##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31,
    2003                                             
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to                                             

Commission file number 333-57279

Skilled Healthcare Group, Inc.

(Exact Name of Registrant as Specified in Its
Charter)


|                                                                                                                     |  |                                         
|-------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                                                                             |  | 95-4644784                              
|(State or Other Jurisdiction of
    Incorporation or Organization)                                                   |  | (I.R.S. Employer
    Identification No.)
|27442 Portola Parkway, Suite 200
    Foothill Ranch, CA 92610(Address of Principal Executive
    Offices) (Zip Code)

Registrants Telephone Number, Including
Area Code:

(949) 282-5800


Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

None




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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 o          No þ

Indicate
by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K. þ

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange
Act).     Yes o          No þ

Indicate by check mark whether the registrant has
filed all documents and reports required to be filed by
Section 12, 13, or 15(d) of the Securities Exchange Act of
1934 subsequent to the distribution of securities under plan
confirmed by a
court.     Yes þ          No o

As of March 15, 2004, the issuer had
1,193,587 shares of class A common stock, $0.01 par value
per share, 70,661 shares of class B non-voting common
stock, $0.01 par value per share, and 15,000 shares of series A
preferred stock, $0.01 par value per share, outstanding. The
Companys common stock is not registered on any national
exchange and there is no market for the registrants stock at
such date.



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SKILLED HEALTHCARE GROUP, INC.

TABLE OF CONTENTS

|               |  |                                                                                           |    |      |    | 
|-------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- | 
|               |  |                                                                                           |    | Page
|               |  |                                                                                           |    |     
|PART
    I    
|Item 1.        |  | Business                                                                                  |    |      | 1  | 
|Item 2.        |  | Properties                                                                                |    |      | 10 | 
|Item 3.        |  | Legal Proceedings                                                                         |    |      | 10 | 
|Item 4.        |  | Submission of Matters to a
    Vote of Security Holders                                   |    |      | 11 | 
|PART
    II   
|Item 5.        |  | Market for Registrants
    Common Equity and Related Stockholder Matters                 |    |      | 11 | 
|Item 6.        |  | Selected Financial Data                                                                   |    |      | 12 | 
|Item 7.        |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations |    |      | 12 | 
|Item 7A.       |  | Quantitative and Qualitative
    Disclosures About Market Risk                            |    |      | 30 | 
|Item 8.        |  | Financial Statements and
    Supplementary Data                                           |    |      | 30 | 
|Item 9.        |  | Changes in and Disagreements
    With Accountants on Accounting and Financial Disclosure  |    |      | 30 | 
|Item 9A.       |  | Controls and Procedures                                                                   |    |      | 30 | 
|PART
    III  
|Item 10.       |  | Directors and Executive
    Officers of the Registrant                                    |    |      | 31 | 
|Item 11.       |  | Executive Compensation                                                                    |    |      | 34 | 
|Item 12.       |  | Security Ownership of
    Certain Beneficial Owners and Management                        |    |      | 41 | 
|Item 13.       |  | Certain Relationships and
    Related Transactions                                        |    |      | 44 | 
|Item 14.       |  | Principal Accounting Fees
    and Services                                                |    |      | 47 | 
|PART
    IV   
|Item 15.       |  | Exhibits, Financial
    Statement Schedules, and Reports on Form 8-K                      |    |      | 48 | 
|Signatures     |  |                                                                                           | 51 |     
|Certifications |  |                                                                                           |    |     
|EXHIBIT 3.1   
|EXHIBIT 10.25 
|EXHIBIT 31.1  
|EXHIBIT 31.2  
|EXHIBIT 32.1  





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##### Table of Contents






PART I






|        |         
|------- | --------
|Item 1. | Business

General

Skilled Healthcare Group, Inc., formerly known as
Fountain View, Inc. (the Company), through its
subsidiaries, is an operator of long-term care facilities and a
provider of a wide range of post-acute care services, with a
strategic emphasis on sub-acute specialty medical care. The
terms Company, we, our, and
us refer to Skilled Healthcare Group, Inc. and
its subsidiaries (formerly known as Fountain View, Inc.). We
operate a network of facilities in California and Texas,
including 48 skilled nursing facilities (SNFs) that offer
sub-acute, rehabilitative and specialty medical skilled nursing
care, as well as five assisted living facilities (ALFs) that
provide room and board and social services. In addition, we
provide a variety of ancillary services such as physical,
occupational and speech therapy in Company-operated facilities
and unaffiliated facilities. We also operate three institutional
pharmacies (one of which is a joint venture), which serve acute
care hospitals as well as SNFs and ALFs, both affiliated and
unaffiliated with us.

