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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
 FORM 10-Q (Mark One)
 þ
    QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934For the quarterly period ended March 31, 2005oro

    TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934
 For the transition period from  to Commission File Number: 000-50351 GENESIS HEALTHCARE CORPORATION  Pennsylvania
    
    20-0023783(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 101 East State StreetKennett Square, Pennsylvania
    
    19348(Address of principal executive offices)
    
    (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. YES þ NO o Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule
12b-2 of the Act). YES þ NO o 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 þ (1) NO o  (1)
    In 2000, prior to the creation of the registrant, a substantial majority of the
registrants subsidiaries filed for relief under Chapter 11 of the Bankruptcy Code and emerged
from such proceedings in 2001. APPLICABLE ONLY TO CORPORATE ISSUERS. As of May 6, 2005: 19,820,859 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 PageCAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
    
    
    1PART I: FINANCIAL INFORMATIONITEM 1:
    
    Financial Statements
    
    
    3ITEM 2:
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    23ITEM 3:
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    39ITEM 4:
    
    Controls and Procedures
    
    
    40PART II: OTHER INFORMATIONITEM 1:
    
    Legal Proceedings
    
    
    41ITEM 2:
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    41ITEM 3:
    
    Defaults Upon Senior Securities
    
    
    41ITEM 4:
    
    Submission of Matters to a Vote of Security Holders
    
    
    42ITEM 5:
    
    Other Information
    
    
    42ITEM 6:
    
    Exhibits
    
    
    43SIGNATURES
    
    
    
    
    44Exhibit
IndexEx-4.1 IndentureEx-4.2 Supplemental IndentureEx-10.1 Amendment to 2003 Stock Incentive PlanEx-10.2 Purchase AgreementEx-10.3 Registration Rights AgreementEx-10.4 Amended and Restated Credit, Security, Guaranty and Pledge AgreementEx-31.1 CertificationEx-31.2 CertificationEx-32.1 CertificationEx-32.2 Certification




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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. All references to NCI in this report refer to NeighborCare, Inc. together with
its subsidiaries, formerly known as Genesis Health Ventures, Inc. 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 expenditure, asset sales, debt and lease
requirements; our potential extension of credit to our joint venture partners; the
expected changes in and effects of government legislation and regulation on our
business; estimates in our pro forma financial data and critical accounting policies,
including the adequacy of our allowance for doubtful accounts, any anticipated impact of
long-lived asset impairments and our ability to provide for outstanding losses and loss
expenses for our self-insured programs; the estimated impact of new accounting
pronouncements upon adoption; the estimated amount of net operating loss carryforwards
available to us;
    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, 2004:  
    changes in the reimbursement rates or methods of payment from Medicare and Medicaid, 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;
    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; 1




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
    our ability to control operating costs and generate sufficient cash flow to meet operational and financial
requirements;
    our ability, and the ability of our subsidiary guarantors, to fulfill debt obligations;
    our covenants and restrictions contained in financing agreements which limit our discretion in the operation
of our business;
    the economic condition of, or changes in, the laws affecting our business in those markets in which we
operate;
    the impact of acquisitions, and our ability to integrate acquired businesses, on our operations and finances;
    our ability to quantify and realize tax benefits relating to our estimated net operating loss carryforwards;
    our ability to ensure and maintain an effective system of internal control over financial reporting;
    the impact of implementing new information systems;
    our charter documents and the Pennsylvania Business Corporation Law of 1988, as amended, which could delay
or prevent a change of control;
    the difficulty in evaluating certain of our financial information due to the spin-off;
    the ability to engage successfully in acquisitions and other strategic transactions;
    federal income tax liabilities and indemnification obligations related to the spin-off;
    potential conflicts of interest as a result of continuing relationships with NCI;
    the ability of NCI, as our single largest supplier of pharmaceutical products and services, to act as a
stand-alone entity; 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 SEC 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. 2




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PART I: FINANCIAL INFORMATION 
 ITEM 1: Financial Statements GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2005 AND SEPTEMBER 30, 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) March 31, 2005
    
    
    September 30, 2004Assets:Current assets:Cash and equivalents
    
    $
    126,167
    
    
    $
    126,071Current portion of restricted investments
in marketable securities
    
    
    33,289
    
    
    
    29,887Accounts receivable, net of allowances for
doubtful accounts of $31,233 and $29,382, at March
31, 2005 and September 30, 2004, respectively
    
    
    228,081
    
    
    
    164,622Prepaid
expenses and other current assets
    
    
    32,116
    
    
    
    33,526Assets held for sale
    
    
    1,400
    
    
    
    6,267Total current assets
    
    
    421,053
    
    
    
    360,373Property and equipment, net
of accumulated depreciation
of $136,976 and $114,162, at March
31, 2005 and September 30, 2004,
respectively
    
    
    717,432
    
    
    
    695,511Assets held for sale
    
    
    2,511
    
    
    
    2,511Restricted investments in
marketable securities
    
    
    74,475
    
    
    
    65,121Other long-term assets
    
    
    113,952
    
    
    
    120,647Total assets
    
    $
    1,329,423
    
    
    $
    1,244,163Liabilities and Shareholders Equity:Current liabilities:Current installments of
long-term debt
    
    $
    4,121
    
    
    $
    27,230Accounts payable and
accrued expenses
    
    
    192,127
    
    
    
    150,661Current portion of
self-insurance liability
reserves
    
    
    33,289
    
    
    
    29,887Total current
liabilities
    
    
    229,537
    
    
    
    207,778Long-term debt
    
    
    419,741
    
    
    
    375,841Deferred income taxes
    
    
    1,084
    
    
    
    Self-insurance liability
reserves
    
    
    59,625
    
    
    
    62,920Other long-term liabilities
    
    
    32,891
    
    
    
    28,858Commitments and contingenciesShareholders equity:Common stock  par $0.01, 45,000,000 authorized at March 31, 2005
and September 30, 2004, 19,731,398 and
20,011,795
outstanding at March 31, 2005 and September 30, 2004,
respectively
    
    
    203
    
    
    
    200Additional paid in capital
    
    
    563,820
    
    
    
    547,841Retained earnings
    
    
    44,821
    
    
    
    20,504Accumulated other
comprehensive (loss)
income
    
    
    (1,505
    )
    
    
    221Treasury stock at cost,
520,000 shares at March
31, 2005
    
    
    (20,794
    )
    
    
    Total shareholders
equity
    
    
    586,545
    
    
    
    568,766Total liabilities
and shareholders
equity
    
    $
    1,329,423
    
    
    $
    1,244,163
 See accompanying notes to unaudited condensed consolidated financial statements. 3




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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Three months endedMarch 31, 2005
    
    
    March 31, 2004Net revenues
    
    $
    454,566
    
    
    $
    378,681Operating expenses:Salaries, wages and benefits
    
    
    254,579
    
    
    
    242,767Other operating expenses
    
    
    126,756
    
    
    
    81,709General and administrative costs
    
    
    21,863
    
    
    
    18,063Loss on early extinguishment of debt
    
    
    4,289
    
    
    
    655Lease expense
    
    
    6,610
    
    
    
    6,797Depreciation and amortization expense
    
    
    13,206
    
    
    
    11,464Interest expense
    
    
    6,261
    
    
    
    7,528Income before income tax expense, equity in net income of
unconsolidated affiliates and minority interests
    
    
    21,002
    
    
    
    9,698Income tax expense
    
    
    7,897
    
    
    
    3,929Income before equity in net income of unconsolidated
affiliates and minority interests
    
    
    13,105
    
    
    
    5,769Equity in net income of unconsolidated affiliates
    
    
    679
    
    
    
    466Minority interests
    
    
    (153
    )
    
    
    (84
    )Income from continuing operations
    
    
    13,631
    
    
    
    6,151Loss from discontinued operations, net of taxes
    
    
    (164
    )
    
    
    (577
    )Net income
    
    $
    13,467
    
    
    $
    5,574Per common share data:Basic:Income from continuing operations
    
    $
    0.68
    
    
    $
    0.31Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.03
    )Net income
    
    $
    0.67
    
    
    $
    0.28Weighted average shares
    
    
    19,985,375
    
    
    
    19,923,669Diluted:Income from continuing operations
    
    $
    0.66
    
    
    $
    0.31Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.03
    )Net income
    
    $
    0.65
    
    
    $
    0.28Weighted average shares
    
    
    20,688,735
    
    
    
    20,038,865
 See accompanying notes to unaudited condensed consolidated financial statements. 4




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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Six months endedMarch 31, 2005
    
    
    March 31, 2004Net revenues
    
    $
    853,593
    
    
    $
    744,991Operating expenses:Salaries, wages and benefits
    
    
    506,355
    
    
    
    475,178Other operating expenses
    
    
    211,740
    
    
    
    158,303General and administrative costs
    
    
    42,698
    
    
    
    38,799Loss on early extinguishment of debt
    
    
    4,832
    
    
    
    828Lease expense
    
    
    13,581
    
    
    
    14,117Depreciation and amortization expense
    
    
    24,525
    
    
    
    23,028Interest expense
    
    
    12,893
    
    
    
    13,349Income before income tax expense, equity in net income of
unconsolidated affiliates and minority interests
    
    
    36,969
    
    
    
    21,389Income tax expense
    
    
    14,379
    
    
    
    8,672Income before equity in net income of unconsolidated
affiliates and minority interests
    
    
    22,590
    
    
    
    12,717Equity in net income of unconsolidated affiliates
    
    
    1,790
    
    
    
    1,024Minority interests
    
    
    (424
    )
    
    
    (159
    )Income from continuing operations
    
    
    23,956
    
    
    
    13,582Income (loss) from discontinued operations, net of taxes
    
    
    359
    
    
    
    (2,002
    )Net income
    
    $
    24,315
    
    
    $
    11,580Per common share data and pro forma per common share data (note 5):Basic:Income from continuing operations
    
    $
    1.20
    
    
    $
    0.68Income (loss) from discontinued operations
    
    
    0.02
    
    
    
    (0.10
    )Net income
    
    $
    1.22
    
    
    $
    0.58Weighted average shares
    
    
    20,004,214
    
    
    
    19,910,887Diluted:Income from continuing operations
    
    $
    1.16
    
    
    $
    0.68Income (loss) from discontinued operations
    
    
    0.02
    
    
    
    (0.10
    )Net income
    
    $
    1.18
    
    
    $
    0.58Weighted average shares
    
    
    20,590,870
    
    
    
    19,993,839
 See accompanying notes to unaudited condensed consolidated financial statements. 5




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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED MARCH 31, 2005 AND 2004
(IN THOUSANDS) Six months endedMarch 31, 2005
    
    
    March 31, 2004Cash flows from operating activities:Net income
    
    $
    24,315
    
    
    $
    11,580Net charges included in operations not requiring funds
    
    
    49,236
    
    
    
    40,529Changes in assets and liabilities:Accounts receivable
    
    
    (59,183
    )
    
    
    (8,325
    )Accounts payable and accrued expenses
    
    
    40,438
    
    
    
    23,203Other, net
    
    
    4,090
    
    
    
    9,376Total adjustments
    
    
    34,581
    
    
    
    64,783Net cash provided by operating activities
    
    
    58,896
    
    
    
    76,363Cash flows from investing activities:Capital expenditures
    
    
    (23,094
    )
    
    
    (14,846
    )Net purchases of restricted marketable securities
    
    
    (14,192
    )
    
    
    (325
    )Purchase of eldercare centers and lease amendments
    
    
    (5,342
    )
    
    
    (48,773
    )Proceeds from sales of eldercare assets
    
    
    5,292
    
    
    
    7,806Other, net
    
    
    1,385
    
    
    
    311Net cash used in investing activities
    
    
    (35,951
    )
    
    
    (55,827
    )Cash flows from financing activities:Proceeds from issuance of long-term debt
    
    
    180,000
    
    
    
    410,000Repayment of long-term debt
    
    
    (176,312
    )
    
    
    (248,484
    )Debt issuance costs and debt prepayment premium
    
    
    (8,861
    )
    
    
    (9,337
    )Purchase of common stock for treasury
    
    
    (20,794
    )
    
    
    Proceeds from exercise of stock options
    
    
    3,118
    
    
    
    Net transactions with NCI, prior to the spin-off
    
    
    
    
    
    
    (55,548
    )Net cash (used in) provided by financing activities
    
    
    (22,849
    )
    
    
    96,631Net increase in cash and equivalents
    
    $
    96
    
    
    $
    117,167Cash and equivalents:Beginning of period
    
    
    126,071
    
    
    
    8,791End of period
    
    $
    126,167
    
    
    $

    125,958Supplemental disclosure of cash flow information:Interest paid
    
    $
    13,463
    
    
    $
    5,734Taxes paid
    
    
    4,597
    
    
    
    1,798Non-cash financing activities:Capital leases
    
    $
    1,570
    
    
    $
    Assumption
of debt
    
    
    15,533
    
    
    
    33,727
 See accompanying notes to unaudited condensed consolidated financial statements. 6




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Genesis HealthCare Corporation and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (1) Organization and Basis of Presentation Spin-off On December 1, 2003, NeighborCare, Inc. (NCI) completed the distribution (the spin-off) of the
common stock of Genesis HealthCare Corporation (GHC or the Company). The spin-off was effected by
way of a pro-rata tax free distribution of GHCs common stock to holders of NCIs common stock on
December 1, 2003 at a rate of 0.5 shares of GHC stock for each share of NCI stock owned as of
October 15, 2003. In connection with the spin-off, NCI and GHC have agreed contractually to continue certain
transitional arrangements and practices for a limited time after the spin-off. In addition, NCI
and GHC have entered into certain mutually beneficial commercial arrangements. Specifically, NCI
and GHC entered into a separation and distribution agreement, a tax sharing agreement, a transition
services agreement, a group purchasing agreement, an employee benefits agreement, a pharmacy
services agreement, as amended, a pharmacy benefit management agreement, as amended, and a durable
medical equipment agreement. The following pro forma financial information gives effect to the spin-off as if it
occurred on October 1, 2003. The pro forma data is for informational purposes only and
does not purport to represent the results of future periods. The pro forma data reflects
adjustments based upon available information and certain assumptions that management of GHC
considers reasonable. No changes in operating revenues and expenses have been made to reflect the
results of any modifications to operations that might have been made had the spin-off been
completed on the aforesaid effective date for purposes of the pro forma results. The
following pro forma information is presented in thousands, except per share information: Six months ended March 31, 2004As reported
    
    
    
Pro formaNet revenues
    
    $
    744,991
    
    
    $
    744,991Income from continuing operations
    
    
    13,582
    
    
    
    12,403Diluted earnings per share  from continuing operations
    
    
    0.68
    
    
    
    0.62
 Basis of Presentation The accompanying unaudited condensed consolidated financial statements through November 30,
2003 have been prepared on a basis which reflects the historical financial statements of GHC
assuming that the operations of NCI contributed in the spin-off were organized as a separate legal
entity, owning certain net assets of NCI. Beginning December 1, 2003, the accompanying unaudited
condensed consolidated financial statements have been prepared on a basis which reflects the net
operation of GHC as a stand-alone entity. Prior to the spin-off, substantially all of GHCs cash accounts were linked to NCIs
centralized cash management system. Accordingly, substantially all cash generated from or used in
GHCs operations had been transferred to and from NCI. For instance, NCI funded nearly all routine
and capital cash disbursements on behalf of GHC. Likewise, on a daily basis, GHC transferred its
cash receipts directly to the concentrated bank account of NCI. The net transactions with NCI as
reflected in the unaudited condensed consolidated statements of cash flows for the six months ended
March 31, 2004 represent these cash activities between NCI and GHC. Prior to the spin-off, the financing activities between NCI and GHC were in the form of equity capital advances
and there were no formal repayment or interest arrangements. The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America which
requires the use of managements estimates. In the opinion of management, the unaudited condensed
consolidated financial statements 7




