1.75% per annum for Eurodollar rate loans and 0.75% per annum
for base rate loans. Under the former Revolving Credit Facility the interest rate margin
ranged from 2.50% per annum to 3.25% per annum for Eurodollar rate loans and from 1.50% per
annum to 2.25% per annum for base rate loans, subject, in each case, to adjustments based on
the Companys senior leverage ratio.
    
    the Amended and Restated Credit Facility includes a $10.0 million swing line
commitment within the $114 million revolving credit limit.
    
    the financial covenants under the Amended and Restated Credit Facility include ALCs
debt and earnings, whereas the financial covenants under the former Revolving Credit
Facility did not. The financial covenants are otherwise substantially the same as under the
former Revolving Credit Facility.
    
    the Amended and Restated Credit Facility includes procedures for ALC and its
subsidiaries to be designated as restricted subsidiaries and guarantors of the Amended and
Restated Credit Facility over time. As this occurs, these subsidiaries will become subject
to the covenants of the Amended and Restated Credit Facility that apply to the Companys
restricted subsidiaries. Also, the Company is permitted to make investments in these
subsidiaries to the same extent that it is permitted to make investments in its other
restricted subsidiaries that have guaranteed the Amended and Restated Credit Facility.
    
    the Amended and Restated Credit Facility increases the Companys ability to make
investments in unrestricted subsidiaries (the unrestricted subsidiaries being ALC and its
subsidiaries unless and until they have been designated as restricted subsidiaries) such
that the Company and its restricted subsidiaries may have investments in unrestricted
subsidiaries outstanding from time to time up to the sum of the amount of investments in
unrestricted subsidiaries at June 30, 2005 plus $40 million.
    
    the Amended and Restated Credit Facility required that ALCs debt in connection with
the $22.0 million of Revenue Bonds secured by ALC facilities located in the States of
Washington, Idaho and Ohio be repaid in full within 180 days after the closing of the
Amended and Restated Credit Facility. The Revenue Bonds were prepaid in December 2005, and
as a result, ALC became a restricted subsidiary under the Amended and Restated Credit
Facility.
    
    the Amended and Restated Credit Facility increases the Companys ability to make
restricted payments to permit annual dividends up to the lesser of (i) 50% of net income, or
(ii) $25 million plus the unused restricted payment amount for the previous fiscal year, or
(iii) $50 million.
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Loss on Refinancing and Retirement of Debt
  Three Months Ended March 312006
    
    
    2005( in thousands)Loss on early retirement of Mortgage Note
    
    $
    
    
    
    $
    140Loss on early retirement of Industrial Development Revenue Bond
    
    
    
    
    
    
    135$
    
    
    
    $
    275
 Interest expense, net
  Three MonthsEnded March 312006
    
    
    2005(in thousands)Interest expense
    
    $
    11,170
    
    
    $
    8,557Interest income
    
    
    (471
    )
    
    
    (373
    )$
    10,699
    
    
    $
    8,184
 8. Derivative Instruments and Hedging Activities  Objectives and Strategies
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Interest Rate Swap and Cap Agreements
    Risk Management Policies
  Quantitative Disclosures
   15




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Valuation Adjustment on Interest Rate Caps
  9. Due to Shareholder and Affiliate
  Affiliate
    
    Purpose
    
    March 31, 2006
    
    
    December 31, 2005(in thousands)Receivable (payable)Current assets:Extendicare Holdings, Inc.
    
    Federal income taxes receivable
    
    $
    6,583
    
    
    $
    10,450Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    17,304
    
    
    
    15,78723,887
    
    
    
    26,237Current liabilities:Virtual Care Provider, Inc.
    
    Working capital advances
    
    
    (3,000
    )
    
    
    (3,000
    )The Northern Group, Inc.
    
    Intercompany operating expenses
    
    
    15
    
    
    
    16Laurier Indemnity Company, Ltd.
    
    Intercompany insurance premium
    
    
    4
    
    
    
    6Extendicare Holdings, Inc.
    
    Working capital advances
    
    
    3
    
    
    
    3(2,978
    )
    
    
    (2,975
    )Long-term liabilities:Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    (12,965
    )
    
    
    (9,815
    )Other:Extendicare Inc.
    
    Advances
    
    
    (185
    )
    
    
    281Extendicare Holdings, Inc.
    
    Advances
    
    
    (3,483
    )
    
    
    (3,483
    )Virtual Care Provider, Inc.
    