We were originally incorporated in Delaware in
1997 as Fountain View, Inc. and became known as Skilled
Healthcare Group, Inc. in 2003.

Our administrative services subsidiary maintains
an Internet website address www.skilledhealthcare.com. Our
periodic reports, together with amendments to these reports, are
available on this Internet website, free of charge, as soon as
reasonably practicable after such material is electronically
filed with, or furnished to, the Securities and Exchange
Commission. The information on this website is not incorporated
by reference in this Annual Report on Form 10-K.

Reorganization under Chapter 11

On October 2, 2001, we and 19 of our
subsidiaries filed voluntary petitions for protection under
Chapter 11 of the U.S. Bankruptcy Code with the
U.S. Bankruptcy Court for the Central District of
California, Los Angeles Division (the Bankruptcy
Court). On November 28, 2001, our remaining three
subsidiaries also filed voluntary petitions for protection under
Chapter 11.

Our financial difficulties and those of our
subsidiaries were attributable to a number of factors. The
federal government had fundamentally changed reimbursement rates
and procedures for medical services provided to individuals in
1999. These changes had a significant adverse effect on the
healthcare industry on the whole as well as on our cash flows.
These changes also exacerbated a long-standing problem of
inadequate reimbursement by the states for medical services
provided to indigent persons under the various states
Medicaid programs. At the same time, we experienced significant
increases in our labor costs and professional liability and
other insurance costs.

Following our petition for protection under
Chapter 11, we and our subsidiaries continued to operate
their businesses as debtors-in-possession subject to the
jurisdiction of the Bankruptcy Court through August 19,
2003 (the Effective Date), when we emerged from
bankruptcy pursuant to the terms of our Third Amended Joint Plan
of Reorganization dated April 22, 2003 (the
Plan). In connection with emerging from bankruptcy,
we changed our name to Skilled Healthcare Group, Inc. From the
date we filed the petition with the Bankruptcy court through
December 31, 2003, we incurred reorganization expenses
totaling approximately $30.1 million.

1



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##### Table of Contents



The principal components of reorganization
expenses incurred during the three years ended December 31,
2003 are as follows (in thousands):

|                                         |  |      |        |      |  |      |        |   |  |   |       |  
|---------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ----- | -
|                                         |  | 2003 |        | 2002 |  | 2001
|                                         |  |      |        |      |  |     
|Professional fees                        |  | $    | 7,336  |      |  | $    | 8,181  |   |  | $ | 4,315 |  
|Court-related services                   |  |      | 503    |      |  |      | 711    |   |  |   | 380   |  
|Refinancing Costs                        |  |      | 1,990  |      |  |      | 762    |   |  |   |      |  
|Other fees                               |  |      | 3,252  |      |  |      | 2,791  |   |  |   | 110   |  
|Less interest earned on accumulated cash |  |      | (115   | )    |  |      | (141   | ) |  |   | (18   | )
|                                         |  |      |        |      |  |      |        |   |  |   |       |  
|Total                                    |  | $    | 12,966 |      |  | $    | 12,304 |   |  | $ | 4,787 |  
|                                         |  |      |        |      |  |      |        |   |  |   |       |  

On July 10, 2003, the Bankruptcy Court
confirmed our Plan, which was approved by substantially all
creditors and implemented on the Effective Date. The principal
provisions of the Plan included:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the incurrence by the Company of
    (i) approximately $32.0 million in indebtedness
    available under new Revolving Credit Facilities;
    (ii) approximately $23.0 million under a new Secured
    Mezzanine Term Loan; and (iii) approximately
    $95.0 million under a new Senior Mortgage Term Loan;                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | the satisfaction of the Companys
    11 1/4% Senior Subordinated Notes due 2008 (Senior
    Subordinated Notes) upon the issuance or payment by us to
    the holders of Senior Subordinated Notes on a pro rata basis of
    (i) approximately $106.8 million of new Senior
    Subordinated Secured Increasing Rate Notes due 2008
    (Increasing Rate Notes) that accrue interest at an
    initial rate of 9.25% and provide for annual rate increases,
    (ii) 58,642 shares of common stock and (iii) cash in
    the amount of $50.0 million, consisting of approximately
    $36.0 million in outstanding interest and approximately
    $14.0 million of principal;
|
| |  | the payment in full of amounts outstanding under
    our $90 million Term Loan Facility and $30 million
    Revolving Credit Facility;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | the issuance of one share of new series A
    preferred stock for each share of the Companys existing
    series A preferred stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | the cancellation of the Companys
    series A common stock and the issuance of
    1.1142 shares of new common stock for each share of
    cancelled series A common stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | the cancellation of the Companys
    series B common stock and options to purchase series C
    common stock, with no distribution made in respect thereof;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | the cancellation of the Companys
    series C common stock and the issuance of one share of new
    common stock for each share of cancelled series C common
    stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | the cancellation of outstanding warrants to
    purchase series C common stock and the issuance of new warrants,
    on substantially the same terms, to purchase a number of shares
    of new common stock equal to the number of shares of
    series C common stock that were subject to the existing
    warrants so cancelled;                                                                                                                                                                                                                                                                                                                                               
|
| |  | an amendment and restatement of the
    Companys stockholders agreement;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | the impairment of certain secured claims and the
    impairment of certain general unsecured claims; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | the restructuring of the Companys and its
    subsidiaries businesses and legal structure.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