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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. Correction of Errors During the six months ended March 31, 2005, the Company recorded an increase to accounts
payable and other operating expenses of $2.8 million to reflect an estimate of previously unaccrued
costs resulting from a weakness in the Companys purchasing cut-off procedures. The Company has
remediated the internal control weakness and believes that the correction is not material to any
previously reported financial statements and is not material to earnings trends. Also during the six months ended March 31, 2005, the Company recorded a $1.3 million increase
to depreciation expense and accumulated depreciation resulting from modifications to the useful
lives assigned to certain fixed assets. The cumulative error principally relates to the period
beginning after the Companys adoption of fresh start reporting, or October 1, 2001 through March
31, 2005. The error accumulated ratably over this period and, therefore, is not material to any
previously reported financial statements and is not material to earnings trends. Description of Business GHCs business is comprised of two primary business segments, inpatient services and
rehabilitation therapy services. These segments are supported by complementary service
capabilities and a general and administrative function. GHC provides inpatient services through skilled nursing and assisted living centers primarily
located in the eastern United States. At March 31, 2005, GHC had 214 owned, leased, managed and
jointly owned eldercare centers with 26,304 beds. Revenues of GHCs owned and leased centers
constitute approximately 89% of GHCs revenues, and are presented in GHCs segment information as
inpatient services revenues. Management fees earned from eldercare centers that are managed and/or
jointly owned by GHC are included in all other revenues presented in GHCs segment information.
See note 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
4,400 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. Other During
the six months ended March 31, 2005, GHC recognized a tax refund and
a tax credit of $0.7 million and $0.2 million, respectively, which
reduced the Companys effective tax rate of 39.8% to 37.5%. (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 services
and other service related businesses. 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. 8




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The proposed Federal Budget that was released in February 2005 contains provisions to cut
Medicare funding for skilled nursing facilities by more than $1.5 billion beginning October 1, 2005
by issuing regulations implementing refinements to the current resource utilization group
classification payment system. GHC refers to the anticipated refinement to the resource
utilization group classification system as RUGs refinement. Although GHC is unable to predict
with certainty the extent of the impact of RUGs refinement on its financial condition and operating
results, GHC believes it could result in a significant reduction in its net income. It is not possible to quantify fully the effect of legislative changes, the interpretation or
administration of such legislation or any 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 further
adversely affect GHCs business. There can be no assurance that payments under governmental and
private third-party payor programs will be timely, will remain at levels similar to present levels
or will, in the future, be sufficient to cover the costs allocable to patients eligible for
reimbursement pursuant to such programs. GHCs financial condition and results of operations will
be affected by the reimbursement process, which in the healthcare industry is complex and can
involve lengthy delays between the time that revenue is recognized and the time that reimbursement
amounts are settled. Use
of Estimates The
Company has made a number of estimates relating to the reporting of
assets, liabilities, revenues and expenses and the disclosure of
contingent assets and liabilities, to prepare these condensed
consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America. Some
of the more significant estimates impact accounts receivable,
long-lived assets and loss reserves for self-insured programs. It is
at least reasonably possible that GHC will revise its estimates
significantly in the near term. Any subsequent differences arising are
recorded in the period in which they are determined. (3) Significant Transactions and Events Issuance of Convertible Senior Subordinated Debentures In March 2005, GHC completed a private placement of $180.0 million aggregate principal amount
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. After paying financing fees of
approximately $5.5 million, GHC used (i) approximately $20.1 million of the net proceeds of the
offering to repurchase shares of its 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 its
senior credit facility, and (iii) the balance for general corporate purposes, including debt
repurchases described below. Senior Credit Facility Amendment In March, 2005, in connection with the offering of the convertible senior subordinated
debentures, GHC entered into an amended and restated senior credit agreement pursuant to which the
Company refinanced the indebtedness under its existing senior credit agreement. The Company repaid
all outstanding borrowings under the term loan portion of the senior credit facility and expanded
the borrowing capacity of the revolving credit portion. The
existing senior credit agreement provided for a revolving credit
facility of $75.0 million, with sub limits
for swing line loans, letters of credit and term loans. The amended and restated senior credit
agreement provides for a $125.0 million revolving credit facility, with sub limits for the issuance
of letters of credit and for swing line loans. Share Repurchase In February 2005, GHCs Board of Directors authorized an increase to the size of its
previously established share repurchase program from $25.0 million to $50.0 million of the
Companys common stock. Share 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. There were 520,000
shares of common stock repurchased at a cost of $20.8 million as of March 31, 2005. 9




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##### Table of Contents



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 commencing in March 2005. There were $23.5
million of 8% senior subordinated notes repurchased as of March 31, 2005. The debt repurchases
resulted in a prepayment premium of $2.4 million, which is included in loss on early extinguishment
of debt. Amendment to 2003 Stock Incentive Plan At the 2005 Annual Meeting of Shareholders of GHC held in February 2005, the shareholders of
GHC approved an amendment to the 2003 Stock Incentive Plan to increase the number of shares of
common stock available for issuance under the 2003 Stock Incentive Plan from 750,000 to 1,000,000. 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 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 is 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 the current fiscal year. In February 2005, CMS approved the New Jersey provider assessment. The New Jersey provider
assessment, which is 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 the current fiscal year. Purchase of Joint Venture Interests Effective January 1, 2005, GHC acquired its joint venture partners interest in a Commonwealth
of Massachusetts skilled nursing facility having 123 beds. Prior to that acquisition, the Company
owned a 50% interest in the facility and managed its operations. Upon completion of the
transaction, GHC owned 100% of the facility and began consolidating the revenues, expenses, assets
and liabilities of the facility on January 1, 2005. The
aggregate consideration consisted of cash of $0.5
million to acquire the remaining partnership interests and the assumption of approximately $6.0
million of debt, all of which was repaid at the closing of the transaction. The facilitys annual
revenues and pretax income are expected to approximate $10.1 million and $1.1 million, respectively. The facility
had total assets of approximately $10.4 million at the date of acquisition. 10




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##### Table of Contents



Acquisition of Previously Leased ElderCare Center and Lease Termination On January 31, 2005, GHC acquired the land and building of a State of New Jersey skilled
nursing facility having 136 beds that it previously leased. The purchase price of approximately
$15.8 million includes the assumption of a $9.5 million, 6% fixed rate mortgage that matures in
October 2007. The revenues, operating expenses and working capital of the purchased center are
consolidated in GHCs historical results. The transaction results in an annual reduction to lease
expense of approximately $1.5 million and an increase to depreciation expense and interest expense
of approximately $0.5 million and $0.6 million, respectively. On January 31, 2005, GHC terminated the lease of a State of New Jersey skilled nursing
facility having 186 beds. Upon termination, the center was classified as a discontinued operation;
consequently, its results of operations in the current and prior year periods have been classified
as discontinued operations in the unaudited condensed consolidated statements of operations. The
annual revenues and pretax income of this center approximate $12.3 million and $1.4 million,
respectively. Sale of Assets On December 1, 2004, GHC sold its two remaining eldercare centers based in the State of
Wisconsin for net cash proceeds of $4.6 million. These centers are classified as assets held for
sale in the condensed consolidated balance sheet at September 30, 2004. (4) Long-Term Debt Long-term debt at March 31, 2005 and September 30, 2004 consists of the following (in
thousands): March 31, 2005
    
    
    September 30, 2004Senior credit facility  term loan
    
    $
    
    
    
    $
    134,075Senior subordinated notes
    
    
    201,475
    
    
    
    225,000Convertible senior subordinated debentures
    
    
    180,000
    
    
    
    Mortgages and other secured debt
    
    
    42,387
    
    
    
    43,996423,862
    
    
    
    403,071Less:Current portion of long-term debt
    
    
    (4,121
    )
    
    
    (27,230
    )Long-term debt
    
    $
    419,741
    
    
    $
    375,841
 Senior credit facility.On December 1, 2003, GHC entered into a senior credit facility
that provided for a fully drawn $185.0 million term loan and a revolving credit facility of $75.0
million. In March 2005, in connection with the offering of the convertible senior subordinated
debentures, GHC entered into an amended and restated senior credit agreement pursuant to which the
Company refinanced the indebtedness under its existing senior credit agreement. The Company repaid
all outstanding borrowings under the term loan portion of the senior credit facility and expanded
the borrowing capacity of the $75.0 million revolving credit portion of the senior credit facility. The
senior credit agreement previously provided for a revolving credit facility, with sub limits
for swing line loans, letters of credit and term loans. The amended and restated senior credit
agreement provides for a $125.0 million revolving credit facility, with sub limits for the issuance
of letters of credit and for swing line loans. However, so long as GHC is not in default and if it
finds lenders that are willing to commit, the amended and restated senior credit agreement allows
GHC to add up to $50.0 million of additional available credit under the revolver, subject to the
approval of GHCs Board of Directors. Each of GHCs material U.S. subsidiaries provided guarantees
of the indebtedness under the amended and restated senior credit agreement. GHC and the guarantors
pledged
substantially all of their personal property to secure the obligations under the amended and
restated senior credit agreement, 11




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##### Table of Contents



subject to certain exceptions agreed upon with the lenders. In
addition, the mortgages that GHC and its subsidiaries provided under the prior credit agreement
continue to secure the amended and restated senior credit agreement, but GHC is not required to
provide additional mortgages except under certain limited circumstances. The amended and restated
senior credit agreement has a five year term. GHC pays interest monthly on the outstanding loans under the amended and restated senior
credit agreement at either a base rate plus a margin or at the London Interbank Offered Rate
(LIBOR) plus a margin. Initially, that margin will be 0.50% for base rate loans and 1.50% for LIBOR
loans. The margin will be adjusted, from time to time, depending on GHCs leverage ratio. For LIBOR
loans, the margin range is from 1.00% to 2.00%. For base rate loans, the margin range is from 0.00%
to 1.00%. GHC pays a commitment fee to the lenders on the unused portion of the revolving credit
facility equal to 0.50% of the unused amount; that percentage will drop to 0.375% if GHCs leverage
ratio drops below 2.25:1.00. The agreements and instruments governing the amended and restated senior credit agreement
contain various restrictive covenants that, among other things,
restrict the
ability of GHC and its subsidiaries that guarantee the indebtedness
under the amended and restated senior credit agreement to: incur
more debt; pay dividends; purchase GHC common stock or make other distributions; make payments in
respect of subordinated debt; make certain investments; create liens; enter into transactions with
affiliates; make acquisitions, merge or consolidate; and transfer or sell assets. The amended and restated senior credit agreement requires that GHC maintain compliance with
certain financial covenants as defined in the agreement, including a senior leverage ratio, a total
leverage ratio and a fixed charge coverage ratio. There is also a limitation on the amount of
capital expenditures that GHC may make. 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. In July 2004, upon the expiration of an 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. Each of GHCs subsidiaries that guarantees the indebtedness
under the amended and restated senior credit agreement also guarantees the senior subordinated
notes. The guarantees will be released at such time that such subsidiary ceases to be a
guarantor under the amended and restated senior credit agreement or all of the senior
subordinated notes are no longer outstanding. The indenture governing
the senior subordinated notes contains various restrictive covenants that, among other things,
restrict the ability of GHC and its subsidiaries that guarantee the senior subordinated notes
to: incur more debt; pay dividends; purchase GHC common stock or make other distributions; make
payments in respect of subordinated debt; make certain investments; create liens; enter into
transactions with affiliates; make acquisitions, merge or consolidate; and transfer or
sell assets. 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 commencing in March 2005. There were $23.5
million of senior subordinated notes repurchased as of March 31, 2005. The debt repurchases
resulted in a prepayment premium of $2.4 million, which is included in loss on early extinguishment
of debt. Convertible
senior subordinated debentures. In March 2005, GHC completed a private placement of
$180.0 million aggregate principal amount 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. Interest is payable semi-annually in March and September. Each of GHCs subsidiaries
that guarantees the indebtedness under the senior subordinated notes also guarantees the
convertible senior subordinated debentures. The guarantees will be released at such time that
such subsidiary ceases to be a guarantor under the senior subordinated notes, all of the senior
subordinated notes are no longer outstanding, or on March 20, 2012. The debentures may be
converted into cash and, depending on the circumstances at the time
of conversion, shares of GHC
common stock. The initial conversion rate for the debentures will be equivalent to 18.4493 shares
of common stock per $1,000 principal amount of the debentures (which is based upon an initial
conversion price equivalent to approximately $54.20 per share), subject to adjustment under
certain circumstances. The holders of the convertible senior subordinated debentures may convert
their debentures into shares of GHC common stock prior to the stated maturity at their option only
under the following circumstances: (1) if, after June 30, 2005, the closing price of GHC common
stock exceeds 130% of the conversion price then in effect for at least 20 trading days in the 30
consecutive trading day period ending on the last trading day of the immediately preceding fiscal
quarter; (2) during the five business days immediately following any five consecutive trading day
period in which the trading price per $1,000 principal amount of debentures for each day of such
period was less than 95% of the product of the closing price of GHC common stock and the
applicable conversion rate then in effect, subject to certain exceptions; (3) the debentures have
been called for redemption; (4) upon the occurrence of specified corporate transactions; or (5)
upon the occurrence of certain designated events. Subject to certain
exceptions, once debentures are tendered for conversion, the value, or conversion value, of the
cash and shares of GHC common stock, if any, to be received by a holder converting $1,000
principal amount of the debentures will be determined by multiplying the applicable conversion
rate by the ten trading day average closing price of GHC common stock. GHC will deliver the
conversion value to holders as follows: (i) an amount in cash, referred to as the principal
return, equal to the lesser of (x) the aggregate conversion value of the debentures to be
converted and (y) the aggregate principal amount of the debentures to be converted, (ii) if the
aggregate conversion value of the debentures to be converted is greater than the principal return,
an amount in whole shares, referred to as the net shares, equal to such aggregate conversion
value less the principal return, referred to as the net share amount, and (iii) an amount in
cash in lieu of any fractional shares of GHC common stock. The number of net shares to be paid
will be determined by dividing the net share amount by the ten trading day average closing price
of GHC common stock. GHC may not redeem the
convertible senior subordinated debentures before March 20, 2010. The holders of the convertible
senior subordinated debentures may require GHC to purchase all or a portion of their debentures
at any of three specified dates during the life of the debentures, with the first such date
being March 15, 2012, or upon the occurrence of certain designated events for cash at a
repurchase price equal to the principal amount plus accrued and unpaid interest plus, in the case
of certain designated events that occur on or prior to March 20, 2010, a make whole premium, if
any, payable solely in shares of GHC common stock. GHC used (i) approximately $20.1 million of the proceeds of the offering to repurchase shares
of its common stock from the initial purchasers of the debentures in negotiated transactions
concurrently with the offering, (ii)
approximately $119.7 million of the proceeds to repay the remaining outstanding borrowings under
the term loan 12