    Advances
    
    
    (1,376
    )
    
    
    (2,738
    )(5,044
    )
    
    
    (5,940
    )$
    2,900
    
    
    $
    7,507
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10. Loss (Gain) on Disposal of Assets and Impairment of Long-lived Assets
  Three Months Ended March 312006
    
    
    2005( in thousands)Gain on sale of Omnicare common stock
    
    $
    (276
    )
    
    $
    Unrealized loss on Omnicare common stock
    
    
    195
    
    
    
    Gain on sale of Maryland property
    
    
    
    
    
    
    (448
    )$
    (81
    )
    
    $
    (448
    )
  11. Discontinued Operations
  Three Months Ended March 312006
    
    
    2005( in thousands)Revenues
    
    $
    2,439
    
    
    $
    5,890Costs and expenses (income):Operating
    
    
    3,757
    
    
    
    6,840Lease costs
    
    
    104
    
    
    
    99Depreciation and amortization
    
    
    50
    
    
    
    437Interest income
    
    
    
    
    
    
    (40
    )Gain on disposal of assets
    
    
    (934
    )
    
    
    Loss on impairment of long-lived assets
    
    
    1,731
    
    
    
    4,708
    
    
    
    7,336Loss) from discontinued operations
before income taxes
    
    
    (2,269
    )
    
    
    (1,446
    )Income tax benefit
    
    
    (935
    )
    
    
    (574
    )Net loss from discontinued operations
    
    $
    (1,334
    )
    
    $
    (872
    )
  (a) Closure and Disposition of Assisted Living Facility in Texas
  17




---



##### Table of Contents



(b) Closure of Assisted Living Facility in Washington
  (c) Lakeside Nursing Facility, Wisconsin
  (d) Closure and Disposition of Three Nursing Facilities in Minnesota
  (e) Sale of Florida Properties
  12. Other Commitments and Contingencies
 Capital Expenditures
   18




---



##### Table of Contents



Insurance and Self-insured Liabilities
  Litigation
   13. Uncertainties and Certain Significant Risks
 Interests in Unrelated Long-Term Care Providers
  Accrual for Self-Insured General and Professional Liabilities
  19




---



##### Table of Contents



Claims and Contingencies
   14. Comprehensive Income
  Three Months Ended March 31,2006
    
    
    2006( in thousands)NET INCOME
    
    $
    10,029
    
    
    $
    12,054OTHER COMPREHENSIVE INCOME (LOSS):Unrealized gain (loss) on investments, before tax
    
    
    
    
    
    
    (32
    )Other comprehensive income (loss), before tax
    
    
    
    
    
    
    (32
    )Income tax benefit (provision) related to items
of other comprehensive income
    
    
    
    
    
    
    13Other comprehensive income (loss), net of tax
    
    
    
    
    
    
    (19
    )COMPREHENSIVE INCOME
    
    $
    10,029
    
    
    $
    12,035
 15. Subsequent Event
  20




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Forward-Looking Statements
  
    
    Medicare and Medicaid payment levels and reimbursement methodologies and the application
of such methodologies and policies adopted by the government and its fiscal intermediaries;
    
    liabilities and claims asserted against us, such as resident care litigation, including
our exposure for punitive damage claims and increased insurance costs;
    
    national and local economic conditions, including their effect on the ability to hire and
retain qualified staff and employees and the associated costs;
    
    federal and state regulation of our business and change in such regulations, as well as
our compliance with such regulations;
    
    actions by our competitors; and
    
    our ability to maintain and increase census levels.
  21




---



##### Table of Contents



Executive Overview
   
    
    provide quality, clinically based services;
    
    strengthen Medicare census in our nursing facilities, private census in our assisted
living facilities and total average daily census, or ADC, in both our nursing and assisted
living facilities;
    
    expand non-government based revenue sources, thereby decreasing the risk and reliance on
government funding;
    
    expand, and actively manage, our asset portfolio through acquisition or internal growth,
and where appropriate, divesting facilities that fail to meet our performance goals;
    
    diversify within the long-term care industry through growth of facilities under full
management and selected consulting services agreements and rehabilitation clinics;
    
    increase our operating efficiency; and
    
    increase operating cash flow.
     22




---



##### Table of Contents



Revenues
  Nursing and Assisted Living Facilities.
 Percentage of Total Nursing andAssisted Living RevenuesFor Three Months Ended March 312006
    
    2005Medicare
    
    
    28.9
    %
    
    
    30.7
    %Private and other
    
    
    28.0
    %
    
    
    24.7
    %Quality mix
    
    
    56.9
    %
    
    
    55.4
    %Medicaid
    
    
    43.1
    %
    
    
    44.6
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
  23




---



##### Table of Contents



Nursing Facilities.
 Percentage of Total Nursing RevenuesFor Three Months Ended March 312006
    
    2005Medicare
    
    
    35.8
    %
    
    
    35.9
    %Private and other
    
    
    16.1
    %
    
    
    15.6
    %Quality Mix
    
    
    51.9
    %
    
    
    51.5
    %Medicaid
    
    
    48.1
    %
    
    
    48.5
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
  Assisted Living Facilities.
 Percentage of TotalAssisted Living RevenuesFor Three Months Ended March 312006
    
    2005Private and other (Quality Mix)
    
    
    78.7
    %
    
    
    78.7
    %Medicaid
    
    
    21.3
    %
    
    
    21.3
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
  Other Revenues.
 Legislative Actions Affecting Revenues
 Legislative Actions Affecting Medicare Revenues
  24




---



##### Table of Contents



Medicaid Rates and State Plan Amendments that affected Medicaid Revenues
    25




---



##### Table of Contents



Three Months Ended March 312006
    
    
    2005Prior year revenue adjustments:Pennsylvania Medicaid state plan amendment
    
    $
    
    
    