In March 2004 we recapitalized the new common
stock authorized pursuant to the Plan into our class A
common stock, $0.01 par value per share (the Class A
common stock). We also designated a new class of common
stock as our class B non-voting common stock, $0.01 par
value per share (the Class B common stock together
with Class A common stock, Common Stock).

2



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Our Business

We have three business segments that offer
different services and products:



| |   |                      
| | - | ---------------------
| |  | nursing services;    
|
| |  | therapy services; and
|
| |  | pharmacy services.   



| |                 
| | ----------------
| | Nursing Services

We provide skilled nursing care in each of our 48
SNFs which collectively have 6,337 licensed beds in
California and Texas. Skilled nursing care consists of
24 hour care by registered nurses, licensed practical or
vocational nurses and certified aides, as well as room and
board, special nutritional programs, social services,
recreational activities and related medical and other services
that may be prescribed by a physician. Assisted living services
include general services provided by our five ALFs, which
collectively have licensed 700 beds. These services consist of
basic room and board, social activities and assistance with
activities of daily living such as dressing and bathing.

We provide specialty medical care, including a
wide range of sub-acute services to patients with medically
complex needs who generally require more intensive treatment and
a higher level of skilled nursing care. These services represent
a area of strategic emphasis for us and typically generate
higher profit margins than basic healthcare services. We also
provide blood transfusions, chemotherapy, dialysis,
enteral/parenteral nutrition, tracheotomy care, and ventilator
care.

We are committed to providing our patients with
the highest possible standard of care. We have a Quality
Assurance department consisting of registered nurses who
routinely visit our facilities and conduct quality assurance
tests to ensure the consistently high quality of care provided
in each facility. Additionally, Quality Assurance department
conduct regular training for the nursing and other staff in each
facility.



| |                 
| | ----------------
| | Therapy Services

We provide rehabilitative physical, occupational
and speech therapy to unaffiliated long term care settings as
well as to our facilities, using progressive, personalized
treatment approach to promote the patients level of
independence in mobility and strength. Many of our patients who
have undergone orthopedic surgeries, including joint
replacements such as total hip or knee replacements or
fractures, receive physical therapy. Our therapists also perform
wound care and utilize electric stimulation to stimulate viable
tissue regrowth. Occupational therapy addresses improvements in
functional skills of the upper body and all aspects of
self-care. We provide range of motion and strengthening
exercises for contracture prevention and reduction. Speech
therapists treat patients with speech disorders, perceptual
problems, cognitive problems and swallowing problems.



| |                  
| | -----------------
| | Pharmacy Services

We provide pharmaceutical products and services
through two institutional pharmacies in Southern California. We
also own a 50% equity interest in a limited liability company
that operates a pharmacy in Austin, Texas. These pharmacies
serve unaffiliated SNFs and ALFs located throughout
much of Southern California and in certain Northern California
and Texas markets, as well as most of our SNFs and
ALFs. Our pharmacies provide prescription drugs,
intravenous products, external nutrition therapy services and
infusion therapy services, including nutrition, pain management,
antibiotics and hydration.