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##### Table of Contents



portion of its senior credit facility, and (iii) the balance for general corporate
purposes, including repurchases of the Companys senior subordinated notes. The following pro
forma financial information is presented as if the above noted financing transactions occurred on October
1, 2004. The pro forma adjustments assume proceeds of the $180.0 million offering of the
2.5% convertible senior subordinated debentures were used to (i) pay $5.6
million of related financing costs, (ii) repay $119.7 million of outstanding
borrowings under the term loan portion of the senior credit facility, (iii)
purchase $20.1 million of our common stock and (iv) purchase $34.6 million of
our 8% senior subordinated notes.
The pro forma data is for informational purposes only and does not purport to
represent the results of future periods. The pro forma data reflects adjustments based
upon available information and certain assumptions that management of GHC considers reasonable. No
changes in operating revenues or expenses have been made to reflect the results of any
modifications to operations that might have been made had the financing transactions been
completed on the aforesaid effective dates for purposes of the pro forma results. The
following pro forma information is presented in thousands, except per share
information: Six months ended March 31, 2005As reported
    
    
    Pro formaNet revenues
    
    $
    853,593
    
    
    $
    853,593Income from continuing operations
    
    
    23,956
    
    
    
    25,218Diluted earnings per share  from continuing operations
    
    
    1.16
    
    
    
    1.26
 Mortgages and other secured debts.At March 31, 2005 and September 30, 2004, GHC had $42.4
million and $44.0 million, respectively, of 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 2.8% to 11.0%, with a
weighted average interest rate of 6.4% and 7.4% at March 31, 2005 and September 30, 2004,
respectively. On November 30, 2004, GHC prepaid an $11.0 million, 11% fixed rate mortgage. GHC
paid the lenders a $0.3 million penalty in connection with the prepayment. On January 31, 2005,
GHC acquired the land and building of a State of New Jersey skilled nursing facility assuming a
$9.5 million, 6% fixed rate mortgage that matures in October 2007. (5) 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 basic weighted average common shares for the six
months ended March 31, 2004 is based upon the number of GHC shares
distributed by NCI on December 1, 2003 in connection with the spin-off, assuming such distribution
took place on October 1, 2003. Therefore, the basic weighted average common shares presented for
the six months ended March 31, 2004 are labeled pro forma. 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 are used to repurchase GHC common stock at the average market price for the
period. For the three and six months ended March 31, 2005, GHCs outstanding stock options yielded
273,824 and 233,171, respectively, potentially dilutive securities, in comparison to the three and
six months ended March 31, 2004, in which GHCs outstanding stock options yielded 44,823 and
23,385, respectively, potentially dilutive securities For the three and six months ended March
31, 2005, GHCs unvested restricted stock yielded an additional 429,536 and 353,485, respectively,
potentially dilutive securities under the modified treasury stock method in comparison to the three
and six months ended March 31, 2004, in which GHCs unvested restricted stock yielded 70,373 and
59,567, respectively, potentially dilutive securities. (6) Comprehensive Income The following table sets forth the computation of comprehensive income for the three and six
months ended March 31, 2005 and 2004 (in thousands): Three months ended March 31,
    
    
    Six months ended March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income
    
    $
    13,467
    
    
    $
    5,574
    
    
    $
    24,315
    
    
    $
    11,580Net unrealized loss on restricted investments
in marketable securities
    
    
    (1,120
    )
    
    
    (430
    )
    
    
    (1,437
    )
    
    
    (312
    )Minimum
pension liability
    
    
    (289
    )
    
    
    
    
    
    
    (289
    )
    
    
    Total comprehensive income
    
    $
    12,058
    
    
    $
    5,144
    
    
    $
    22,589
    
    
    $
    11,268
 (7) Assets Held for Sale and Discontinued Operations In the normal course of business, GHC continually evaluates the performance of its operating
units, with an emphasis on selling or closing under-performing or non-strategic assets. GHC
accounts for discontinued operations and assets held for sale under the provisions of Statement of
Financial Accounting Standards No. 144, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of(SFAS
144). Under SFAS 144, discontinued businesses, including assets held for sale, are removed from
the results of continuing operations. The results of operations in the current and prior year
periods, along with any cost to exit such businesses in the year of discontinuation, are classified
as discontinued operations in the consolidated statements of operations. 13




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The Company has classified several businesses as held for sale or closed. In 2002, GHC
identified, and has since sold, all of its eldercare centers located in the states of Florida,
Wisconsin and Illinois. In addition to these assets, since fiscal 2002 GHC has identified other
eldercare centers in various states, one rehabilitation therapy services clinic, two physician
service practices and its ambulance and diagnostics businesses as held for sale or closed due to
under-performance. Consolidated interest expense has been allocated to discontinued operations for all periods
presented based on allocated debt expected to be repaid in connection with the sale of the assets.
The amount of after-tax interest expense allocated to discontinued operations in the three and six
months ended March 31, 2005 was $0.1 million and $0.2 million, respectively. For the three and six
months ended March 31, 2004 after-tax interest expense allocated to discontinued operations was
$0.2 million and $0.4 million, respectively. GHC has separately classified an aggregate of $3.9 million and $8.8 million of carrying value
associated with its assets held for sale in its unaudited condensed consolidated balance sheets at
March 31, 2005 and September 30, 2004, respectively. GHCs assets held for sale are classified in
the unaudited condensed consolidated balance sheets within both current and non-current assets.
The current portion of assets held for sale represents those assets for which the Company has
binding agreements of sale. The following table sets forth net revenues and the components of income (loss) from
discontinued operations for the three and six months ended March 31, 2005 and 2004 (in thousands): Three Months Ended March 31,
    
    
    Six Months Ended March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net revenues
    
    $
    1,930
    
    
    $
    11,686
    
    
    $
    8,453
    
    
    $
    25,870Net operating income (loss) of discontinued businesses
    
    $
    359
    
    
    $
    (966
    )
    
    $
    1,088
    
    
    $
    (2,770
    )Loss on discontinuation or sale of businesses
    
    
    (635
    )
    
    
    
    
    
    
    (484
    )
    
    
    (583
    )Income tax benefit (expense)
    
    
    112
    
    
    
    389
    
    
    
    (245
    )
    
    
    1,351(Loss) income from discontinued operations, net of taxes
    
    $
    (164
    )
    
    $
    (577
    )
    
    $
    359
    
    
    $
    (2,002
    )
 The loss on discontinuation of businesses represents the write-down of assets to estimated net
realizable value. (8) Segment Information The Companys principal operating segments are identified by the types of products and
services from which revenues are derived and are consistent with the reporting structure of the
Companys internal organization. The Company includes in inpatient services revenues all room and board charges and ancillary
service revenue for its eldercare customers at the eldercare centers which the Company owns or
leases. The Company includes in rehabilitation therapy services all revenues earned from the
provisions of speech pathology, physical therapy and occupational therapy. The accounting policies of the segments are the same as those of the consolidated
organization. All intersegment sales prices are market based. Summarized financial information concerning the Companys reportable segments is shown in the
following table. The All other services and corporate costs category of revenues and EBITDA
represents operating information of business units below the prescribed quantitative thresholds
that trigger segment reporting requirements, and the Companys corporate support functions. The
operating business units in this category derive revenues from the following services: management
services, respiratory health services, physician services, hospitality services, staffing services
and other healthcare related services. The Other adjustments category consists of certain
expenses that have not been allocated to the Companys reportable segments or the All other
services and corporate costs category. This approach to segment reporting is consistent with the
Companys 14




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##### Table of Contents



internal financial reporting and the information used by the chief operating decision
maker regarding the performance of the Companys reportable and non-reportable segments. Three months ended March 31,
    
    
    Six months ended March 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Inpatient services  external
    
    $
    409,772
    
    
    $
    336,244
    
    
    $
    763,908
    
    
    $
    664,050Rehabilitation services:External
    
    
    32,871
    
    
    
    31,080
    
    
    
    65,066
    
    
    
    59,015Intersegment
    
    
    20,225
    
    
    
    19,841
    
    
    
    40,005
    
    
    
    37,515All other services:External
    
    
    11,923
    
    
    
    11,357
    
    
    
    24,619
    
    
    
    21,926Intersegment
    
    
    15,147
    
    
    
    15,410
    
    
    
    28,994
    
    
    
    40,555Elimination of intersegment revenues
    
    
    (35,372
    )
    
    
    (35,251
    )
    
    
    (68,999
    )
    
    
    (78,070
    )Total net revenues
    
    
    454,566
    
    
    
    378,681
    
    
    
    853,593
    
    
    
    744,991EBITDA (1):Inpatient services
    
    
    56,259
    
    
    
    38,242
    
    
    
    105,768
    
    
    
    79,384Rehabilitation services
    
    
    3,724
    
    
    
    6,055
    
    
    
    6,189
    
    
    
    8,648All other services and corporate costs
    
    
    (15,225
    )
    
    
    (14,952
    )
    
    
    (32,738
    )
    
    
    (29,438
    )Loss on early extinguishment of debt
    
    
    (4,289
    )
    
    
    (655
    )
    
    
    (4,832
    )
    
    
    (828
    )Total EBITDA
    
    
    40,469
    
    
    
    28,690
    
    
    
    74,387
    
    
    
    57,766Capital and other:Depreciation and amortization expense
    
    
    (13,206
    )
    
    
    (11,464
    )
    
    
    (24,525
    )
    
    
    (23,028
    )Interest expense
    
    
    (6,261
    )
    
    
    (7,528
    )
    
    
    (12,893
    )
    
    
    (13,349
    )Income tax expense
    
    
    (7,897
    )
    
    
    (3,929
    )
    
    
    (14,379
    )
    
    
    (8,672
    )Equity in net income of unconsolidated affiliates
    
    
    679
    
    
    
    466
    
    
    
    1,790
    
    
    
    1,024Minority interests
    
    
    (153
    )
    
    
    (84
    )
    
    
    (424
    )
    
    
    (159
    )Income from continuing operations
    
    
    13,631
    
    
    
    6,151
    
    
    
    23,956
    
    
    
    13,582(Loss) income from discontinued operations, net of taxes
    
    
    (164
    )
    
    
    (577
    )
    
    
    359
    
    
    
    (2,002
    )Net income
    
    $
    13,467
    
    
    $
    5,574
    
    
    $
    24,315
    
    
    $
    11,580
   (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. Total assets by segment at March 31, 2005 and September 30, 2004 were as follows (in thousands): March 31, 2005
    
    
    September 30, 2004Inpatient services
    
    $
    931,287
    
    
    $
    865,440Rehabilitation therapy services
    
    
    38,063
    
    
    
    36,212All other
    
    
    360,073
    
    
    
    342,511Total assets
    
    $
    1,329,423
    
    
    $
    1,244,163
 15




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##### Table of Contents



(9) Restricted Investments in Marketable Securities At March 31, 2005 and September 30, 2004, the Company reported restricted investments in
marketable securities of $107.8 million and $95.0 million, respectively. The Companys restricted
investments are held by Liberty Health Corporation, LTD. (LHC), GHCs wholly owned captive
insurance subsidiary incorporated under the laws of Bermuda. The investments held by LHC are
restricted by statutory capital requirements in Bermuda. In addition, certain of these investments
are pledged as security for letters of credit issued by LHC. As a result of such restrictions and
encumbrances, GHC and LHC are precluded from freely transferring funds through inter-company loans,
advances or cash dividends. The Companys restricted investments in marketable securities are classified in the unaudited
condensed consolidated balance sheets within both current and non-current assets. The current
portion of restricted investments in marketable securities represents an estimate of the level of
outstanding self-insured losses the Company expects to pay in the succeeding 12 months. (10) Stock Option Plan GHC applies the intrinsic-value-based method of accounting prescribed by Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations
including FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB Opinion No. 25, issued in March 2000, to account for its
fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant
only if the current market price of the underlying stock exceeded the exercise price. SFAS No.
123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements
using a fair-value-based method of accounting for stock-based employee compensation plans. As
allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based
method of accounting described above, and has adopted only the disclosure requirements of SFAS No.
123. See note 11  New Accounting Pronouncements regarding the issuance of SFAS No. 123R. The following table illustrates the effect on net income (in thousands, except per share data)
if the fair-value-based method had been applied to all outstanding and unvested awards in each
period. Three months ended March 31,
    
    
    Six months ended March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income  as reported
    
    $
    13,467
    
    
    $
    5,574
    
    
    $
    24,315
    
    
    $
    11,580Deduct: Total stock-based employee
compensation determined under fair
value based method for all stock option
awards, net of related tax effects
    
    
    (625
    )
    
    
    (669
    )
    
    
    (1,394
    )
    
    
    (1,883
    )Net income  pro forma
    
    $
    12,842
    
    
    $
    4,905
    
    
    $
    22,921
    
    
    $
    9,697Earnings per share:Basic  as reported
    
    $
    0.67
    
    
    $
    0.28
    
    
    $
    1.22
    
    
    $
    0.58Basic  pro forma
    
    
    0.64
    
    
    
    0.25
    
    
    
    1.15
    
    
    
    0.49Diluted  as reported
    
    $
    0.65
    
    
    $
    0.28
    
    
    $
    1.18
    
    
    $
    0.58Diluted  pro forma
    
    
    0.62
    
    
    
    0.24
    
    
    
    1.11
    
    
    
    0.48
 16




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##### Table of Contents



The fair value of stock options granted is estimated at the grant date using the
Black-Scholes option-pricing model, which requires the use of highly subjective assumptions,
including expected stock price volatility. The assumptions used in preparing the estimates were as
follows: Three months ended March 31,
    
    
    Six months ended March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Volatility
    
    
    39.30
    %
    
    
    41.90
    %
    
    
    33.73
    %
    
    
    40.13
    %Expected life (in years)
    
    
    8.9
    
    
    
    9.7
    
    
    
    8.9
    
    
    
    9.7Rate of return
    
    
    4.27
    %
    
    
    4.66
    %
    
    
    4.27
    %
    
    
    4.66
    %Dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
 (11) New Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123R,
Share-Based Payment(SFAS 123R), which requires companies to measure and recognize compensation
expense for all stock-based payments at fair value. On April 14,
2005, the Securities and Exchange Commission issued rules to
allow companies to adopt the standard at the beginning of the fiscal year that begins after June
15, 2005, and, thus, will be effective for GHC beginning October 1, 2005. GHC is currently
evaluating the option valuation methodologies, transition alternatives and assumptions in light of
SFAS 123R, and therefore cannot estimate the impact of its adoption at this time. Adoption of the
expensing requirements of SFAS 123R will increase GHCs operating expenses. The new methodologies
and assumptions may be different than those currently employed by GHC
in disclosing the impact of applying the fair value-based method
under SFAS 123 to outstanding and unvested awards. See
note 10  Stock Option Plan for information related to the pro forma effects of stock-based
employee compensation on GHCs reported results assuming application of the fair value recognition
provisions of SFAS 123. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107), Share-Based
Payment, which provides interpretive guidance related to the interaction between SFAS 123R and
certain SEC rules and regulations, as well as provides the SEC staffs views regarding the
valuation of share-based payment arrangements. In particular, SAB 107 provides guidance related to
share-based payment transactions with non employees, the transition from non-public to public
entity status, valuation methods (including assumptions such as expected volatility and expected
term), the accounting for certain redeemable financial instruments issued under share-based payment
arrangements, the classification of compensation expense, non-GAAP financial measures, first-time
adoption of SFAS No. 123R in an interim period, capitalization of compensation cost related to
share-based payment arrangements, the accounting for income tax effects of share-based payment
arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to
adoption of SFAS No. 123R, and disclosures in Managements Discussion and Analysis of Financial
Condition and Results of Operations subsequent to adoption of SFAS No. 123R. The Company is
currently assessing the impact of SAB 107 on its implementation and adoption of SFAS 123R. In March, 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position
(FSP) FIN 46 (R)-5, Implicit Variable Interests under FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities to address whether a reporting enterprise
should consider whether it holds an implicit variable interest in a variable interest entity (VIE)
or potential VIE when specific conditions exist. The determination of whether an implicit variable
interest exists should be based on whether the reporting enterprise
may absorb the variability of the
VIE or potential VIE. This FSP is effective, for entities to which the interpretations of FIN 46(R)
have been applied, in the first reporting period beginning after March 3, 2005, or GHCs quarter
ended June 30, 2005. GHC has not yet determined the impact of adopting FSP FIN 46 (R)-5, if any,
on its consolidated financial statements and related disclosures. At their March 2005 meeting, the Emerging Issues Task Force (EITF) reaffirmed its position
regarding Issue No. 04-5 (EITF 04-05), Investors Accounting for an Investment in a Limited
Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain
Rights. The tentative conclusion provides a framework for addressing the question of when a sole
general partner, as defined in EITF 04-5, should consolidate a limited partnership. The EITF has
concluded that the general partner of a limited partnership should consolidate a
limited partnership unless (1) the limited partners possess substantive kick-out rights as defined
in paragraph B20 of FIN 46(R), Consolidation of Variable Interest Entities,or (2) the limited
partners possess substantive participating 17