    $
    15,800Pennsylvania IGT and other Medicaid adjustments
    
    
    250
    
    
    
    946Other states Medicaid
    
    
    1,018
    
    
    
    2071,268
    
    
    
    16,953Prior year provider tax expense associated with
Pennsylvania state plan amendment above
    
    
    
    
    
    
    13,333Net impact on income from continuing operations
before income taxes
    
    $
    1,268
    
    
    $
    3,620
 Regulatory Environment Affecting Operations
   Significant Events and Developments
 Events of 2006
 Extendicares Strategic Initiative.
 26




---



##### Table of Contents



Increase in Medicare Part A rate.
 Total and Medicare Census in Our Skilled Nursing Facilities.
 Total and Private Census in Our Assisted Living Facilities.
 Impact of Below Inflationary Medicaid Rate Increases and Prior Year Revenue Adjustments.
 Acquisitions.
 New Construction.
 Lease Extensions.
 27




---



##### Table of Contents



Discontinued Operations.
  Event subsequent to March 31, 2006
  Events prior to 2006
 Acquisition of ALC.
  Amended and Restated Credit Facility.
 28




---



##### Table of Contents



Acquisitions and New Developments.
  Medicaid State Plan Amendments and Waivers.
 Dispositions and Discontinued Operations.
 Non-monetary Exchange of Omnicare Warrant to Omnicare Shares and Cash.
 Impairment Provision against Senior Health -Texas Advances.
 Other Disposal of Assets and Impairments of Long-lived Assets.
 29




---



##### Table of Contents



Loan Repayments.
 Adoption of FIN No. 47.
   (In thousands)Cumulative effect of accounting change, net of
income taxes
    
    $
    6,414Property and equipment
    
    
    1,671Deferred state income taxes
    
    
    535Due to shareholder and affiliates:Deferred federal income taxes
    
    
    3,741Total asset retirement obligation
    
    $
    12,361
 Key Performance Indicators
  Census
  30




---



##### Table of Contents



Average Daily Census
  Occupancy Percentage
  Quality Mix
  Average Revenue Rate by Payor Source
  EBITDA and EBITDA Percentage
  31




---



##### Table of Contents



Review of Key Performance Indicators
  Nursing Facilities  ADC and Quality Mix
  All Nursing Facilities  Continuing Operations
 Three MonthsEnded March 312006
    
    
    2005Medicare
    
    
    2,421
    
    
    
    2,433Private and other
    
    
    1,980
    
    
    
    2,000Quality Mix
    
    
    4,401
    
    
    
    4,433Medicaid
    
    
    8,585
    
    
    
    8,390Total
    
    
    12,986
    
    
    
    12,823
  Nursing Facilities  Same-Facility
 Three Months Ended March 312006
    
    
    2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Medicare
    
    
    2,345
    
    
    
    18.6
    %
    
    
    2,433
    
    
    
    19.0
    %
    
    
    (3.6
    %)Private and other
    
    
    1,916
    
    
    
    15.2
    %
    
    
    2,000
    
    
    
    15.6
    %
    
    
    (4.3
    %)Quality Mix
    
    
    4,261
    
    
    
    33.8
    %
    
    
    4,433
    
    
    
    34.6
    %
    
    
    (3.9
    %)Medicaid
    
    
    8,360
    
    
    
    66.2
    %
    
    
    8,390
    
    
    
    65.4
    %
    
    
    (0.4
    %)Total
    
    
    12,621
    
    
    
    100.0
    %
    
    
    12,823
    
    
    
    100.0
    %
    
    
    (1.6
    %)
  32




---



##### Table of Contents



Same-Facility Nursing ADCFirst
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter2005
    
    2005
    
    2005
    
    2005Medicare ADC
    
    
    2,433
    
    
    
    2,443
    
    
    
    2,233
    
    
    
    2,216Total ADC
    
    
    12,823
    
    
    
    12,684
    
    
    
    12,662
    
    
    
    12,661
 Assisted Living Facilities  ADC and Quality Mix
  All
Assisted Living Facilities  Continuing Operations
 Three MonthsEnded March 312006
    
    
    2005Private and other
    
    
    5,066
    
    
    
    3,863Medicaid
    
    
    2,100
    
    
    
    1,435Total
    
    
    7,166
    
    
    
    5,298
   All Assisted Living Facilities  Same-Facility (excludes ALC acquisition)
 Three Months Ended March 312006
    
    
    2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Private and other
    
    
    1,070
    
    
    
    85.9
    %
    
    
    1,079
    
    
    
    89.1
    %
    
    
    (0.8
    %)Medicaid
    
    
    175
    
    
    
    14.1
    %
    
    
    132
    
    
    
    10.9
    %
    
    
    32.6
    %Total
    
    
    1,245
    
    
    
    100.0
    %
    
    
    1,211
    
    
    
    100.0
    %
    
    
    2.8
    %
  All Assisted Living Facilities  Same-Facility (including ALC acquisition)
 Three Months Ended
    
    
    Three Months EndedMarch 31, 2006
    
    
    December 31, 2005
    
    
    % Change% of
    
    
    
    
    