3



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The following table sets forth the revenues from
external customers from each of our business segments for the
year ended December 31, 2003, 2002 and 2001 (in thousands):

|                  |       |                         |         |         |  |      |         |         |  |   |         |         | 
|----------------- | ----- | ----------------------- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------- | ------- | 
|                  |       |                        
|                  |       | Year Ended December 31,
|                  |       |                        
|                  |       | 2003                    |         | 2002    |  | 2001
|                  |       |                         |         |         |  |     
|Nursing Services  |       | $                       | 299,314 |         |  | $    | 281,447 |         |  | $ | 270,162 |        
|Therapy Services  |       |                         | 17,678  |         |  |      | 21,098  |         |  |   | 18,997  |        
|Pharmacy Services |       |                         | 42,350  |         |  |      | 39,980  |         |  |   | 29,171  |        
|Other             |       |                         | (53     | )       |  |      | (978    | )       |  |   | 90      |        
|                  |       |                         |         |         |  |      |         |         |  |   |         |        
|                  | Total |                         | $       | 359,289 |  |      | $       | 341,547 |  |   | $       | 318,420 | 
|                  |       |                         |         |         |  |      |         |         |  |   |         |        

See Note (3), Business Segments,
in the notes to the consolidated financial statements listed
under Item 15(a) of Part IV of this report for further
information concerning our operations.

Employees

As of December 31, 2003, we had
approximately 7,150 full-time equivalent employees. We have two
collective bargaining agreements with a union covering
approximately 400 employees. We consider the relations with our
employees to be good and have not experienced any strikes or
work stoppages. We are subject to federal and state minimum wage
and applicable federal and state wage and hour laws and maintain
various employee benefits plans.

Competition

We operate in a highly competitive industry. Our
facilities compete primarily on a local and regional basis with
many long-term care providers, some of whom may own as few as a
single center. Our ability to compete successfully varies from
location to location and depends on a number of factors, which
include the number of competing centers in the local market; the
types of services available; quality of care; reputation, age
and appearance of each center; and the cost of care in each
location. In general, we seek to compete in each market by
establishing a reputation within the local community for quality
and caring health services, attractive and comfortable
facilities, and providing specialized health care. The
competitiveness of our markets is further increased by the fact
that within California and Texas a Certificate of Need is no
longer required in order to build or expand a SNF.

Our pharmacies also operate in a highly
competitive environment. They compete with regional and local
pharmacies and pharmacies operated by other long-term care
chains or by other companies ranging from small local operators
to companies that are national in scope and distribution
capability. We also expect to encounter continued competition in
connection with our rehabilitation services which include
physical, occupational and speech therapy.

Insurance

We maintain insurance for general and
professional liability, workers compensation and
employers liability, employee benefits liability,
property, casualty, directors and officers, inland marine,
crime, boiler and machinery, automobile, employment practices
liability, earthquake and flood, We believe that our insurance
programs are adequate and where there has been a direct transfer
of risk to the insurance carrier, we do not recognize a
liability in our consolidated financial statements.

Workers Compensation.Our Texas operations have medical only
coverage and an excess employers liability policy with a
$1,000,000 per occurrence self-insured retention. Our California
operations have a fully insured high-deductible workers
compensation policy with a $500,000 per occurrence deductible.

General and Professional Liability.Our skilled nursing services subject
us to certain liability risks. Malpractice claims may be
asserted against us if our services are alleged to have resulted
in patient injury or other adverse effects, the risk of which is
greater for higher-acuity patients, such as those receiving
specialty

4



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and sub-acute services, than for traditional
long-term care patients. We have from time to time been subject
to malpractice claims and other litigation in the ordinary
course of business.


Effective April 10, 2001, we obtained a
retrospectively rated claims-made policy with a self-insured
retention of $250,000 for our California and Arizona facilities
and $1,000,000 for our Texas facilities. Each facility has an
occurrence and aggregate coverage limit of $4,000,000 and
$5,000,000, respectively, and our overall company-wide aggregate
coverage limit is $5,000,000. We do not carry any excess general
and professional liability insurance coverage.

Additional insurance for periods prior to
April 10, 2001 is provided for certain facilities through a
claims-made umbrella policy with limits of $15,000,000 per
occurrence and in the aggregate for the period March 1,
1999 to March 1, 2000 and $25,000,000 per occurrence and in
the aggregate for the policy period March 1, 2000 to
April 10, 2001 over primary general and professional
liability policies. Coverage was extended for all incidents
occurring from March 1, 2000 to April 10, 2001, under
the March 1, 2000 policy, through June 9, 2003. This
extension takes us beyond the statute of limitations in all
applicable jurisdictions for any incident occurring prior to
April 10, 2001.

Our liabilities for professional and
workers compensation risks are estimated by our
independent actuaries quarterly and semi-annually, respectively,
using the most recent trends of claims, settlements and other
relevant data. Our liabilities have been estimated on an
undiscounted basis. We believe adequate provision has been made
in the financial statements for liabilities that may arise out
of patient care and compensable employee injuries.