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##### Table of Contents



rights similar to the rights described in Issue 96-16, Investors Accounting for an Investee
When the Investor has a Majority of the Voting Interest but the Minority Shareholder or
Shareholders Have Certain Approval or Veto Rights. In addition, the EITF has concluded that the
guidance should be expanded to include all limited partnerships, including those with multiple
general partners. EITF 04-05 has not been finalized and no effective date has been announced. The
EITF acknowledged that the tentative conclusions reached in EITF 04-05 conflict with certain
aspects of Statement of Position 78-9 Accounting for Investments in Real Estate Ventures(SOP
78-9). The EITF requested that the FASB consider amending the guidance in SOP 78-9 to be consistent
with the tentative conclusions reached in EITF 04-5. The FASB discussed this request at its meeting
in November 2004 and agreed to propose an amendment to SOP 78-9 to address that inconsistency. The
EITFs tentative conclusions will be reconsidered at its meeting in June 2005, at which time a
final consensus is expected to be reached. Depending on the outcome of the discussions of the EITF
in future meetings, the outcome could impact whether or not the Company consolidates investment
partnerships it holds a general partner interest in. (12) 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 financial position of GHC. At March 31, 2005 GHC has:  
    extended $4.1 million in working capital lines of credit to certain jointly owned and
managed companies, of which $2.2 million was unused;
    posted $3.0 million of outstanding letters of credit to guarantee the performance to
third parties of various trade activities;
    provided $0.3 million of financial guarantees related to loan commitments of two jointly
owned and managed companies; and
    contractual commitments of approximately $5.6 million related to its internal
construction program. (13) 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 consolidated financial statements. GHC is the borrower under the senior
credit facility, the senior subordinated notes and the convertible senior subordinated debentures
described in note 4  Long-Term Debt and incurs interest expense thereunder. 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. The Company has
agreed to file a registration statement 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, GHCs wholly owned insurance captive, and certain separately mortgaged eldercare centers
(Non-guarantors). The following tables present the unaudited condensed consolidating financial
statements of GHC (Parent), the Guarantors and the Non-guarantors. 18




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##### Table of Contents



GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS
MARCH 31, 2005
(IN THOUSANDS) Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedAssets:Current assets
    
    $
    135,900
    
    
    $
    253,116
    
    
    $
    37,566
    
    
    $
    (5,529
    )
    
    $
    421,053Property and equipment, net
    
    
    23,908
    
    
    
    686,216
    
    
    
    7,308
    
    
    
    
    
    
    
    717,432Other long-term assets
    
    
    95,704
    
    
    
    33,375
    
    
    
    77,889
    
    
    
    (16,030
    )
    
    
    190,938Investments in subsidiaries
    
    
    302,479
    
    
    
    
    
    
    
    
    
    
    
    (302,479
    )
    
    
    Intercompany receivables
    
    
    532,606
    
    
    
    
    
    
    
    
    
    
    
    (532,606
    )
    
    
    Total assets
    
    $
    1,090,597
    
    
    $
    972,707
    
    
    $
    122,763
    
    
    $
    (856,644
    )
    
    $
    1,329,423Liabilities and shareholders equity:Current liabilities
    
    $
    61,342
    
    
    $
    115,832
    
    
    $
    61,627
    
    
    $
    (9,264
    )
    
    $
    229,537Intercompany payables
    
    
    
    
    
    
    522,604
    
    
    
    10,002
    
    
    
    (532,606
    )
    
    
    Long-term debt
    
    
    387,347
    
    
    
    24,687
    
    
    
    12,150
    
    
    
    (4,443
    )
    
    
    419,741Other long-term liabilities
    
    
    55,363
    
    
    
    (538
    )
    
    
    38,775
    
    
    
    
    
    
    
    93,600Shareholders equity
    
    
    586,545
    
    
    
    310,122
    
    
    
    209
    
    
    
    (310,331
    )
    
    
    586,545Total liabilities and shareholders equity
    
    $
    1,090,597
    
    
    $
    972,707
    
    
    $
    122,763
    
    
    $
    (856,644
    )
    
    $
    1,329,423
 GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEETS
SEPTEMBER 30, 2004
(IN THOUSANDS) Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedAssets:Current assets
    
    $
    127,796
    
    
    $
    188,928
    
    
    $
    45,139
    
    
    $
    (1,490
    )
    
    $
    360,373Property and equipment, net
    
    
    21,489
    
    
    
    657,866
    
    
    
    16,156
    
    
    
    
    
    
    
    695,511Other long-term assets
    
    
    93,319
    
    
    
    38,701
    
    
    
    72,334
    
    
    
    (16,075
    )
    
    
    188,279Investments in subsidiaries
    
    
    255,979
    
    
    
    
    
    
    
    
    
    
    
    (255,979
    )
    
    
    Intercompany receivables
    
    
    547,964
    
    
    
    
    
    
    
    
    
    
    
    (547,964
    )
    
    
    Total assets
    
    $
    1,046,547
    
    
    $
    885,495
    
    
    $
    133,629
    
    
    $
    (821,508
    )
    
    $
    1,244,163Liabilities and shareholders equity:Current liabilities
    
    $
    90,174
    
    
    $
    76,724
    
    
    $
    46,152
    
    
    $
    (5,272
    )
    
    $
    207,778Intercompany payables
    
    
    
    
    
    
    520,640
    
    
    
    27,324
    
    
    
    (547,964
    )
    
    
    Long-term debt
    
    
    341,596
    
    
    
    26,500
    
    
    
    12,188
    
    
    
    (4,443
    )
    
    
    375,841Other long-term liabilities
    
    
    46,011
    
    
    
    421
    
    
    
    45,346
    
    
    
    
    
    
    
    91,778Shareholders equity
    
    
    568,766
    
    
    
    261,210
    
    
    
    2,619
    
    
    
    (263,829
    )
    
    
    568,766Total liabilities and shareholders equity
    
    $
    1,046,547
    
    
    $
    885,495
    
    
    $
    133,629
    
    
    $
    (821,508
    )
    
    $
    1,244,163
 19




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##### Table of Contents



GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005
(IN THOUSANDS) Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    1,576
    
    
    $
    478,468
    
    
    $
    9,894
    
    
    $
    (35,372
    )
    
    $
    454,566Equity in net income (loss) of subsidiaries
    
    
    34,465
    
    
    
    
    
    
    
    
    
    
    
    (34,465
    )
    
    
    Operating expenses
    
    
    29,555
    
    
    
    403,616
    
    
    
    9,624
    
    
    
    (35,308
    )
    
    
    407,487Lease expense
    
    
    332
    
    
    
    6,208
    
    
    
    70
    
    
    
    
    
    
    
    6,610Depreciation and amortization expense
    
    
    2,345
    
    
    
    10,840
    
    
    
    21
    
    
    
    
    
    
    
    13,206Interest expense
    
    
    5,723
    
    
    
    318
    
    
    
    299
    
    
    
    (79
    )
    
    
    6,261Income (loss) before income tax (benefit) expense,
equity in net income of unconsolidated
affiliates and minority interests
    
    
    (1,914
    )
    
    
    57,486
    
    
    
    (120
    )
    
    
    (34,450
    )
    
    
    21,002Income tax (benefit) expense
    
    
    (14,445
    )
    
    
    22,541
    
    
    
    (35
    )
    
    
    (164
    )
    
    
    7,897Income before equity in net income of
unconsolidated affiliates and minority interests
    
    
    12,531
    
    
    
    34,945
    
    
    
    (85
    )
    
    
    (34,286
    )
    
    
    13,105Equity in net income of unconsolidated affiliates
    
    
    936
    
    
    
    
    
    
    
    
    
    
    
    (257
    )
    
    
    679Minority interests
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (152
    )
    
    
    (153
    )Income (loss) from continuing operations
    
    
    13,467
    
    
    
    34,944
    
    
    
    (85
    )
    
    
    (34,695
    )
    
    
    13,631Loss from discontinued operations
    
    
    
    
    
    
    (119
    )
    
    
    (45
    )
    
    
    
    
    
    
    (164
    )Net income (loss)
    
    $
    13,467
    
    
    $
    34,825
    
    
    $
    (130
    )
    
    $
    (34,695
    )
    
    $
    13,467
 GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2004
(IN THOUSANDS) Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    3,394
    
    
    $
    393,590
    
    
    $
    16,948
    
    
    $
    (35,251
    )
    
    $
    378,681Equity in net income of subsidiaries
    
    
    23,253
    
    
    
    
    
    
    
    
    
    
    
    (23,253
    )
    
    
    Operating expenses
    
    
    24,247
    
    
    
    339,656
    
    
    
    14,542
    
    
    
    (35,251
    )
    
    
    343,194Lease expense
    
    
    480
    
    
    
    6,317
    
    
    
    
    
    
    
    
    
    
    
    6,797Depreciation and amortization expense
    
    
    1,845
    
    
    
    8,942
    
    
    
    677
    
    
    
    
    
    
    
    11,464Interest expense
    
    
    6,483
    
    
    
    804
    
    
    
    241
    
    
    
    
    
    
    
    7,528Income (loss) before income tax (benefit) expense,
equity in net income of unconsolidated
affiliates and minority interests
    
    
    (6,408
    )
    
    
    37,871
    
    
    
    1,488
    
    
    
    (23,253
    )
    
    
    9,698Income tax (benefit) expense
    
    
    (11,303
    )
    
    
    14,843
    
    
    
    580
    
    
    
    (191
    )
    
    
    3,929Income before equity in net income of
unconsolidated affiliates and minority interests
    
    
    4,895
    
    
    
    23,028
    
    
    
    908
    
    
    
    (23,062
    )
    
    
    5,769Equity in net income of unconsolidated affiliates
    
    
    662
    
    
    
    135
    
    
    
    
    
    
    
    (331
    )
    
    
    466Minority interests
    
    
    17
    
    
    
    58
    
    
    
    
    
    
    
    (159
    )
    
    
    (84
    )Income from continuing operations
    
    
    5,574
    
    
    
    23,221
    
    
    
    908
    
    
    
    (23,552
    )
    
    
    6,151Loss from discontinued operations
    
    
    
    
    
    
    (568
    )
    
    
    (9
    )
    
    
    
    
    
    
    (577
    )Net income
    
    $
    5,574
    
    
    $
    22,653
    
    
    $
    899
    
    
    $
    (23,552
    )
    
    $
    5,574
 20




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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
SIX MONTHS ENDED MARCH 31, 2005
(IN THOUSANDS) Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    2,926
    
    
    $
    892,953
    
    
    $
    26,713
    
    
    $
    (68,999
    )
    
    $
    853,593Equity in net income of subsidiaries
    
    
    64,353
    
    
    
    
    
    
    
    
    
    
    
    (64,353
    )
    
    
    Operating expenses
    
    
    54,729
    
    
    
    754,647
    
    
    
    25,018
    
    
    
    (68,769
    )
    
    
    765,625Lease expense
    
    
    837
    
    
    
    12,744
    
    
    
    
    
    
    
    
    
    
    
    13,581Depreciation and amortization expense
    
    
    4,370
    
    
    
    19,970
    
    
    
    185
    
    
    
    
    
    
    
    24,525Interest expense
    
    
    11,760
    
    
    
    746
    
    
    
    539
    
    
    
    (152
    )
    
    
    12,893Income
(loss) before income tax (benefit) expense,
equity in net income of unconsolidated
affiliates and minority interests
    
    
    (4,417
    )
    
    
    104,846
    
    
    
    971
    
    
    
    (64,431
    )
    
    
    36,969Income tax (benefit) expense
    
    
    (26,429
    )
    
    
    40,825
    
    
    
    386
    
    
    
    (403
    )
    
    
    14,379Income
(loss) before equity in net income of
unconsolidated affiliates and minority interests
    
    
    22,012
    
    
    
    64,021
    
    
    
    585
    
    
    
    (64,028
    )
    
    
    22,590Equity in net income of unconsolidated affiliates
    
    
    2,303
    
    
    
    
    
    
    
    
    
    
    
    (513
    )
    
    
    1,790Minority interests
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (423
    )
    
    
    (424
    )Income from continuing operations
    
    
    24,315
    
    
    
    64,020
    
    
    
    585
    
    
    
    (64,964
    )
    
    
    23,956Income (loss) from discontinued operations, net of taxes
    
    
    
    
    
    
    621
    
    
    
    (262
    )
    
    
    
    
    
    
    359Net income
    
    $
    24,315
    
    
    $
    64,641
    
    
    $
    323
    
    
    $
    (64,964
    )
    
    $
    24,315
 GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
SIX MONTHS ENDED MARCH 31, 2004
(IN THOUSANDS) Parent
    
    
    Guarantors
    
    
    Non-guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    6,831
    
    
    $
    786,838
    
    
    $
    29,392
    
    
    $
    (78,070
    )
    
    $
    744,991Equity in net income (loss) of subsidiaries
    
    
    45,126
    
    
    
    
    
    
    
    
    
    
    
    (45,126
    )
    
    
    Operating expenses
    
    
    47,086
    
    
    
    675,971
    
    
    
    28,121
    
    
    
    (78,070
    )
    
    
    673,108Lease expense
    
    
    1,073
    
    
    
    13,044
    
    
    
    
    
    
    
    
    
    
    
    14,117Depreciation and amortization expense
    
    
    3,741
    
    
    
    18,044
    
    
    
    1,243
    
    
    
    
    
    
    
    23,028Interest expense
    
    
    11,427
    
    
    
    1,449
    
    
    
    473
    
    
    
    
    
    
    
    13,349Income (loss) before income tax (benefit) expense,
equity in net income of unconsolidated
affiliates and minority interests
    
    
    (11,370
    )
    
    
    78,330
    
    
    
    (445
    )
    
    
    (45,126
    )
    
    
    21,389Income tax (benefit) expense
    
    
    (21,448
    )
    
    
    30,542
    
    
    
    (174
    )
    
    
    (248
    )
    
    
    8,672Income (loss) before equity in net income of
unconsolidated affiliates and minority interests
    