    
    % of
    
    
    2006 toADC
    
    
    Total
    
    
    ADC
    
    
    Total
    
    
    2005Private and other
    
    
    5,018
    
    
    
    70.5
    %
    
    
    5,100
    
    
    
    70.4
    %
    
    
    (1.6
    %)Medicaid
    
    
    2,099
    
    
    
    29.5
    %
    
    
    2,148
    
    
    
    29.6
    %
    
    
    (2.3
    %)Total
    
    
    7,117
    
    
    
    100.0
    %
    
    
    7,248
    
    
    
    100.0
    %
    
    
    (1.8
    %)
  33




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##### Table of Contents



Assisted Living ADCFirst
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter2005
    
    2005
    
    2005
    
    2005EHSI Assisted Living Facilities (same facility):Private and other ADC
    
    
    1,079
    
    
    
    1,112
    
    
    
    1,123
    
    
    
    1,105Total ADC
    
    
    1,211
    
    
    
    1,239
    
    
    
    1,256
    
    
    
    1,250ALC Assisted Living Facilities (same facility):Private and other ADC
    
    
    2,770
    
    
    
    4,108
    
    
    
    4,049
    
    
    
    3,995Total ADC
    
    
    4,048
    
    
    
    6,112
    
    
    
    6,089
    
    
    
    5,998Total Assisted Living Facilities (same facility)Private and other ADC
    
    
    3,849
    
    
    
    5,220
    
    
    
    5,172
    
    
    
    5,100Total ADC
    
    
    5,259
    
    
    
    7,351
    
    
    
    7,345
    
    
    
    7,248
 All Nursing and Assisted Living Facilities  Occupancy and Number of Facilities Under Operation
  All Facilities:
  Occupancy
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    ADC
    
    Capacity2006
    
    2005
    
    2006
    
    2005
    
    2006
    
    2005Nursing
    
    
    92.4
    %
    
    
    93.5
    %
    
    
    12,986
    
    
    
    12,823
    
    
    
    14,058
    
    
    
    13,715Assisted Living:Mature facilities
    
    
    82.2
    %
    
    
    83.5
    %
    
    
    1,026
    
    
    
    1,066
    
    
    
    1,248
    
    
    
    1,276Developmental facilities
    
    
    60.4
    %
    
    
    92.5
    %
    
    
    268
    
    
    
    185
    
    
    
    444
    
    
    
    200ALC acquisition (all mature)
    
    
    85.9
    %
    
    
    90.1
    %
    
    
    5,872
    
    
    
    4,047
    
    
    
    6,837
    
    
    
    4,491Total Assisted Living
    
    
    84.0
    %
    
    
    88.8
    %
    
    
    7,166
    
    
    
    5,298
    
    
    
    8,529
    
    
    
    5,967Nursing and Assisted Living
    
    
    89.2
    %
    
    
    92.1
    %
    
    
    20,152
    
    
    
    18,121
    
    
    
    22,587
    
    
    
    19,682
  34




---



##### Table of Contents



Same Facility Basis:
  Same Facility BasisOccupancy
    
    
    
    
    
    
    
    
    
    Operational ResidentPercentage
    
    ADC
    
    Capacity2005
    
    2005
    
    2005
    
    2005
    
    2005
    
    2005Nursing
    
    
    92.4
    %
    
    
    93.5
    %
    
    
    12,621
    
    
    
    12,823
    
    
    
    13,661
    
    
    
    13,715Assisted Living:Mature facilities
    
    
    84.1
    %
    
    
    83.8
    %
    
    
    1,024
    
    
    
    1,026
    
    
    
    1,218
    
    
    
    1,224Developmental facilities
    
    
    75.2
    %
    
    
    92.5
    %
    
    
    221
    
    
    
    185
    
    
    
    294
    
    
    
    200Total Assisted Living
    
    
    82.4
    %
    
    
    85.0
    %
    
    
    1,245
    
    
    
    1,211
    
    
    
    1,512
    
    
    
    1,424Nursing and Assisted Living
    
    
    91.4
    %
    
    
    92.7
    %
    
    
    13,866
    
    
    
    14,034
    
    
    
    15,173
    
    
    
    15,139
  Facilities Under Operation and Percent Ownership:
  As of
    
    As ofMarch 31,
    
    December 31,2006
    
    2005Number of facilities under operation:Nursing
    
    
    141
    
    
    
    139Assisted Living
    
    
    208
    
    
    
    211Total
    
    
    349
    
    
    
    350Number of facilities owned:Nursing
    
    
    132
    
    
    
    130Assisted Living
    
    
    153
    
    
    
    155Total
    
    
    285
    
    
    
    285Number of facilities under capital leases:Assisted Living
    
    
    5
    
    
    
    5Percent of facilities:Owned
    
    
    81.7
    %
    
    
    81.4
    %Under capital leases
    
    
    1.4
    %
    
    
    1.4
    %Under operating leases
    
    
    16.9
    %
    
    
    17.2
    %100.0
    %
    
    
    100.0
    %
  35




---



##### Table of Contents



Nursing Facilities  Average Revenue per Resident Day by Payor Source
  All Nursing Facilities  Continuing Operations
 Three MonthsEnded March 312006
    