Although we have not been subject to any
judgments or settlements in excess of our respective insurance
limits, there can be no assurance that claims for damages in
excess of such coverage limits will not arise in the future.

Government Regulation

Licensure.Our SNF,
ALF, therapy and pharmacy businesses are subject to various
regulatory and licensing requirements of state and local
authorities in California and Texas. Each SNF is licensed by
either the California Department of Health Services or the Texas
Department of Human Services. Each ALF is licensed by the
California Department of Social Services and the pharmacies are
licensed by the California Board of Pharmacy and the Texas State
Board of Pharmacy. All licenses must be renewed annually, and
failure to comply with applicable rules, laws and regulations
could lead to revocation of licenses. In granting, monitoring
and renewing licenses, these agencies consider, among other
things, the physical condition of the facility, the
qualifications of the administrative and nursing staffs, the
quality of care and compliance with applicable laws and
regulations. Such regulatory and licensing requirements are
subject to change, and there can be no assurance that we will
continue to be able to maintain necessary licenses or that it
will not incur substantial costs in doing so. Failure to comply
with such requirements could result in the loss of the right to
reimbursement by Medicare or Medicaid as well as the right to
conduct the business of the licensed entity. Further, the
facilities operated by us are subject to periodic inspection by
governmental and other regulatory authorities to assure
continued compliance with various standards and to provide for
their continued licensing under state law and certification
under the Medicare and Medicaid Programs.

From time to time, we receive notices from
federal and state regulatory agencies relating to alleged
deficiencies for failure to comply with components of the
regulations. Facilities that are not in substantial compliance
and do not correct deficiencies within a certain time frame may
be subject to civil money penalties and/or may be terminated
from the Medicare and/or Medicaid Programs. While we endeavor to
comply with all applicable regulatory requirements, from time to
time certain of our nursing facilities have been subject to
various sanctions and penalties as a result of deficiencies
alleged by the Centers for Medicare & Medicaid Services
(CMS), the federal agency responsible for
administering the Medicare program, or state survey agencies
under contract with CMS to conduct surveys for the Medicare and
Medicaid programs. In certain instances denial of certification
or licensure revocation actions have occurred. There can be no
assurance that we will not be subject to additional sanctions
and penalties in the future as a result of such actions.

5



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##### Table of Contents



In November 2002, CMS implemented Nursing Home
Compare, a national initiative to publicly report quality
measures to improve the quality of care of each Medicare and
Medicaid certified nursing facility. In January 2004, CMS
upgraded this program to include enhanced quality measures. This
report uses a set of quality indicators calculated from the
minimum data set assessments prepared by the nursing facilities
on each resident. The quality measures are intended to assist
consumers in evaluating nursing facilities, and to assist CMS in
working with the nursing facility industry to develop quality
improvement programs where needed.

Medicare and Medicaid.Our SNFs are subject to various
requirements for participation in government health insurance
programs such as Medicare and Medicaid. To receive Medicare and
Medicaid payments, each facility must also comply with a number
of rules regarding charges and claims procedures, the violation
of which can result in denial of reimbursement. Medicare is a
health insurance program administered by the federal government
for the aged, certain chronically disabled individuals and
certain individuals with end-stage renal disease. Medicare
benefits are not available for the costs of intermediate and
custodial levels of care including but not limited to residents
in ALFs; however, medical and physician services furnished to
patients requiring such care may be reimbursable under Medicare.
Medicaid is a means-tested entitlement health insurance program
for certain low-income and needy individuals that is jointly
funded by the federal and state governments and administered by
the states.

Cost-based Reimbursement System.Through December 31, 1998, for
eight of our SNFs and through June 30, 1998, for 36 of our
SNFs, the Medicare Program utilized a cost-based reimbursement
system which, subject to limits fixed for the particular
geographic area on the costs for routine services (excluding
capital related expenses), reimbursed SNFs for reasonable direct
and indirect allowable costs incurred in providing services as
defined by the Medicare Program. Allowable reasonable costs
normally included administrative and general costs, as well as
operating costs and rental, depreciation and interest expenses.
Reimbursement was subject to retrospective audit adjustment. An
interim rate based upon estimated costs was paid by Medicare
during the cost reporting period and a cost settlement was made
following an audit of the actual costs as reported in the filed
cost report. Such adjustments could result in additional
payments being made to us or in recoupments from us. We provide
for estimated retroactive audit adjustments as of each reporting
period in our financial statements.