    
    10,078
    
    
    
    47,788
    
    
    
    (271
    )
    
    
    (44,878
    )
    
    
    12,717Equity in net income of unconsolidated affiliates
    
    
    1,502
    
    
    
    
    
    
    
    
    
    
    
    (478
    )
    
    
    1,024Minority interests
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (159
    )
    
    
    (159
    )Income (loss) from continuing operations
    
    
    11,580
    
    
    
    47,788
    
    
    
    (271
    )
    
    
    (45,515
    )
    
    
    13,582Loss from discontinued operations, net of taxes
    
    
    
    
    
    
    (1,934
    )
    
    
    (68
    )
    
    
    
    
    
    
    (2,002
    )Net income
(loss)
    
    $
    11,580
    
    
    $
    45,854
    
    
    $
    (339
    )
    
    $
    (45,515
    )
    
    $
    11,580
 21




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GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED MARCH 31, 2005
(IN THOUSANDS) Non-Parent
    
    
    Guarantors
    
    
    guarantors
    
    
    ConsolidatedNet cash (used in)
provided by
operating
activities
    
    $
    (62,112
    )
    
    
    107,837
    
    
    
    13,171
    
    
    $
    58,896Net cash used in
investing
activities
    
    
    (2,451
    )
    
    
    (24,612
    )
    
    
    (8,888
    )
    
    
    (35,951
    )Net cash provided
by (used in)
financing
activities
    
    
    9,939
    
    
    
    (26,531
    )
    
    
    (6,257
    )
    
    
    (22,849
    )Net
(decrease) increase in cash
and equivalents
    
    $
    (54,624
    )
    
    
    56,694
    
    
    
    (1,974
    )
    
    $
    96
 GENESIS HEALTHCARE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED MARCH 31, 2004
(IN THOUSANDS) Non-Parent
    
    
    Guarantors
    
    
    guarantors
    
    
    ConsolidatedNet cash (used in)
provided by
operating
activities
    
    $
    (29,749
    )
    
    $
    105,314
    
    
    $
    798
    
    
    $
    76,363Net cash used in
investing
activities
    
    
    (11,843
    )
    
    
    (43,873
    )
    
    
    (111
    )
    
    
    (55,827
    )Net cash provided
by (used in)
financing
activities
    
    
    167,637
    
    
    
    (69,495
    )
    
    
    (1,511
    )
    
    
    96,631Net increase
(decrease) in cash
and equivalents
    
    $
    126,045
    
    
    $
    (8,054
    )
    
    $
    (824
    )
    
    $
    117,167
 (14) Subsequent Events Debt Repurchase In
April 2005, GHC repurchased an additional $47.3 million of
its 8% senior subordinated notes
resulting in a prepayment premium of $5.0 million, which will be recognized as a loss on early
extinguishment of debt in the third quarter of fiscal 2005. 22




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ITEM 2: Managements Discussion and Analysis of Financial Condition and Results of Operations Overview We are one of the largest providers of healthcare and support services to the elderly in the
United States. Within our network of geographically concentrated facilities, we offer services
focusing on the primary medical, physical and behavioral issues facing the medically complex
elderly population. We are focused on qualitative and quantitative clinical performance measures
in order to enhance and improve continuously the care provided in our facilities. Through our
physicians, nurses, therapists and other members of our interdisciplinary medical care team, we
apply a comprehensive approach to the complex needs facing the elderly, which we believe has
resulted in our above-industry average occupancy levels and an enhanced level of Medicare and
private paying patients. We receive higher rates of reimbursement from Medicare and private paying
patients. For the six months ended March 31, 2005, the average occupancy level in our inpatient
facilities was approximately 90%, and approximately 47% of our net revenues were from Medicare,
private pay and other non-Medicaid patients. Approximately 89% of our net revenues are generated through inpatient services. Our inpatient
services business is offered through a network of skilled nursing and assisted living centers
primarily located in the eastern United States. Our eldercare centers are concentrated in the
states of Pennsylvania, New Jersey, Maryland and Massachusetts. We currently own, lease, manage or
jointly own 214 eldercare facilities, consisting of 178 skilled nursing facilities, 23 assisted
living facilities and 13 transitional care units together totaling 26,304 beds. Our rehabilitation therapy business, which represents approximately 8% of our net revenues,
provides an extensive range of rehabilitation therapy services to the elderly, including speech
pathology, physical therapy and occupational therapy in our eldercare regional market
concentrations. These services are provided by approximately 4,400 licensed rehabilitation
therapists and assistants employed or contracted by us at substantially all of the eldercare
facilities we operate, as well as by contract to third-party healthcare facilities operated by
other providers and through our 13 outpatient rehabilitation agencies. We also provide other
complementary healthcare services, the revenues for which are included in all other services
revenues in our segment financial information. The aging of the population and increased life expectancies are the primary driving forces
behind the growth of our businesses. We believe that positive demographic trends imply that there
will be a growing demand for the services offered by healthcare providers that deliver the most
efficient, responsive, cost effective and high quality eldercare services. We are continually
engaged in various efforts to improve our profitability by focusing on key operational initiatives,
including: improving the level of Medicare and private paying patients, increasing our rate of
occupancy, improving nursing staff scheduling and retention, reducing reliance on overtime
compensation and temporary nursing agency services, and capitalizing on best demonstrated practices
in various areas of cost control. As a result, we believe we will be well positioned to take
advantage of the favorable demographic and growth trends in our industry. Government funded programs, principally Medicaid and Medicare, provide approximately 75% of
our revenue. Over the past five years, changes in funding from these government sources has had a
significant impact on our cash flows and profitability. Through trade and other organizations, we
actively participate in partnership with other healthcare providers to pursue strategies to
minimize any potentially adverse impact of government funding proposals. We believe the
continuation of government funding at levels sufficient to operate our business profitably is our
greatest financial risk. Labor costs, including salaries, wages and benefits, account for approximately 70% of our
total operating expenses. We compete with other healthcare providers and with non-healthcare
providers for both professional and non-professional employees. In recent years, we and our
industry have experienced shortages in qualified professional clinical staff. While in our
inpatient services segment we have been able to retain the services of an adequate number of
qualified personnel to staff our facilities and sites of services, we have used expensive temporary
nursing agency services to supplement staffing, particularly in fiscal 2001 and 2002. In fiscal
2003, we implemented programs to improve staff scheduling and retention, and to reduce reliance on
overtime compensation and temporary nursing agency services. Our efforts resulted in a significant
reduction in our reliance on temporary nursing agency services, without a significant change in
overall nursing hours per patient day. However, if a shortage of nurses or other health care
workers occurred in the geographic areas in which we operate, it could adversely affect our ability
to attract and retain qualified personnel and could further increase our operating costs, without a
corresponding 23




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increase in the level of government funded reimbursement. Beginning in fiscal 2004 and
continuing into fiscal 2005, we and our industry are experiencing a shortage of qualified
rehabilitation therapists. As the demand for these services continues to exceed the supply of
available therapists, we and our competitors have been forced to offer more attractive wage and
benefit packages to these professionals while utilizing outside contractors for these services at
premium rates. Although we have been able to retain adequate levels of qualified therapists to
maintain our standards of quality care in the services we provide, the shortage of qualified
therapists has impacted negatively our ability to generate incremental therapy business. For a description of the material challenges and risks of the Company, 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, 2004. Revenue Sources We receive revenues from Medicare, Medicaid, private insurance, self-pay residents, other
third-party payors and long-term care facilities that utilize our rehabilitation therapy services
and other service related businesses. The sources and amounts of our revenues are determined by a number of factors, including
licensed bed capacity and occupancy rates of our eldercare 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 the case mix of the patients as well as payor mix
among Medicare, Medicaid and private pay can significantly affect our profitability. On July 30, 2004, the Centers for Medicare and Medicaid Services (CMS) published notice of the
fiscal year 2005 prospective payment system rates that became effective October 1, 2004 and which
are in effect through September 30, 2005. The fiscal year 2005 rules provide for a 2.8% increase
in the annual inflation update factor and continue the current payment system with certain payment
add-ons that were authorized to compensate for non-therapy ancillaries. The proposed Federal Budget that was released in February 2005 contains provisions to cut
Medicare funding for skilled nursing facilities by more than $1.5 billion for fiscal year 2006 by
issuing regulations implementing refinements to the current resource utilization group
classification payment system. We refer to the anticipated refinement to the resource utilization
group classification system as RUGs refinement. CMS has indicated it will soon publish a notice
of proposed rule-making proposing RUGs refinement. The notice will permit a 60-day public comment
period. By law, fiscal year skilled nursing facility Medicare prospective payment system rates
must be published annually by August 1. Although we are unable to predict with certainty the
extent of the impact of RUGs refinement on our financial condition and operating results, we
believe it could result in a significant reduction in our EBITDA and net income. The proposed Federal Budget for 2006 also proposes to reduce by 30% the amount that Medicare
reimburses skilled nursing facilities and other non-hospital providers for bad debts arising from
uncollectible Medicare coinsurance and deductibles. The proposal is to phase in the reduction over
a three-year period at 10% per year. Based on our current volume of Medicare bad debts, this
proposed rule would respectively reduce our EBITDA and net
income by $1.7 million and $1.0
million in the first year, respectively. We cannot currently determine if, or when, this proposal
will be implemented. The Medicare Modernization Act suspended application of the $1,500 payment caps (therapy caps)
on Medicare Part B rehabilitation through December 31, 2005. The therapy caps in place effective
September 1, 2003 imposed payment limits to services provided by independent therapists as well as
to those provided by outpatient rehabilitation facilities and other forms of rehabilitation
agencies. Extension of the moratorium removes a significant financial threat to our therapy
business for the short term. No assurances can be made or given that Congress will extend the
moratorium on application of the therapy caps beyond calendar year 2005. As mandated by the law,
the General Accounting Office is conducting a study of alternatives to the therapy caps. Many state fiscal years are from July 1 to June 30. These states are currently preparing
their budgets for the coming year. State budget pressures in recent years have translated into
reductions in the rate of state spending 24




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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. 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 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 seven states where we operate
(Massachusetts, West Virginia, Rhode Island, North Carolina, New Hampshire, Pennsylvania and New
Jersey). Legislation authorizing a provider assessment is under active consideration in
Connecticut. In January 2005, CMS approved the Pennsylvania provider assessment. The Pennsylvania
provider assessment, which is 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, EBITDA and net income of $42.0 million, $6.1
million and $3.7 million, respectively in the quarter ended March 31, 2005, of which, $30.9 million
of revenue, $5.4 million of EBITDA and $3.3 million of net income relates to periods prior to the
current fiscal year. In February 2005, CMS approved the New Jersey provider assessment. The New
Jersey provider assessment, which is retroactive to July 1, 2004 and will expire on June 30, 2006,
was recognized cumulatively in the quarter ended March 31, 2005. Recognition of the New Jersey
provider assessment resulted in increased revenue, EBITDA and net income of $12.8 million, $3.0
million and $1.8 million, respectively in the quarter ended March 31, 2005, of which $4.3 million
of revenue, $1.0 million of EBITDA and $0.6 million of net income relates to periods prior to the
current fiscal year. The proposed Federal Budget for 2006 includes proposed reform of the Medicaid program to cut a
total of $60.0 billion in projected Medicaid expenditure growth over 10 years, including a
provision that would reduce the maximum amount of provider taxes that a state may impose on
providers for purposes of qualifying for federal matching funds from 6% of a states Medicaid
outlay to 3%. No predictions can be made as to the ultimate outcome of this budget proposal or the
future of provider tax plan provisions. It is not possible to quantify fully the effect of legislative changes, the interpretation or
administration of such legislation or any 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. 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 process. 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 will have on us. Efforts to impose reduced allowances, greater discounts and more
stringent cost controls by government and other payors are expected to continue. 25




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Significant Transactions and Events Issuance of Convertible Senior Subordinated Debentures In March 2005, we completed a private placement of $180.0 million aggregate principal amount
of our 2.5% convertible senior subordinated debentures due 2025 to qualified institutional buyers
under Rule 144A of the Securities Act of 1933, as amended. We used (i) approximately $20.1 million
of the 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 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 debt repurchases described below. Senior Credit Facility Amendment In March 2005, in connection with the offering of the convertible senior subordinated
debentures, we entered into an amended and restated senior credit agreement pursuant to which we
refinanced the indebtedness under our existing senior credit agreement. We repaid all outstanding
borrowings under the term loan portion of the senior credit facility and expanded the borrowing
capacity of the revolving credit portion. The
senior credit agreement previously provided for a revolving credit facility of $75.0 million, with sub limits
for swing line loans, letters of credit and term loans. The amended and restated senior credit
agreement provides for a $125.0 million revolving credit facility, with sub limits for the issuance
of letters of credit and for swing line loans. 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.
Share 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. There were 520,000 shares of common stock repurchased at
a cost of $20.8 million as of March 31, 2005. 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 commencing in March 2005. There were $23.5
million of 8% senior subordinated notes repurchased as of March 31, 2005. The debt repurchases
resulted in a prepayment premium of $2.4 million, which is included in loss on early extinguishment
of debt. In April 2005, we repurchased an additional $47.3 million of 8% senior subordinated notes
resulting in a prepayment premium of $4.7 million, which will be recognized as a loss on early
extinguishment of debt in the third quarter of fiscal 2005. Amendment to 2003 Stock Incentive Plan At our 2005 Annual Meeting of Shareholders held in February 2005, our shareholders approved an
amendment to the 2003 Stock Incentive Plan to increase the number of shares of common stock
available for issuance under the 2003 Stock Incentive Plan from 750,000 to 1,000,000. 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 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 is retroactive to July 1, 2003 and will expire on June 30, 2007, was recognized
cumulatively in the quarter 26




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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 the current fiscal year. In February 2005, CMS approved the New Jersey provider assessment. The New Jersey provider
assessment, which is 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 the current fiscal year. Purchase of Joint Venture Interests Effective January 1, 2005, we acquired our joint venture partners interest in a Commonwealth
of Massachusetts skilled nursing facility having 123 beds. Prior to that acquisition, we owned a
50% interest in the facility and managed its operations. Upon completion of the transaction, we
owned 100% of the facility and began consolidating the revenues, expenses, assets and liabilities
of the facility on January 1, 2005. The aggregate consideration
consisted of cash of $0.5 million to
acquire the remaining partnership interests and the assumption of approximately $6.0 million of
debt, all of which was repaid at the closing of the transaction. The facilitys annual revenues
and pretax income are expected to approximate $10.1 million and $1.1 million, respectively. The facility had total
assets of approximately $10.4 million at the date of acquisition. Acquisition of Previously Leased ElderCare Center and Lease Termination In January 2005, we acquired the land and building of a State of New Jersey skilled nursing
facility having 136 beds that we previously leased. The purchase price of approximately $15.8
million includes the assumption of a 6%, $9.5 million fixed rate mortgage that matures in October
2007. The revenues, operating expenses and working capital of the purchased center are
consolidated in our historical results. The transaction results in an annual reduction to lease
expense of approximately $1.5 million and an increase to depreciation expense and interest expense
of approximately $0.5 million and $0.6 million, respectively. In January 2005, we terminated the lease of a State of New Jersey skilled nursing facility
having 186 beds. Upon termination, the center was classified as a discontinued operation;
consequently, its results of operations in the current and prior year periods have been classified
as discontinued operations in the unaudited condensed consolidated statements of operations. The
annual revenues and pretax income of this center approximate $12.3 million and $1.4 million,
respectively. Sale of Assets On December 1, 2004, we sold our two remaining eldercare centers based in the State of
Wisconsin for net cash proceeds of $4.6 million. These centers are classified as assets held for
sale in the condensed consolidated financial statements at and for the year ended September 30, 2004. Spin-off On December 1, 2003, NeighborCare, Inc. (NCI) completed the distribution (the spin-off) of our
common stock. The spin-off was effected by way of a pro-rata tax free distribution of our common
stock to holders of NCIs common stock on December 1, 2003 at a rate of 0.5 shares of our stock for
each share of NCI stock owned as of October 15, 2003. In connection with the spin-off, we and NCI have agreed contractually to continue certain
transitional arrangements and practices for a limited time after the spin-off. In addition, we and
NCI have entered into certain mutually beneficial commercial arrangements. Specifically, we and
NCI entered into a separation and distribution agreement, a tax sharing agreement, a transition
services agreement, a group purchasing agreement, an employee benefits agreement, a pharmacy
services agreement, as amended, a pharmacy benefit management agreement, as amended, and a durable
medical equipment agreement. 27