    
    2005
    
    
    ChangeMedicare (Part A and Part B)
    
    $
    396.63
    
    
    $
    370.69
    
    
    
    7.0
    %Private and other
    
    $
    217.30
    
    
    $
    196.35
    
    
    
    10.7
    %Medicaid
    
    $
    150.52
    
    
    $
    145.04
    
    
    
    3.8
    %Total
    
    $
    206.57
    
    
    $
    195.86
    
    
    
    5.5
    %Medicare Part A only
    
    $
    367.06
    
    
    $
    340.12
    
    
    
    7.9
    %
   All Nursing Facilities  Continuing Operations
 Three MonthsEnded March 312006
    
    
    2005
    
    
    ChangeMedicaid per above
    
    $
    150.52
    
    
    $
    145.04
    
    
    
    3.8
    %State provider taxes
    
    $
    10.92
    
    
    $
    8.56
    
    
    
    27.6
    %Medicaid, net of state provider taxes
    
    $
    139.60
    
    
    $
    136.48
    
    
    
    2.3
    %
  36




---



##### Table of Contents



Assisted Living Facilities  Average Revenue per Resident Day by Payor Source
  All Assisted Living Facilities
 Three MonthsEnded March 312006
    
    
    2005
    
    
    ChangePrivate and other
    
    $
    98.02
    
    
    $
    85.69
    
    
    
    14.4
    %Medicaid
    
    $
    64.05
    
    
    $
    62.53
    
    
    
    2.4
    %Total
    
    $
    88.06
    
    
    $
    79.42
    
    
    
    10.9
    %
   EHSI Assisted Living Facilities
 Three MonthsEnded March 312006
    
    
    2005
    
    
    ChangePrivate and other
    
    $
    86.80
    
    
    $
    81.23
    
    
    
    6.9
    %Medicaid
    
    $
    59.59
    
    
    $
    53.42
    
    
    
    11.5
    %Total
    
    $
    82.71
    
    
    $
    77.46
    
    
    
    6.8
    %
 ALC Assisted Living Facilities
 Three MonthsEnded March 312006
    
    
    2005
    
    
    ChangePrivate and other
    
    $
    99.64
    
    
    $
    87.35
    
    
    
    14.1
    %Medicaid
    
    $
    64.29
    
    
    $
    63.50
    
    
    
    1.2
    %Total
    
    $
    88.12
    
    
    $
    79.82
    
    
    
    10.4
    %
 37




---



##### Table of Contents



EBITDA and EBITDA Percentage
  Three MonthsEnded March 312006
    
    
    2005(in thousands)Income from continuing operations
before income taxes
    
    $
    17,838
    
    
    $
    21,340Add (deduct):Depreciation and amortization
    
    
    11,923
    
    
    
    9,903Accretion of retirement obligations
    
    
    219
    
    
    
    Interest expense, net
    
    
    10,699
    
    
    
    8,184Valuation adjustment on interest rate caps
    
    
    (89
    )
    
    
    1,298Loss (gain) on disposal of assets and
impairment of long-lived assets
    
    
    (81
    )
    
    
    (448
    )Loss on refinancing and retirement of debt
    
    
    
    
    
    
    275EBITDA
    
    $
    40,509
    
    
    $
    40,552
  Three MonthsEnded March 312006
    
    2005(in thousands)EBITDA
    
    $
    40,509
    
    
    $
    40,552Total Revenues
    
    $
    307,333
    
    
    $
    288,257EBITDA as percentage of total revenues
    
    
    13.2
    %
    
    
    14.1
    %
  38




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##### Table of Contents





Results from Operations




Three MonthsEnded March 312006
    
    2005RevenuesNursing and assisted living facilities
    
    
    97.4
    %
    
    
    97.4
    %Outpatient therapy
    
    
    0.9
    
    
    
    1.0Other
    
    
    1.7
    
    
    
    1.6100.0
    
    
    
    100.0Operating and general and administrative costs
    
    
    85.0
    
    
    
    84.4Lease, depreciation and amortization
    
    
    5.7
    
    
    
    5.0Accretion of retirement obligations
    
    
    0.1
    
    
    
    Interest expense, net
    
    
    3.5
    
    
    
    2.8Valuation adjustment on interest rate caps
    
    
    (0.0
    )
    
    
    0.5Loss on disposal of assets, provision for closure and
exit costs and impairment of long-lived assets
    
    
    (0.1
    )
    
    
    (0.2
    )Loss on refinancing and retirement of debt
    
    
    
    
    
    
    0.1Income from continuing operations before income taxes
    
    
    5.8
    
    
    
    7.4Income tax expense
    
    
    2.1
    
    
    
    2.9Net income from continuing operations before income taxes
    
    
    3.7
    
    
    
    4.5Loss from discontinued operations before income taxes
    
    
    (0.7
    )
    
    
    (0.5
    )Income tax benefit on discontinued operations
    
    
    (0.3
    )
    
    
    (0.2
    )Net loss from discontinued operations
    
    
    (0.4
    )
    