Fiscal intermediaries also occasionally undertake
a more in-depth audit of a facilitys billing or other
records. In 1999, one of our fiscal intermediaries performed
focused audits as a part of the normal annual audit process at
certain of our SNFs. The auditors identified certain matters
that represented a departure from prior practices of the fiscal
intermediary. In 2000, we received adjustments on certain of
these audits which totaled approximately $2.8 million.
Substantially all of these amounts were repaid to the
Intermediary during 2000. We have appealed these adjustments and
believe that the ultimate resolution of these items will not
have a material effect on our financial position or results of
operations. While we do not believe that we are subject to any
other focused reviews or audits, there can be no assurance that
substantial monies will not be expended by us in connection with
any such audit or to defend allegations arising therefrom. If it
were found that a significant number of our Medicare claims
failed to comply with Medicare billing or other requirements,
our financial position and results of operations could be
materially adversely affected.

Prospective Payment System (PPS).The Balanced Budget Act of 1997 (the
Balanced Budget Act) required, among other things, a
phase-in of PPS for SNFs. Under PPS, Medicare reimbursement is
determined by classifying a patient into one of 44 Resource
Utilization Grouping (RUG) categories, based on the
nature of the patients condition and services needed. The
RUG classification determines the payment amount for each
patient treated, and this amount is intended to cover all
inpatient services for Medicare patients, including routine
nursing care, most capital-related costs associated with the
inpatient stay, and ancillary services, such as respiratory
therapy, occupational therapy, speech therapy and certain
covered drugs.

In addition, the Balanced Budget Act granted
states greater flexibility in establishing payment rates
beginning October 1, 1997. There can be no assurance that
budget constraints or other factors will not cause states to
reduce Medicaid reimbursement to nursing facilities or that
payments to nursing facilities will be made on a timely basis.
Any such efforts to reduce Medicaid payment rates or failure of
states to meet their

6



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##### Table of Contents



Medicaid obligations on a timely basis could have
a material adverse effect on our financial position and results
of operations.


In 1999 and 2000, refinements were made to the
Balanced Budget Act. These refinements restored substantial
Medicare funding to SNFs and other healthcare providers
originally eliminated by the Budget Act. A number of the
refinements made in 1999 and 2000 remain in place today,
including, among other things:



| |   |                                                                    
| | - | -------------------------------------------------------------------
| |  | a 20% add-on for 12 high acuity non-therapy RUG
    categories; and
|
| |  | a 6.7% add-on for all rehabilitation RUG
    categories.           

These add-ons are scheduled to expire when the
CMS implements refinements to the current RUG payment system. It
is expected that these refinements will not be implemented until
at least October 1, 2005. We cannot predict when CMS will
release its refinements nor can we predict what their ultimate
impact will be on our operating results or cash flows, if any.

In addition, the 1999 and 2000 refinements to the
Balanced Budget Act included a three-year moratorium on the
Balanced Budget Acts two $1,500 Part B therapy caps. The
moratorium expired on December 31, 2002. After several
delays in implementation during 2003, the annual caps of $1,590
for physical and speech therapy services combined and $1,590 for
occupational therapy services, which were adjusted for
inflation, were applied to services provided during the period
from September 1, 2003 through December 8, 2003. On
December 8, 2003, the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003 (the Medicare
Modernization Act) was signed into law and included an
additional two-year moratorium on the Part B therapy caps until
December 31, 2005.

The Medicare Modernization Act also increases by
128% the RUG payment for a SNF resident with AIDS, unless
the Medicare program certifies that the facilitys
applicable payment adjustment adequately compensates for the
facilitys increased costs associated with caring for a
resident with AIDS. The Medicare Modernization Act also adds a
pilot program in certain states for national and state criminal
background checks of workers who have direct patient access in
long-term care facilities.

CMS implemented two increases in nursing facility
Medicare rates effective October 1, 2003. The first
increase of 3.26% was a cumulative correction for understated
market basket increases that CMS had relied on since 1998. The
second increase of 3.0%, which is applied to the Medicare rates
subsequent to being adjusted for the 3.26% increase above, was
an annual market basket increase for the federal fiscal year
beginning October 1, 2003.