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Results of Operations Factors Affecting Comparability of Financial Information Our unaudited condensed consolidated statements of operations for the first two months
(through November 30, 2003) of the six months ended March 31, 2004 have been prepared on a basis
which reflects our historical financial statements assuming that the operations of NCI contributed
in the spin-off were organized as a separate legal entity which owned certain net assets of NCI. The allocation methodology followed in preparing the consolidated financial statements prior
to the December 1, 2003 spin-off may not necessarily reflect the results of operations, cash flows
or financial position of us in the future, or what the results of operations, cash flows or
financial position would have been had we been a separate stand-alone public entity for all periods
presented. Management believes that the unaudited condensed consolidated statement of operations for the
six months ended March 31, 2005 is generally comparable to the unaudited condensed consolidated
statement of operations for the six months ended March 31, 2004, with the exception of interest
expense and depreciation and amortization expense. This lack of comparability is due to the
restructuring of our capital structure following the spin-off and the related incremental interest
costs and amortization of deferred financing fees in connection with our new financing
arrangements. 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
statement of operations, balance sheet or statement of cash flows (or equivalent statements) of the
registrant; or includes amounts, or is subject to adjustments that have the effect of including
amounts, that are excluded from the most directly comparable financial measure so calculated and
presented. In this regard, GAAP refers to accounting principles generally accepted in the United
States of America. Pursuant to the requirements of Regulation G, we have provided reconciliations
of the non-GAAP financial measures to the most directly comparable GAAP financial measures. Management believes that the presentation of EBITDA provides useful information to investors
regarding our results of operations because it is useful for trending, analyzing and benchmarking
the performance and value of our business. We use EBITDA primarily as a performance measure and
believe that the GAAP financial measure most directly comparable to EBITDA is net income. We use
EBITDA as a measure to assess the relative performance of our eldercare properties and 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 operating
performance of the business unit and the employees responsible for business unit performance.
Consequently, management uses EBITDA to determine the extent to which our employees have met
performance goals, and therefore may or may not be eligible for incentive compensation awards. We
also use EBITDA in our annual budget process. We believe EBITDA facilitates internal comparisons
to historical operating performance of prior periods and external comparisons to competitors
historical operating performance. Although we use EBITDA as a financial measure to assess the
performance of our business, the use of EBITDA is limited because it does not consider certain
material costs necessary to operate our business. These costs include the cost to service our
debt, the non-cash depreciation and amortization associated with our long-lived assets, the cost of
our federal and state tax obligations, our share of the earnings or losses of our less than 100%
owned operations and the operating results of 28




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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 a substitute for, or superior to, GAAP
financial measures. The following table reconciles net income to EBITDA (in thousands). Three months ended March 31,
    
    
    Six months ended March 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Net income
    
    $
    13,467
    
    
    $
    5,574
    
    
    $
    24,315
    
    
    $
    11,580Add back:Loss (income) from discontinued operations, net of taxes
    
    
    164
    
    
    
    577
    
    
    
    (359
    )
    
    
    2,002Equity in net income of unconsolidated affiliates
    
    
    (679
    )
    
    
    (466
    )
    
    
    (1,790
    )
    
    
    (1,024
    )Minority interests
    
    
    153
    
    
    
    84
    
    
    
    424
    
    
    
    159Income tax expense
    
    
    7,897
    
    
    
    3,929
    
    
    
    14,379
    
    
    
    8,672Interest expense
    
    
    6,261
    
    
    
    7,528
    
    
    
    12,893
    
    
    
    13,349Depreciation and amortization expense
    
    
    13,206
    
    
    
    11,464
    
    
    
    24,525
    
    
    
    23,028EBITDA
    
    $
    40,469
    
    
    $
    28,690
    
    
    $
    74,387
    
    
    $
    57,766
 Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 In the current quarter, revenues were $454.6 million, an increase of $75.9 million, or 20.0%,
over the same period in the prior year. Of this growth, inpatient services revenue increased by
$73.5 million, external rehabilitation therapy services revenue increased by $1.8 million and other
businesses revenue increased by $0.6 million. The $73.5 million of revenue growth in our inpatient services segment is primarily attributed
to increased payor rates. In aggregate, payor rates contributed $76.5 million of additional revenue versus the prior
year quarter, with $67.9 million of such increase occurring in the Medicaid payor category, $54.8
million of which was due to the cumulative recognition of the New Jersey and Pennsylvania provider
assessments, with $45.0 million of such provider assessments pertaining to periods prior to the
current quarter. An additional $3.2 million of the Medicaid rate increase is due to recognition of
New Hampshire provider assessments. The balance of Medicaid rate increases (approximately 6.0%)
resulted from both increased acuity levels and scheduled rate increases. A 5.8% increase in our
average Medicare rate, attributed to the October 1, 2004 upward Medicare rate adjustments of 2.8%
and higher Medicare patient acuity, was the primary reason for the remainder of the overall rate
increase. Approximately $2.5 million of the overall revenue increase is due to the step
acquisition of an eldercare center, which we previously jointly owned and managed. We purchased
our joint venture partners ownership interests in the center and, beginning in January 2005, we
own and consolidate 100% of the operation. The preceding were partially offset by a $3.7 million
revenue decline as the result of the current year quarter having one less day than the prior leap
year quarter and a $2.3 million revenue decline resulting from a reduction in overall occupancy .
Overall occupancy declined to 90.2% in the current quarter from 91.1% in the same period in the
prior year. Total patient days decreased 19,173 to 1,654,499 in the current quarter compared to
1,673,672 in the same period of the prior year. A 10,256 patient day increase attributed to the
step acquisition of an eldercare center was offset by a decline of 18,392 patient days as the
result of the current year quarter having one less day than the prior leap year quarter and an
11,037 patient day decline in the occupancy of our centers which were included in both reporting
periods. Increased revenue volume generated by ongoing customer contracts was the primary reason for
the $1.8 million increase in external rehabilitation therapy services revenue. 29




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The $0.6 million increase in other business revenue resulted from $2.3 million of increases
primarily due to increased volume in our respiratory therapy services business, increased
management fee revenues and increased investment income resulting
from higher cash and investment levels. The
preceding were partially offset by $1.7 million of revenue declines due to decreased external
business volume in our non-core hospitality, physicians services and staffing services businesses. For the current quarter, net income increased to $13.5 million from $5.6 million in the same
period in the prior year. Revenue increases of $75.9 million, as previously discussed, were
partially offset by $11.8 million of increased salaries, wages and benefits and $45.0 million of
higher other operating expenses. Of the $11.8 million of increased salaries, wages and benefits,
$1.2 million is attributed to the step acquisitions of an eldercare center, approximately $1.6
million is attributed to the replacement of higher cost temporary agency nurses with internally
employed nurses, with the balance of the increase due to normal inflationary growth in wage and
benefits in both our inpatient services segment and rehabilitation therapy services segment and
increased rehabilitation therapy services business volume. Of the $45.0 million of increased other
operating expenses, $47.0 million is attributed to increased provider assessments primarily for New
Jersey and Pennsylvania, with $37.2 million of such provider assessments pertaining to periods
prior to the current quarter, $1.6 million is attributed to increased utilization of temporary
agencies with our rehabilitation services business as a result of an industry-wide shortage of
therapists and $0.8 million is attributed to the step acquisition of an eldercare center. These
increases in other operating expenses were offset by approximately $1.9 million of reduced costs
attributed to the replacement of higher cost temporary agency nurses with internally employed
nurses and $3.7 million of reduced bad debt expense due to improvement in the collection of older
accounts receivable. The balance of the increase in other operating expenses of approximately $1.2
million is largely attributed to normal inflationary increases in cost. General and administrative
costs increased by $3.8 million primarily due to higher adverse claims development associated with
our self-insured general and professional liability and workers compensation programs. Net income
was further reduced from increases in early extinguishment of debt costs, depreciation and
amortization expense and income tax expense as further discussed below. Net income increased due
to lower interest expense, lower after-tax losses of discontinued operations and higher earnings of
less than 100% owned subsidiaries, each of which is further discussed below. For the current quarter, EBITDA increased $11.8 million to $40.5 million compared with $28.7
million in the same period of the prior year. Inpatient services EBITDA increased $18.0 million,
of which $9.1 million was due to the first-time recognition of provider tax assessments for New
Jersey and Pennsylvania, with $7.8 million of such provider tax assessments pertaining to prior
periods. Approximately $8.4 million of the increase resulted from the previously discussed
increase in payor rates, reduced utilization of external nursing agencies and reduced bad debt
expense offset by inflationary increases in cost. An additional $0.5 million of the increase was
due to the step acquisition of an eldercare center. EBITDA of our rehabilitation therapy services
segment declined $2.3 million with $2.2 million of combined external and intersegment revenue
increases being offset by $2.7 million of higher labor related costs, $1.6 million of increased
utilization of temporary agencies and $0.2 million of increased other costs. The increase in
rehabilitation therapy labor and temporary agency costs is primarily being driven by high market
demand for a limited pool of qualified therapists. Increased loss on early extinguishment of debt
in the current quarter decreased EBITDA by $3.6 million. Of the $4.3 million loss on early
extinguishment of debt recognized in the current quarter, $1.2 million is due to the write-off of
unamortized financing fees on the fully repaid term loan component of our senior credit facility
and $0.7 million is due to the repayment of 8% subordinated
debt. In addition, prepayment premiums
approximating 10% of the $23.5 million of repaid 8% subordinated debt resulted in $2.4 million of
debt extinguishment charges. The remaining decrease in EBITDA of $0.3 million in the current
quarter is principally attributed to changes in EBITDA of our other services businesses and
corporate costs. 30




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Capital Costs and Other Depreciation and amortization expense increased by $1.7 million to $13.2 million in the
current quarter compared to $11.5 million for the same period in the prior year. The increase is
principally attributed to $1.3 million of adjustments to depreciation expense that were recorded in
the current quarter following modifications to the useful lives assigned to certain fixed assets. Lease expense decreased by $0.2 million to $6.6 million in the current quarter, compared to
$6.8 million for the same period in the prior year, primarily due to the purchase of six previously
leased facilities, offset by increases in lease costs. Interest expense decreased by $1.3 million in the current quarter to $6.2 million, compared to
$7.5 million for the same period in the prior year, principally due to the repayment of debt since
the year ago quarter. Income tax expense in the current year quarter is estimated using an effective tax rate of
approximately 39.8%, offset by the recognition of a $0.7 million tax refund. Income tax in the
prior year quarter was estimated using an effective tax rate of 39.0%. 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 a loss of $0.2 million in the
current quarter and a loss of $0.6 million in the prior year quarter. The change is primarily due
to the relative results of operations of those businesses identified as discontinued operations. Operating results of our less than 100% owned subsidiaries in the current quarter improved
compared to the same period in the prior year, resulting in a combined increase of $0.1 million in
equity in net income of unconsolidated affiliates and minority interests. Six Months Ended March 31, 2005 Compared to Six Months Ended March 31, 2004 In the current year to date period, revenues were $853.6 million, an increase of $108.6
million, or 14.6%, over the same period in the prior year. Of this growth, inpatient services
revenue increased by $99.9 million, external rehabilitation therapy services revenue increased by
$6.0 million and other businesses revenue increased by $2.7 million. The $99.9 million of revenue growth in our inpatient services segment is primarily attributed
to increased payor rates and acquisitions. In aggregate, payor rates
contributed $97.3 million
of additional revenue versus the prior year to date period, with $83.6 million of such increase occurring in the Medicaid
payor category, $54.8 million of which was due to the cumulative recognition of the New Jersey and
Pennsylvania provider assessments, with $35.3 million of such provider assessments pertaining to
periods prior to fiscal 2005. An additional $6.1 million of the Medicaid rate increase is due to
recognition of New Hampshire provider assessments. The balance of Medicaid rate increases
(approximately 6.8%) resulted from both increased acuity levels and scheduled rate increases. A
5.7% increase in our average Medicare rate, attributed to the October 1, 2004 upward Medicare rate
adjustments of 2.8% and higher Medicare patient acuity, was the primary reason for the remainder of
the overall rate increase. Approximately $9.2 million of the overall revenue increase is due to
step acquisitions of three eldercare centers, which we previously jointly owned and managed. We
purchased our joint venture partners ownership interests in the centers and currently we own and
consolidate 100% of the operations. Increased Medicare Part B volume resulted in $2.1 million of
increased revenues. The preceding were partially offset by a $3.7 million revenue decline as the
result of the current year to date period having one less day than the same period in the prior
leap year and a $4.8 million revenue decline resulting from a reduction in overall occupancy.
Overall occupancy declined to 90.3% in the current year to date period from 91.2% in the same
period in the prior year. Total patient days decreased 1,370 to 3,339,413 in the current year to
date period compared to 3,340,783 in the same period of the prior year. A 38,043 patient day
increase attributed to step acquisitions of three eldercare centers was offset by a decline of
18,392 patient days as the result of the current year to date period having one less day than the
prior leap year to date period and an 21,021 patient day decline in the occupancy of our centers
which were included in both reporting periods. 31