    
    (0.3
    )Net income
    
    
    3.3
    %
    
    
    4.2
    %


2006 March Quarter Compared with 2005 March Quarter


Revenues
  39




---



##### Table of Contents



(in Millions) Medicare revenues due to the improvement in RUGs mix and other factors
    
    $
    3.5 average daily nursing Medicaid rates
    
    
    3.2 an increase in private and other nursing rates
    
    
    3.0 Medicare revenues due to increases in Medicare Part A rates effective October 1, 2005
    
    
    2.2 an increase in assisted living revenues
    
    
    0.8 nursing ancillary revenues
    
    
    0.4 Medicare census decreasing from 18.8% of total in the 2005 March quarter to 18.5% in
the 2006 March quarter
    
    
    (1.4
    ) total nursing census decreasing from 12,825 in the 2005 March quarter to 12,621 in
the 2006 March quarter
    
    
    (3.1
    )8.6Adjustments relating to prior years: Pennsylvania Medicaid revenues, relating to prior periods, recognized in the 2005 March
quarter attributable to the approval of the state plan amendments and waivers for the period
July 1, 2003 through December 31, 2004 (the related increase in state assessment expense of
$13.3 million is reflected in operating expenses below)
    
    
    (16.5
    ) Other prior year settlement adjustments in the 2006 March quarter as compared to the
2005 March quarter
    
    
    0.8Total decrease in revenues from same facility nursing and assisted living facilities
    
    $
    (7.1
    )
 Operating and General and Administrative Costs
  (in Millions) wages, benefits and contracted staffing, which included an average
wage rate increase of 4.2% in nursing home operations
    
    $
    6.7 state assessments and bed taxes
    
    
    1.6 bad debt expense
    
    
    0.9 fines and penalties
    
    
    0.8 utilities and telephone expense
    
    
    0.6 drugs
    
    
    0.5 professional fees
    
    
    0.5 other operating and administrative expenses
    
    
    1.012.6Adjustment relating to prior year: state assessment taxes in the 2005 March quarter in Indiana and
Pennsylvania for the period July 1, 2003 through December 31, 2004 due to
final approval of the state plan amendments and waivers
    
    
    (13.3
    )Total
decrease in same facility operating and general and administrative costs
    
    $
    (0.7
    )
 40




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##### Table of Contents



Lease Costs, Depreciation and Amortization
  Accretion of Retirement Obligation
  Interest Expense, Net
   Valuation Adjustment on Interest Rate Caps
  Gain on Disposal of Assets and Impairment of Long-Lived Assets
   41




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##### Table of Contents



Loss on Refinancing and Retirement of Debt
   Income Taxes
  Net Income from Continuing Operations
  Loss from Discontinued Operations
    Net Income
  Related Party Transactions
   42




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##### Table of Contents







March 31
    
    
    December 31Affiliate
    
    Purpose
    
    2006
    
    
    2005(in thousands)Receivable (payable)Current assets:Extendicare Holdings, Inc.
    
    Federal income taxes receivable
    
    $
    6,583
    
    
    $
    10,450Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    17,304
    
    
    
    15,78723,887
    
    
    
    26,237Current liabilities:Virtual Care Provider, Inc.
    
    Working capital advances
    
    
    (3,000
    )
    
    
    (3,000
    )The Northern Group, Inc.
    
    Intercompany operating expenses
    
    
    15
    
    
    
    16Laurier Indemnity Company,
Ltd.
    
    Intercompany insurance premium
    
    
    4
    
    
    
    6Extendicare Holdings, Inc.
    
    Working capital advances
    
    
    3
    
    
    
    3(2,978
    )
    
    
    (2,975
    )Long-term liabilities:Extendicare Holdings, Inc.
    
    Deferred federal income taxes
    
    
    (12,965
    )
    
    
    (9,815
    )Other:Extendicare Inc.
    
    Advances
    
    
    (185
    )
    
    
    281Extendicare Holdings, Inc.
    
    Advances
    
    
    (3,483
    )
    
    
    (3,483
    )Virtual Care Provider, Inc.
    
    Advances
    
    
    (1,376
    )
    
    
    (2,738
    )(5,044
    )
    
    
    (5,940
    )$
    2,900
    
    
    $
    7,507




Liquidity and Capital Resources


Sources and Uses of Cash
  Three Months EndedMarch 312006
    
    2005(in thousand)Cash provided by operating activities
    
    $
    22,292
    
    
    $
    23,143Cash used in investing activities
    
    
    (29,643
    )
    
    
    (148,056
    )Cash provided by financing activities
    
    
    9,126
    
    
    
    104,553Increase (decrease) in cash and cash equivalents
    
    
    1,775
    
    
    
    (20,360
    )
 43




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44




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##### Table of Contents



Summary of Long-term Debt
  Interest
    
    
    March 31,
    
    
    December 31,Rate (1)
    
    
    2006
    
    
    2005(in thousands)9.50% Senior Notes due 2010
    
    
    9.54
    %
    
    $
    149,767
    
    
    $
    149,7566.875% Senior Subordinated Notes due 2014
    
    
    7.23
    %
    
    
    122,316
    
    
    