Therapy Regulation.We furnish therapy services on a
contract basis to certain affiliated and unaffiliated providers.
For Medicare patients, the providers bill the Medicare Program
for reimbursement of the amounts paid to us for these services.
Medicare Part A therapy services furnished in SNFs are
reimbursed under the inpatient PPS as discussed above. Medicare
Part B therapy services are reimbursed on a per-visit basis and,
for Medicare, are based on the Medicare physician fee schedule.
Providers have been paid under this fee schedule for therapy
services since January 1, 1999. Therapy caps for all
Part B rehabilitation services, as mentioned above, were
delayed until December 31, 2005 under the Medicare
Modernization Act. These provisions affect the reimbursement to
us in connection with the services provided by On-Track, our
outpatient therapy subsidiary, and for Part B services provided
to patients of our SNFs.

Pharmacy Regulation.Our pharmacies are subject to a
variety of state licensing and other laws governing the storage,
handling, selling or dispensing of drugs, in addition to federal
regulation under the Food, Drug and Cosmetic Act and the
Prescription Drug Marketing Act. Moreover, we are required to
register our pharmacies with the United States Drug Enforcement
Administration, and to comply with requirements imposed by that
agency with respect to security and reporting of inventories and
transactions. Medicare pays for the costs of prescription drugs
furnished in a number of different settings. The Medicare
Modernization Act contains a number of reforms that revise
payment methodologies for outpatient settings, beginning
January 1, 2004. Medicaid Programs generally reimburse
pharmacies for drugs supplied to patients based on the cost of
the drug plus a mark-up that varies depending on the type of
drugs supplied.

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The Medicare Modernization Act also establishes a
new Medicare outpatient prescription drug benefit, effective in
2006. The new drug benefit will be provided through risk-bearing
private plans contracting with the government (including plans
offering only the new drug benefit as well as integrated plans
offering other Medicare benefits). The standard outpatient drug
benefit will have a $250 annual deductible, 25% coinsurance
requirement between the deductible and an initial benefit cap of
$2,250 in drug spending. Then there will be a coverage gap until
catastrophic coverage with a 5 percent copayment begins at
$3,600 in out-of-pocket costs ($5,100 in drug spending).

Referral Restrictions and Fraud and Abuse.We are also subject to federal and
state laws that govern financial and other arrangements between
healthcare providers or potential referral sources. Federal law,
as well as the law in California, Texas and Arizona and other
states, prohibits direct or indirect payments in some cases or
fee-splitting arrangements between healthcare providers that are
designed to induce or encourage the referral of patients to, or
the recommendation of, a particular provider for medical
products and services. These laws include the federal
Anti-Kickback Statute that prohibits, among other things, the
knowing or willful offer, payment, solicitation or receipt of
any form of remuneration in return for, or to induce, the
referral of federal health care program patients, including
Medicare and Medicaid patients. The definition of
remuneration has been broadly interpreted to include
anything of value, including, for example, gifts, discounts, the
furnishing of supplies or equipment, credit arrangements,
payments of cash and waivers of payments. Several courts have
interpreted the statutes intent requirement to mean that
if any one purpose of an arrangement involving remuneration is
to induce referrals of federal healthcare covered business, the
statute has been violated. A wide array of relationships and
arrangements, including ownership interests in a company by
persons who refer or are in a position to refer patients, as
well as personal service agreements have, under certain
circumstances, been alleged or been found to violate these
provisions. Certain arrangements, such as the provision of
services for less or above fair market value compensation, may
also violate such laws. Because of the laws broad reach,
the federal government has published regulations, known commonly
as safe harbors, which set forth the requirements
under which certain relationships will not be considered to
violate the law. These safe harbors set forth provisions that,
if all their applicable requirements are met, will assure
healthcare providers and other parties that they will not be
prosecuted under the Anti-Kickback Statute. The failure of a
transaction or arrangement to fit precisely within one or more
safe harbors does not necessarily mean that it is illegal or
that prosecution will be pursued. However, conduct and business
arrangements that do not fully satisfy each applicable safe
harbor may result in increased scrutiny by government
enforcement authorities such as the Office of the Inspector
General (OIG). One of these safe harbors protects
payments for personal or management services, if the aggregate
payments are set in advance, at a fair market rate and which do
not vary with the value or volume of services referred, provided
there is a written contract which meets certain requirements. A
safe harbor for discounts, which focuses primarily on
appropriate disclosure, is also available.

A violation of the federal Anti-Kickback Statute
and similar state laws could result in the loss of eligibility
to participate the federal health care programs, including
Medicare or Medicaid, and in criminal penalties of up to five
years imprisonment and/or $25,000 in fines. In addition, some
kickback allegations have been claimed to violate the federal
False Claims Act, discussed in more detail below.