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Increased revenue volume generated by ongoing customer contracts was the primary reason for
the $6.0 million increase in external rehabilitation therapy services revenue. The $2.7 million increase in other business revenue resulted from $4.5 million of increases
primarily due to increased volume in our respiratory therapy services business, increased
management fee revenues, increased investment income resulting from
higher cash and investment levels and
increased revenue resulting from the change in fair market value of assets held in our deferred
compensation plan. The preceding were partially offset by $1.8 million of revenue declines due to
decreased external business volume in our non-core hospitality, physicians services and staffing
services businesses. For the year to date period, net income increased to $24.3 million from $11.6 million in the
same period in the prior year. Revenue increases of $108.6 million, as previously discussed, were
partially offset by $31.2 million of increased salaries, wages and benefits and $53.4 million of
higher other operating expenses. Of the $31.2 million of increased salaries, wages and benefits,
$4.8 million is attributed to the step acquisitions of three eldercare centers, approximately $4.1
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 and
increased rehabilitation therapy services business volume. Of the $53.4 million of increased other
operating expenses, $48.6 million is attributed to increased provider assessments primarily for New
Jersey and Pennsylvania, with $28.8 million of such provider assessments pertaining to periods
prior to fiscal 2005, $3.5 million is attributed to increased utilization of temporary agencies
with our rehabilitation services business as a result of an industry-wide shortage of therapists
and $2.0 million is attributed to step acquisitions of three eldercare centers. An additional
$2.8 million of increased operating expenses is due to an adjustment to reflect an estimate of
previously unaccrued costs resulting from a weakness in our purchasing cut-off procedures. We have
remediated the internal control weakness and believe that the correction is not material to any
previously reported financial statements and is not material to earnings trends. These increases
in other operating expenses were offset by approximately $4.8 million of reduced costs attributed
to the replacement of higher cost temporary agency nurses with internally employed nurses and $5.4
million of reduced bad debt expense due to improvement in the collection of older accounts
receivable. The balance of the increase in other operating expenses
of approximately $6.7 million
is largely attributed to normal inflationary increases in cost. General and administrative costs
increased by $3.9 million primarily due to higher adverse claims development associated with our
self-insured general and professional liability and workers compensation programs. Net income was
further reduced from increases in early extinguishment of debt costs, depreciation and amortization
expense and income tax expense as further discussed below. Net income increased due to lower lease
expense, interest expense, lower after-tax losses of discontinued operations and higher earnings of
less than 100% owned subsidiaries, each of which is further discussed below. For the year to date period, EBITDA increased $16.6 million to $74.4 million compared with
$57.8 million in the same period of the prior year. Inpatient services EBITDA increased $26.4
million, of which $9.1 million was due to the first-time recognition of provider tax assessments
for New Jersey and Pennsylvania, with $6.4 million of such provider tax assessments pertaining to
periods prior to fiscal 2005. Approximately $2.0 million of the increase was due to step
acquisitions of three eldercare centers with the remaining $15.3 million increase resulting from
the previously discussed increase in payor rates, reduced utilization of external nursing agencies
and reduced bad debt expense offset by inflationary increases in cost. EBITDA of our
rehabilitation therapy services segment declined $2.5 million with $8.5 million of combined
external and intersegment revenue increases being offset by $6.9 million of higher labor related
costs, $3.5 million of increased utilization of temporary agencies and $0.6 million of increased
other costs. The increase in rehabilitation therapy labor and temporary agency costs is primarily
being driven by high market demand for a limited pool of qualified therapists. Increased loss on
early extinguishment of debt in the current year to date period decreased EBITDA by $4.0 million.
Of the $4.8 million loss on early extinguishment of debt recognized in the current year to date
period $0.4 million is due to the write-off of unamortized financing fees for several repaid
mortgages, $1.3 million is due to the full write-off of the term loan component of our senior
credit facility and $0.7 million is due to the repayment of 8% subordinated debt. In addition,
prepayment premiums approximating 10% of the $23.5 million of repaid 8% subordinated debt resulted in
$2.4 million of debt extinguishment charges. The remaining decrease in EBITDA of $3.3 million in
the current year to date period is principally attributed to changes in EBITDA of our other
services businesses and corporate costs. 32




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Capital Costs and Other Depreciation and amortization expense increased by $1.5 million to $24.5 million in the
current year to date period compared to $23.0 million for the same period in the prior year. The
increase is principally attributed to $1.3 million of adjustments to depreciation expense that were
recorded in the current year following modifications to the useful lives assigned to certain fixed
assets. Lease expense decreased by $0.5 million to $13.6 million in the current year to date period,
compared to $14.1 million for the same period in the prior year, primarily due to the purchase of
six previously leased facilities, offset by increases in lease costs. Interest expense decreased by $0.5 million in the current year to date period to $12.9
million, compared to $13.3 million for the same period in the prior year, principally due to the
repayment of debt since the year ago period. Income tax expense in the current year to date period is estimated using an effective tax rate
of approximately 39.8%, offset by the recognition of a $0.2 million tax credit and a $0.7 million
tax refund. Income tax in the prior year to date period was estimated using an effective tax rate
of 39.0%. 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 income of $0.4 million in the
current year to date period and a loss of $2.0 million in the prior year to date period. The
change is primarily due to the relative results of operations of those businesses identified as
discontinued operations. Operating results of our less than 100% owned subsidiaries in the current year-to-date period
improved compared to the same period in the prior year, resulting in a combined increase of $0.5
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 statements of cash flows
will facilitate understanding of the discussion that follows. Our operating cash flow has been used to fund trade accounts receivable, fund capital
expenditures, service our indebtedness and make selective acquisitions. Funding 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, 2005 and 2004 were $58.9 million and $76.4 million,
respectively. The $17.5 million decline in cash flow from operations primarily resulted from $38.9
million in reduced cash flow resulting from growth in accounts receivable and the timing of
payments to vendors and employees, with the remaining $21.4 million improvement in operating cash
flow primarily resulted from growth in operations and the net benefits of the Pennsylvania and New
Jersey provider assessment. Significant growth in both accounts receivable and accounts payable is
attributed to accrued but unpaid portions of the Pennsylvania and New Jersey provider assessments
which added approximately $48.0 million and $38.6 million to our accounts receivable and accounts
payable balances at March 31, 2005, respectively. All of the accrued provider assessment
receivables and payables were received and paid subsequent to 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 incur capital expenditure costs at levels significantly above the levels incurred in prior years
as we intend to increase our investment in both physical plant and information systems. For fiscal
2005, capital expenditures are anticipated to be within the range of $50.0 million to $60.0
million. Capital expenditures were $23.1 million and $14.8 million for the six months ended March
31, 2005 and 2004, respectively. Investing activities for the six months ended March 31, 2005 and
2004 also include proceeds received from the sale of eldercare centers of $5.3 million and $7.8
million, respectively, principally from 33




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the sale of eldercare centers located in the state of Wisconsin. We do not expect to receive
significant cash proceeds from asset sales in fiscal 2005. In the six months ended March 31, 2005,
approximately $5.3 million of net cash was used principally to purchase a previously leased skilled
nursing facility, and in the six months ended March 31, 2004, $48.8 million of cash was used to
purchase five previously leased eldercare centers and to restructure nine lease agreements in an
effort to reduce future lease payments. Investing activities for the six months ended March 31,
2005 and 2004 also include $14.2 million and $0.3 million, respectively, of net purchases of
restricted marketable securities held by our wholly owned insurance captive. Cash
flows from financing activities for the six months ended March 31, 2005 are reflective of
a significant number of financing transactions that occurred in the most recent quarter of fiscal
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 the 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. In January 2005, we repaid a $6.0 million mortgage that was assumed in the same period
upon the step acquisition of a skilled nursing facility joint venture partnership. Cash from net financing activities for the six months ended March 31, 2004 was a net source of
cash of $96.6 million, attributed to $400.7 million of net proceeds from our new financing
arrangements following the spin-off, offset by the use of $218.5 million to repay indebtedness of
NCI, $27.2 million to repay mortgage debt of five eldercare centers, $2.9 million of scheduled
principal payments and $55.5 million of cash transferred to NCI in connection with the spin-off. We continually evaluate the most efficient use of our capital, including investments in our
property and equipment, information systems, potential asset acquisitions or dispositions,
purchasing, refinancing, exchanging or retiring certain of our outstanding debt securities to the
extent permitted by our existing covenant restrictions. As part of such ongoing evaluation, our
Board of Directors has authorized the repurchase of up to $50.0 million of our common stock and
principal amounts of our 8% senior subordinated notes in accordance
with the restrictions of our amended and restated senior credit
agreement. 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. There were 520,000 shares of common stock repurchased at a cost of $20.8 million as
of March 31, 2005. 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 described below
will provide sufficient resources to meet our working capital requirements, debt service and other
short-term and long-term liquidity needs. At March 31, 2005, we had restricted investments in marketable securities of $107.8 million,
which are held by Liberty Health Corporation, LTD. (LHC), our wholly owned captive insurance
subsidiary incorporated under the laws of Bermuda. The investments held by LHC are restricted by
statutory capital requirements in Bermuda. As a result of such restrictions and encumbrances, we
and LHC are precluded from freely transferring funds through intercompany loans, advances or cash
dividends. Transactions Occurring After March 31, 2005 Debt
Repurchase.In April 2005, we repurchased an additional
$47.3 million of our 8% senior
subordinated notes resulting in a prepayment premium of $5.0 million, which will be recognized as a
loss on early extinguishment of debt in the third quarter of fiscal 2005. As a result of this
subsequent debt repurchase, our cash and debt levels were reduced to approximately $79.0 million
and $377.0 million, respectively. 34




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Recent Financing Transactions Convertible senior
subordinated debentures. In March 2005, we completed a private placement of $180.0 million
aggregate principal amount of our 2.5% convertible senior subordinated debentures due 2025 to
qualified institutional buyers under Rule 144A of the Securities Act of 1933, as amended. Interest
is payable semi-annually in March and September. Each of our subsidiaries that guarantees the
indebtedness under the senior subordinated notes also guarantees the convertible senior
subordinated debentures. The guarantees will be released at such time that such subsidiary ceases
to be a guarantor under the senior subordinated notes, all of the senior subordinated notes are no
longer outstanding, or on March 20, 2012. The debentures may be
converted into cash and, depending on the circumstances at the time
of conversion, shares of our
common stock. The initial conversion rate for the debentures will be equivalent to 18.4493 shares
of common stock per $1,000 principal amount of the debentures (which is based upon an initial
conversion price equivalent to approximately $54.20 per share), subject to adjustment under
certain circumstances. The holders of the convertible senior subordinated debentures may convert
their debentures into shares of our common stock prior to the stated maturity at their option
only under the following circumstances: (1) if, after June 30, 2005, the closing price of our
common stock exceeds 130% of the conversion price then in effect for at least 20 trading days
in the 30 consecutive trading day period ending on the last trading day of the immediately
preceding fiscal quarter; (2) during the five business days immediately following any five
consecutive trading day period in which the trading price per $1,000
principal amount of debentures for each day of such period was less than 95% of the product
of the closing price of our common stock and the applicable conversion rate then in effect,
subject to certain exceptions; (3) the debentures have been called for redemption; (4) upon the
occurrence of specified corporate transactions; or (5) upon the occurrence of certain designated
events. Subject
to certain exceptions, once debentures are tendered for conversion,
the value, or conversion value, of the cash and shares of our common stock, if any, to
be received by a holder converting $1,000 principal amount of the debentures will be determined
by multiplying the applicable conversion rate by the ten trading day average closing price of
our common stock. We will deliver the conversion value to holders as follows: (i) an amount in cash,
referred to as the principal return, equal to the lesser of (x) the aggregate conversion value of
the debentures to be converted and (y) the aggregate principal amount of the debentures to be
converted, (ii) if the aggregate conversion value of the debentures to be converted is greater
than the principal return, an amount in whole shares, referred to as the net shares, equal to
such aggregate conversion value less the principal return, referred to as the net share amount,
and (iii) an amount in cash in lieu of any fractional shares of our common stock. The number of
net shares to be paid will be determined by dividing the net share amount by the ten trading day
average closing price of our common stock. We may not redeem the
convertible senior subordinated debentures before March 20, 2010. The holders of the convertible
senior subordinated debentures may require us to purchase all or a portion of their debentures
at any of three specified dates during the life of the debentures, with the first such date being
March 15, 2012, or upon the occurrence of certain designated events for cash at a repurchase
price equal to the principal amount plus accrued and unpaid interest plus, in the case of certain
designated events that occur on or prior to March 20, 2010, a make whole premium, if any, payable
solely in shares of our common stock. In connection with the
issuance of the convertible senior subordinated debentures, we have agreed with The Nasdaq Stock
Market, Inc. not to take certain actions without prior shareholder approval if, as a result of
such actions, greater than 19.99% of our common stock outstanding immediately prior to the
issuance of the debentures would be issued. Amendment to Senior Credit Facility.In connection with the offering of the convertible
senior subordinated debentures, we entered into an amended and restated senior credit agreement
pursuant to which we refinanced the indebtedness under our existing senior credit agreement. We
repaid all outstanding borrowings under the term loan portion of the senior credit facility and
expanded the borrowing capacity of the revolving credit portion. The
senior credit agreement previously provided for a revolving credit
facility of $75.0 million with sub limits
for swing line loans, letters of credit and term loans. The amended and restated senior credit
agreement provides for a $125.0 million revolving credit facility, with sub limits for the issuance
of letters of credit and for swing line loans. However, so long as we are not in default and if we
find lenders that are willing to commit, the amended and restated senior credit agreement allows us
to add up to $50.0 million of additional available credit under the revolver, subject to the
approval of our Board of Directors. Each of our material U.S. subsidiaries provided guarantees of
the indebtedness under the amended and restated senior credit agreement. We and the guarantors
pledged substantially all of our personal property to secure the obligations under the amended and
restated senior credit agreement, subject to certain exceptions agreed upon with the lenders. In
addition, the mortgages that we and our subsidiaries provided under the prior credit agreement
continue to secure the amended and restated senior credit agreement, but we are not required to
provide additional mortgages except under certain limited circumstances. The amended and restated
senior credit agreement has a five year term. We pay interest on the outstanding loans under the amended and restated senior credit
agreement at either a base rate plus a margin or at the London Interbank Offered Rate (LIBOR) plus
a margin. Initially, that margin will be 0.50% for base rate loans and 1.50% for LIBOR loans. The
margin will be adjusted, from time to time, depending on our leverage ratio, as defined. For LIBOR
loans, the margin range is from 1.00% to 2.00%. For base rate loans, the margin range is from
0.00% to 1.00%. We pay a commitment fee to the lenders on the unused portion of the revolving
credit facility equal to 0.50% of the unused amount; that percentage will drop to 0.375% if our
leverage ratio drops below 2.25:1.00. The agreements and instruments governing the amended and restated senior credit agreement
contain various restrictive covenants that, among other things, restrict our ability to: incur
more debt; pay dividends; purchase our common stock or make other distributions; make payments in
respect of subordinated debt; make certain investments; create liens; enter into transactions with
affiliates; make acquisitions, merge or consolidate; and transfer or sell assets. 35




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The amended and restated senior credit agreement requires that we maintain compliance with
certain financial covenants as defined in the agreement, including a senior leverage ratio, a total
leverage ratio and a fixed charge coverage ratio. There is also a limitation on the amount of
capital expenditures that we may make. Contractual Obligations and Commitments We have future obligations for debt repayments and future minimum rentals under operating
leases. The obligations as of March 31, 2005 are summarized as follows (in thousands): Payments Due by PeriodContractual Obligations
    
    Total
    
    
    Less than 1 year
    
    
    1-3 years
    
    
    4-5 years
    
    
    ThereafterLong-term debt
    
    $
    423,862
    
    
    $
    4,121
    
    
    $
    15,609
    
    
    $
    3,223
    
    
    $
    400,909Operating leases
    
    
    139,753
    
    
    
    22,146
    
    
    
    39,916
    
    
    
    30,063
    
    
    