    122,255Term Loan due 2010, at variable interest rates
    
    
    6.31
    %
    
    
    85,355
    
    
    
    85,5706.00% EHI Term Note due 2010
    
    
    6.00
    %
    
    
    55,000
    
    
    
    55,0006.00% EI Term Note due 2010
    
    
    6.00
    %
    
    
    8,900
    
    
    
    8,900Other mortgage notes payable, interest rates ranging
from 0% to 8.0%, maturing through 2008
    
    
    6.66
    %
    
    
    3,750
    
    
    
    3,8366.25% Industrial Development Revenue Bond, maturing 2008
    
    
    6.25
    %
    
    
    735
    
    
    
    735Credit Facility Revolver
    
    
    6.64
    %
    
    
    22,000
    
    
    
    ALC Debt:6.24% Red Mortgage Capital Note due 2014
    
    
    6.51
    %
    
    
    36,367
    
    
    
    36,533DMG Mortgage notes payable, interest rates ranging from
5.98% to 6.06%, due 2008
    
    
    6.01
    %
    
    
    26,981
    
    
    
    27,263Capital lease obligations, interest rates ranging from
2.84% to 13.54%, maturing through 2009
    
    
    6.36
    %
    
    
    12,126
    
    
    
    12,222Oregon Trust Deed Notes, interest rates ranging from
6.63% to 6.77%, maturing from 2020 through 2026
    
    
    6.75
    %
    
    
    9,425
    
    
    
    9,483HUD Insured Mortgages, interest rates ranging from
7.40% to 7.55%, due 2036
    
    
    6.89
    %
    
    
    7,655
    
    
    
    7,673Long-term debt before current maturities
    
    
    
    
    
    
    540,377
    
    
    
    519,226Less current maturities
    
    
    
    
    
    
    4,196
    
    
    
    4,142Total long-term debt
    
    
    
    
    
    $
    536,181
    
    
    $
    515,084
 
 (1)
    
    Interest rate is effective interest rate as of March 31, 2006. 45




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##### Table of Contents



9.50% Senior Notes due 2010
      Year
    
    Redemption Price2006
    
    
    104.750
    %2007
    
    
    102.375
    %2008 and thereafter
    
    
    100.000
    %
 46




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##### Table of Contents



6.875% Senior Subordinated Notes due 2014
 .
    Year
    
    Redemption Price2009
    
    
    103.438
    %2010
    
    
    102.292
    %2011
    
    
    101.146
    %2012 and thereafter
    
    
    100.000
    %
 Amended and Restated Credit Facility
  
    
    the credit extended to us under the Amended and Restated Credit Facility includes a
term loan for $86.0 million. The principal balance of the term loan is payable in equal
quarterly installments of $215,000 over the first four years of the Amended and Restated
Credit Facility, equal quarterly installments of $20.6 million over the first three quarters
of the last year of the Amended and Restated Credit Facility, and a final principal
installment of $20.6 million due on the maturity date.
    
    the revolving credit limit under the Amended and Restated Credit Facility reflects a
reduction by $41.0 million from the $155.0 million limit under the former Revolving Credit
Facility to $114.0 million under the Amended and Restated
 47




---



##### Table of Contents



Credit Facility. We may request
an increase in the credit extended or available under the Amended and Restated Credit
Facility by up to $15.0 million, but such increase must be approved by one or more
participating lenders. The increase may be in the form of additional term loans or in the
form of an increase in the revolving credit limit.
    
    the maturity date of the Amended and Restated Credit Facility is July 31, 2010,
reflecting an extension of more than one year from the maturity date of the former Revolving
Credit Facility.
    
    the interest rate margins over the Eurodollar rate or the base rate, as applicable,
have been reduced and fixed at 1.75% per annum for Eurodollar rate loans and 0.75% per annum
for base rate loans. Under the former Revolving Credit Facility the interest rate margin
ranged from 2.50% per annum to 3.25% per annum for Eurodollar rate loans and from 1.50% per
annum to 2.25% per annum for base rate loans, subject, in each case, to adjustments based on
our senior leverage ratio.
    
    the Amended and Restated Credit Facility includes a $10.0 million swing line
commitment within the $114 million revolving credit limit.
    
    the financial covenants under the Amended and Restated Credit Facility include ALCs
debt and earnings, whereas the financial covenants under the former Revolving Credit
Facility did not. The financial covenants are otherwise substantially the same as under the
former Revolving Credit Facility.
    
    the Amended and Restated Credit Facility includes procedures for ALC and its
subsidiaries to be designated as restricted subsidiaries and guarantors of the Amended and
Restated Credit Facility over time. As this occurs, these subsidiaries will become subject
to the covenants of the Amended and Restated Credit Facility that apply to our restricted
subsidiaries. Also, we are be permitted to make investments in these subsidiaries to the
same extent that we are permitted to make investments in our other restricted subsidiaries
that have guaranteed the Amended and Restated Credit Facility.
    
    the Amended and Restated Credit Facility increases the our ability to make
investments in unrestricted subsidiaries (the unrestricted subsidiaries being ALC and its
subsidiaries unless and until they have been designated as restricted subsidiaries) such
that we and our restricted subsidiaries may have investments in unrestricted subsidiaries
outstanding from time to time up to the sum of the amount of investments in unrestricted
subsidiaries at June 30, 2005 plus $40 million.
    
    the Amended and Restated Credit Facility required that ALCs debt in connection with
the $22.0 million of Revenue Bonds secured by ALC facilities located in the States of
Washington, Idaho and Ohio be repaid in full within 180 days after the closing of the
Amended and Restated Credit Facility. The Revenue Bonds were prepaid in full in December
2005, and as a result, ALC became a restricted subsidiary under the Amended and Restated
Credit Facility.
    
    the Amended and Restated Credit Facility increases our ability to make restricted
payments to permit annual dividends up to the lesser of (i) 50% of net income, or (ii) $25
million plus the unused restricted payment amount for the previous fiscal year, or (iii) $50
million.
  48




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##### Table of Contents



Credit Ratings
  S&P
    
    Moodys2010 Senior Notes
    
    B+
    
    
    B12014 Notes
    
    B
    
    
    B2Revolving Credit Facility and Term Loan
    
    BB
    
    Ba2
 Interest Rate Swap and Cap Agreements
   49




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##### Table of Contents



Letters of Credit
  Off Balance Sheet Arrangements
  Cash Management
  50




---



##### Table of Contents



Future Liquidity and Capital Resources
  Capital Commitments
  Accrual for Self-Insured Liabilities
  Revenue Bonds Commitments
    51




---



##### Table of Contents



Contractual Obligations
  Payments Due By YearAfterTotal
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2010(dollars in thousands)Long-term debt
    
    $
    540,377
    
    
    $
    3,222
    
    
    $
    7,111
    
    
    $
    27,682
    
    
    $
    53,800
    
    
    $
    278,237
    
    
    $
    170,325Operating lease commitments
    
    
    158,470
    
    
    
    15,697
    
    
    
    19,389
    
    
    
    19,488
    
    
    
    19,276
    
    
    
    19,380
    
    
    
    65,240New construction purchase
commitments
    
    
    7,300
    
    
    
    5,300
    
    
    
    2,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other capital expenditure
purchase commitments
    
    
    10,900
    
    
    
    10,900
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    717,047
    
    
    $
    35,119
    
    
    $
    28,500
    
    
    $
    47,170
    
    
    $
    73,076
    
    
    $
    297,617
    
    
    $
    235,565
    52




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##### Table of Contents







Critical Accounting Policies







Item 3. Quantitative and Qualitative Disclosures About Market Risk


Qualitative Disclosures
     53




---



##### Table of Contents





Quantitative Disclosures




EstimatedFair Value ofMaturity Date through December 31,
    
    
    Liability2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    Thereafter
    
    
    Total
    
    
    (Asset)(dollars in thousands)LONG-TERM DEBT:Fixed Rate
    
    $
    2,577
    
    
    $
    6,251
    
    
    $
    26,822
    
    
    $
    12,090
    
    
    $
    214,957
    
    
    $
    170,325
    
    
    $
    433,022
    
    
    $
    447,805Average Interest Rate
    
    
    6.18
    %
    
    
    6.73
    %
    
    
    6.07
    %
    
    
    6.38
    %
    
    
    8.47
    %
    
    
    7.06
    %
    
    
    7.66
    %Variable Rate
    
    $
    645
    
    
    $
    860
    
    
    $
    860
    
    
    $
    41,710
    
    
    $
    63,280
    
    
    
    
    
    
    $
    107,355
    
    
    $
    107,355Average Interest Rate
    
    
    6.31
    %
    
    
    6.31
    %
    
    
    6.31
    %
    
    
    6.31
    %
    
    
    6.42
    %
    
    
    
    
    
    
    6.38
    %INTEREST RATE SWAPS:(fixed to variable)
Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    275,000
    
    
    $
    275,000
    
    
    $
    9,744Average Pay Rate (variable rate).
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.59
    %
    
    
    8.59
    %Average Receive Rate (fixed rate)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.31
    %
    
    
    8.31
    %INTEREST RATE CAPS:Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    150,000
    
    
    $
    150,000
    
    
    $
    (310
    )Notional Amount
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    125,000
    
    
    $
    125,000
    
    
    $
    5,096







Item 4. Controls and Procedures


Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls Over Financial Reporting
  54




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##### Table of Contents



PART II
 OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 6. Exhibits
  55




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 SIGNATURES
   Date: May 12, 2006
    By:
    /s/ Richard L. BertrandRichard L. BertrandSenior Vice President, Chief Financial
Officer and Treasurer and Director
(Principal Accounting Officer) 56




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##### Table of Contents



EXTENDICARE HEALTH SERVICES, INC.
 
 EXHIBIT INDEX
 31.1
    
    Certifications of Chairman of the Board and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certifications of Senior Vice President, Chief Financial Officer and
Treasurer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32
    
    Written Statement of Chairman of the Board and Chief Executive
Officer and Senior Vice President, Chief Financial Officer and
Treasurer pursuant to 18 U.S.C. Section 1350.
 57