    47,628$
    563,615
    
    
    $
    26,267
    
    
    $
    55,525
    
    
    $
    33,286
    
    
    $
    448,537
 We have committed to exercise our option to purchase one of our currently leased
eldercare centers in the State of New Hampshire for $4.1 million. The purchase option is
contingent upon the lenders consent for assumption of approximately $2.0 million of debt. In
addition, we have entered into contractual commitments of approximately $5.6 million related to our
internal construction program. Off-Balance Sheet Commitments In addition to the contractual obligations and commitments described above, we also have
contingent obligations related to outstanding lines of credit, letters of credit and guarantees. Requests for providing commitments to extend financial guarantees and extend credit are
reviewed and approved by senior management and the board of directors in accordance with
obligational authority policies. Management regularly reviews all outstanding commitments, letters
of credit and financial guarantees, and the results of these reviews are considered in assessing
the need for any reserves for possible credit and guarantee loss. We have extended $4.1 million in working capital lines of credit to certain jointly owned and
managed companies, of which $2.2 million were unused at March 31, 2005. 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 $3.0 million of outstanding letters of credit. The letters of credit guarantee
performance to third parties of various trade activities. The letters of credit are not recorded
as liabilities on our consolidated balance sheet unless they are probable of being utilized by the
third party. The financial risk approximates the amount of outstanding letters of credit. We have provided $0.3 million of financial guarantees related to loan commitments of one
jointly owned and managed company. The guarantees are not recorded as liabilities on our
consolidated balance sheet unless we are required to perform under the guarantee. Credit risk
represents the accounting loss that would be recognized at the reporting date if counter-parties
failed to perform completely as contracted. The credit risk amounts are equal to the contractual
amounts, assuming that the amounts are fully advanced and that no amounts could be recovered from
other parties. 36




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Income Taxes For the six months ended March 31, 2005, we utilized $14.7 million in net operating loss
carryforwards, and had estimated net operating loss carryforwards remaining of $171.3 million. For
the reasons which follow, we do not believe that the tax benefits related to the net operating loss
carryforwards are more likely than not to be realized and, therefore, they remain fully reserved.
In addition to taxable income limitations, the tax benefits related to net operating loss
carryforwards are subject to statutory limitations as well as contractual limitations between us
and NCI. Moreover, the net operating loss carryforwards available to us will not be
determinable until preparation of NCIs federal tax return for its fiscal year ended September 30,
2004 is completed. This is expected to occur in the third quarter of fiscal 2005 and could
materially reduce our estimated net operating loss carryforwards. During
the six months ended March 31, 2005, we recognized a tax refund and a
tax credit of $0.7 million and $0.2 million, respectively, which
reduced our effective tax rate of 39.8% to 37.5%. 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. 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, 2004:  
    Allowance for Doubtful Accounts;
    Loss Reserves for Certain Self-Insured Programs;
    Revenue Recognition / Contractual Allowances; and
    Long-Lived Asset Impairments. During the current quarter, we did not make any material changes to our estimates or methods
by which estimates are derived with regard to our critical accounting policies. New Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123R,
Share-Based Payment(SFAS 123R), which requires companies to measure and recognize compensation
expense for all stock-based payments at fair value. On April 14,
2005, the Securities and Exchange Commission issued rules to
allow companies to adopt the standard at the beginning of the fiscal year that begins after June
15, 2005 and, thus, will be effective for us beginning October 1, 2005. We are currently
evaluating the option valuation methodologies, transition alternatives and assumptions in light of
SFAS 123R, and therefore cannot estimate the impact of our adoption at this time. Adoption of the
expensing requirements of SFAS 123R will increase our operating expenses. The new methodologies
and assumptions may be different than those currently employed by us
in
disclosing the impact of applying the fair value-based method
under SFAS 123 to outstanding and unvested awards.
See
note 10  Stock Option Plan for information related to the pro forma effects of stock-based
employee compensation on our reported results assuming application of the fair value recognition
provisions of SFAS 123. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107), Share-Based
Payment, which provides interpretive guidance related to the interaction between SFAS 123R and
certain SEC rules and regulations, as well as provides the SEC staffs views regarding the
valuation of share-based payment arrangements. In particular, SAB 107 provides guidance related to
share-based payment transactions with non employees, the transition from non-public to public
entity status, valuation methods (including assumptions such as expected volatility and expected
term), the accounting for certain redeemable financial instruments issued under share-based payment
arrangements, the classification of compensation expense, non-GAAP financial measures, first-time
adoption of SFAS No. 123R in an interim period, capitalization of compensation cost related to
share-based payment arrangements, the accounting for income tax effects of share-based payment
arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to
adoption of SFAS No. 123R and disclosures in Managements Discussion and Analysis of Financial
Condition and Results of Operations subsequent to adoption of 37




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SFAS No. 123R. We are currently assessing the impact of SAB 107 on our implementation and
adoption of SFAS 123R. In March, 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position
(FSP) FIN 46 (R)-5, Implicit Variable Interests under FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities to address whether a reporting enterprise
should consider whether it holds an implicit variable interest in a variable interest entity (VIE)
or potential VIE when specific conditions exist. The determination of whether an implicit variable
interest exists should be based on whether the reporting enterprise
may absorb the variability of the
VIE or potential VIE. This FSP is effective, for entities to which the interpretations of FIN
46(R) have been applied, in the first reporting period beginning after March 3, 2005, or our
quarter ended June 30, 2005. We have not yet determined the impact of adopting FSP FIN 46 (R)-5,
if any, on our consolidated financial statements and related disclosures. At their March 2005 meeting, the Emerging Issues Task Force (EITF) reaffirmed its position
regarding Issue No. 04-5 (EITF 04-05), Investors Accounting for an Investment in a Limited
Partnership When the Investor Is the Sole General Partner and the Limited Partners Have Certain
Rights. The tentative conclusion provides a framework for addressing the question of when a sole
general partner, as defined in EITF 04-5, should consolidate a limited partnership. The EITF has
concluded that the general partner of a limited partnership should consolidate a limited
partnership unless (1) the limited partners possess substantive kick-out rights as defined in
paragraph B20 of FIN 46(R), Consolidation of Variable Interest Entities,or (2) the limited
partners possess substantive participating rights similar to the rights described in Issue 96-16,
Investors Accounting for an Investee When the Investor has a Majority of the Voting Interest but
the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights. In addition, the
EITF has concluded that the guidance should be expanded to include all limited partnerships,
including those with multiple general partners. EITF 04-05 has not been finalized and no effective
date has been announced. The EITF acknowledged that the tentative conclusions reached in EITF
04-05 conflict with certain aspects of Statement of Position 78-9 Accounting for Investments in
Real Estate Ventures(SOP 78-9). The EITF requested that the FASB consider amending the guidance
in SOP 78-9 to be consistent with the tentative conclusions reached in EITF 04-5. The FASB
discussed this request at its meeting in November 2004 and agreed to propose an amendment to SOP
78-9 to address that inconsistency. The EITFs tentative conclusions will be reconsidered at its
meeting in June 2005, at which time a final consensus is expected to be reached. Depending on the
outcome of the discussions of the EITF in future meetings, the outcome could impact whether or not
we consolidate investment partnerships we hold a general partner interest in. Other We manage the operations of 43 eldercare centers and 13 transitional care units. Under a
majority of these arrangements, we employ the operational staff of the managed business for ease of
benefit administration and bill the related wage and benefit costs on a dollar-for-dollar basis to
the owner of the managed property. In this capacity, we operate as an agent on behalf of the
managed property owner and are not the primary obligor in the context of a traditional
employee/employer relationship. Historically, we have treated these transactions on a net basis,
thereby not reflecting the billed labor and benefit costs as a component of our net revenue or
expenses. For the six months ended March 31, 2005, we billed our managed clients $56.6 million for
such labor related costs compared to $55.1 million for the comparable period in the prior year. Seasonality Our earnings generally fluctuate from quarter to quarter. This seasonality is related to a
combination of factors, which include the timing of Medicaid rate increases and payroll tax
obligations, inclement weather, seasonal census cycles, and the number of calendar days in a given
quarter. 38




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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, and Managements Discussion and Analysis of
Financial Condition and Results of Operations. Update on Laws
Governing Health Information The security rules of the
Health Insurance Portability and Accountability Act of 1996, or HIPAA, went into effect on April
20, 2005. Further, on April 18, 2005, the Department of Health and Human Services, or DHHS,
published its Proposed Rule on Enforcement of the HIPAA Administrative Simplification provisions,
including the transaction standards, the security standards and the privacy rule. This proposed
enforcement rule addresses, among other issues, DHHSs policies for determining violations and
calculating civil money penalties, how DHHS will address the statutory limitations on the
imposition of civil money penalties, and various procedural issues.  At this time, we believe
we are in substantial compliance with the HIPAA requirements that are currently in effect, and
we continue to make good faith efforts to address compliance. 
 ITEM 3: Quantitative and Qualitative Disclosures about Market Risk We are exposed to the impact of interest rate changes. At March 31, 2005, we have $8.0 million of debt subject to variable rates of interest. A one
percent change in LIBOR would result in a change to our interest expense of $0.1 million annually. At March 31, 2005, we have $126.2 million of cash and equivalents that are affected by market
rates of interest. A one percent change in the rate of interest would result in a change in
interest income of $1.3 million annually. At March 31, 2005, we held $12.0 million of restricted investments in marketable securities
that are affected by market rates of interest. A one percent change in the rate of interest would
result in a change in interest income of $0.1 million annually. 39




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ITEM 4: Controls and Procedures (a) Evaluation 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 our disclosure controls and procedures (as defined
in Exchange Act Rule 13a-15(e)). 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 Form 10-Q, is properly recorded, processed,
summarized and reported within the time periods required by the Securities and Exchange
Commissions rules and forms. Management necessarily applied its judgment in assessing the costs
and benefits of such controls and procedures that, by their nature, can provide only reasonable
assurance regarding managements control objectives. Management does not expect that its disclosure
controls and procedures will prevent all errors and fraud. A control system, irrespective of how
well it is designed and operated, can only provide reasonable assurance, and cannot guarantee that
it will succeed in its stated objectives. We are currently documenting, evaluating the design effectiveness of and testing the internal
controls of our significant processes over financial reporting, as required by Section 404 of the
Sarbanes-Oxley Act, in order to allow our management to report on, and our Registered Independent
Public Accounting Firm to attest to, our internal controls over financial reporting. The evaluation
and testing requires significant costs and management time. In the course of our ongoing evaluation
and testing, management has identified certain deficiencies and implemented remediation plans or is
in the process of planning remediation for the deficiencies. Based on an evaluation of the effectiveness of disclosure controls and procedures, our chief
executive officer and chief financial officer concluded that our disclosure controls and procedures
were effective in reaching a reasonable level of assurance that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time period specified in the Securities and Exchange
Commissions rules and forms. (b) Changes in internal controls. There was no change in our internal controls over financial reporting 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. 40




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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 the 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 plaintiffs complaint against all named 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 The following table provides information with respect to common stock repurchased by us during
the three months ended March 31, 2005: Total Number of
    
    
    Approximate DollarShares Purchased
    
    
    Value of Shares thatTotal Number
    
    
    Average
    
    
    as Part of Publicly
    
    
    May Yet Beof Shares
    
    
    Price Paid
    
    
    Announced Plans
    
    
    Purchased Under thePeriod
    
    Repurchased
    
    
    per Share
    
    
    or Programs (1)
    
    
    Plans or Programs (1)1/1/05 - 1/31/05
    
    
    20,000
    
    
    $
    35.41
    
    
    
    20,000
    
    
    $
    49,290,7302/1/05 - 2/28/05
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    49,290,7303/1/05 - 3/31/05
    
    
    500,000
    
    
    $
    40.15
    
    
    
    500,000
    
    
    $
    29,205,730Total
    
    
    520,000
    
    
    $
    39.97
    
    
    
    520,000
   (1)
    
    In November 2004, our Board of Directors authorized the repurchase of up to $25.0
million of our common stock commencing in December 2004. In February 2005, our Board of Directors authorized an increase to our previously
established share repurchase program from $25.0 million to $50.0 million of our common
stock. 
 ITEM 3: Defaults Upon Senior Securities None 41




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ITEM 4: Submission of Matters to a Vote of Security Holders Pursuant to the election of the two directors listed below, George V. Hager,
Jr. and Kevin M. Kelley were each elected as Class I directors to serve until
the 2008 Annual Meeting of Shareholders and until their successors are duly
elected and qualified. Robert H. Fish, Charles W. McQueary and Charlene
Connolly Quinn continue to serve as Class II directors to serve until the 2006
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 23, 2005, we held our 2005 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 matters were voted on:  
    the election of George V. Hager, Jr. and Kevin M. Kelley to hold office for a term of
three years and until each of their successors are duly elected and qualified; and
    the amendment to the 2003 Stock Incentive Plan increasing the number of shares of Common
Stock available for issuance under the 2003 Stock Incentive Plan from 750,000 to 1,000,000. A summary of the voting results follows: Votes For
    
    
    
    Votes Against
    
    
    
    Votes Withheld
    
    
    
    Broker Non-votesElection of George V. Hager, Jr.
    
    
    
    15,711,745
    
    
    
    
    
    
    
    
    
    2,141,247
    
    
    
    
    Election of Kevin M. Kelley
    
    
    
    16,935,335
    
    
    
    
    
    
    
    
    
    917,657
    
    
    
    
    Amendment to the 2003 Stock Incentive Plan
    
    
    
    14,172,552
    
    
    
    
    1,197,214
    
    
    
    
    111,095
    
    
    
    
    2,372,131
 
 ITEM 5: Other Information- None. 42




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ITEM 6: Exhibits  (a)
    Exhibits  4.1
    Indenture, dated as of March 2, 2005, with respect to the 2.5% Convertible Senior
Subordinated Debentures due 2025 of Genesis HealthCare Corporation by and among Genesis
HealthCare Corporation, the subsidiary guarantors named therein and The Bank of New York,
as trustee.4.2
    Supplemental Indenture, dated March 16, 2005, with respect to the 8% Senior Subordinated
Notes due 2013 of Genesis HealthCare Corporation by and among Genesis HealthCare Corporation, the
subsidiary guarantors named therein and The Bank of New York, as trustee.10.1
    Amendment to 2003 Stock Incentive Plan of Genesis HealthCare Corporation, dated as of
February 23, 2005.10.2
    Purchase Agreement, dated as of February 24, 2005, by and among Genesis HealthCare
Corporation, the subsidiary guarantors named therein and the Initial Purchasers named therein.10.3
    Registration Rights Agreement, dated as of March 2, 2005, by and among Genesis HealthCare
Corporation, the subsidiary guarantors named therein and Wachovia Capital Markets LLC, on behalf
of the Initial Purchasers.10.4
    Amended and Restated Credit, Security, Guaranty and Pledge Agreement dated as of
March 2, 2005 among Genesis HealthCare Corporation, as Borrower, the Guarantors referred to
therein, and the Lenders referred to therein, and Wachovia Capital Markets LLC as co-lead
arranger and bookrunner, Wachovia Bank, National Association as administrative agent, General
Electric Capital Corporation as co-lead arranger and documentation agent, Citicorp North America, Inc. as syndication agent and Merrill Lynch Capital, a Division of Merrill Lynch Business
Financial Services, Inc. as syndication agent (schedules and exhibits are omitted; Genesis
HealthCare Corporation agrees to furnish supplementally a copy of such schedules and/or exhibits
to the Securities and Exchange Commission upon request).31.1
    Certification of George V. Hager, Jr., Chief Executive Officer,
of the Company dated May 10, 2005 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 10, 2005 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 10, 2005 pursuant to 18 U.S.C. Section 1350.32.2
    Certification of James V. McKeon, Chief Financial Officer, of
the Company dated May 10, 2005 pursuant to 18 U.S.C. Section 1350. 43




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Genesis HealthCare Corporation/s/ James V. McKeonDate:  May 10, 2005
    James V. McKeon,Chief Financial Officer/s/ George V. Hager, Jr.Date:  May 10, 2005
    George V. Hager, Jr.,Chief Executive Officer and Chairman of the Board 44