In addition, the federal government and some
states restrict certain business relationships between
physicians and other providers of healthcare services. Effective
January 1, 1995, the federal physician self-referral
prohibition, also known as the Stark Law, prohibits any
physician (or an immediate family member of the physician) with
a financial relationship (defined as a direct or indirect
ownership or investment interest or direct or indirect
compensation arrangement) with an entity from making any
Medicare or Medicaid referrals for a broad array of
designated health services to such entity, unless an
exception applies. It also prohibits an entity receiving a
prohibited referral from billing and collecting for services
rendered pursuant to such prohibited referral. Designated
health services under the Stark Law include physical
therapy, durable medical equipment and supplies, parenteral and
enteral nutrients, equipment and supplies, home health services,
outpatient prescription drugs, and inpatient and outpatient
hospital services. A person who engages in a scheme to
circumvent the Stark Laws prohibitions may be fined up to
$100,000 for each such arrangement or scheme. In addition,
anyone who presents or causes to be presented a claim to the
Medicare program in

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violation of the Stark Law is subject to monetary
penalties of up to $15,000 per claim submitted, an assessment of
several times the amount claimed, and possible exclusion from
participation in federal healthcare programs. In addition,
claims submitted in violation of the Stark Law may be alleged to
be subject to liability under the federal False Claims Act and
its whistleblower provisions (as discussed below).


There are also various federal and state laws,
including the federal False Claims Act, prohibiting other types
of fraud by healthcare providers, including criminal provisions
that prohibit filing false claims or making false statements to
receive payment or certification under Medicare and Medicaid, or
failing to refund overpayments or improper payments. Violation
of these provisions is a felony punishable by up to five years
imprisonment and/or $25,000 in fines. Federal civil provisions
prohibit the known filing of a false claim or the known use of
false statements to obtain payment. The penalties for such a
violation are fines of not less than $5,500 or more than
$11,000, plus treble damages, for each claim filed.

State and federal governments are devoting
increasing attention and resources to anti-fraud initiatives
against healthcare providers. The Accountability Act and the
Balanced Budget Act expand the penalties for healthcare fraud,
including broader provisions for the exclusion of providers from
the Medicare and Medicaid Programs and the establishment of
civil monetary penalties for violations of the anti-kickback
provisions. While the Company believes that its practices are
consistent with Medicare and Medicaid guidelines, those
guidelines are often vague and subject to interpretation. There
can be no assurance that aggressive anti-fraud enforcement
actions will not adversely affect our business.

OIG Work Plan.Under
major anti-fraud demonstration projects, the OIG, in cooperation
with other federal and state agencies, has focused on the
activities of SNFs, home health agencies, hospices and DME
suppliers in certain states, including California and Texas, in
which we currently operate. The Fiscal Year 2004 OIG Work Plan
identified twelve investigative focus areas relating to nursing
home care. While management does not believe we are the subject
of OIG investigations, there can be no assurance that
substantial monies will not be expended by us to cooperate with
any such investigation or to defend allegations arising
therefrom. If it were found that any of our practices failed to
comply with the anti-fraud provisions, we could be materially
affected.

Corporate Compliance Program.In July 1999, we implemented a formal
corporate compliance program. This included the appointment of a
Compliance Officer who oversees the program and reports directly
to our Board of Directors. This program sets standards, policies
and procedures regarding compliance with applicable laws
governing financial relationships among healthcare providers or
other potential sources of referrals and is designed to ensure
that our business and billing practices comply with applicable
laws. This program also formally establishes policies and
procedures with respect to quality of care and residents
rights. A toll-free compliance hotline has been established to
provide employees and other persons the ability to report
suspected violations or questionable practices.

Pending Legislation.Government reimbursement programs are subject to statutory and
regulatory changes, retroactive rate adjustments, administrative
ceilings and government funding restrictions, all of which could
materially decrease the rates paid to us for our services. Since
1972, Congress has consistently attempted to curb federal
spending on healthcare programs. We expect that there will
continue to be a number of state and federal proposals to reform
Medicare and Medicaid reimbursement and coverage policies for
healthcare services. We cannot, at this time, predict what
healthcare reform legislation will ultimately be enacted and
implemented or whether other changes in the administration or
interpretation of the governmental healthcare programs will
occur. There can be no assurance that future healthcare
legislation or other changes in the administration or
interpretation of governmental healthcare programs, if enacted,
will not have a material adverse effect on our financial
position or our results of operations.

Environmental Matters

We are also subject to a wide variety of federal,
state and local environmental and occupational health and safety
laws and regulations. As a healthcare provider, we face
regulatory requirements in areas of: air and water quality
control; waste management; asbestos, polychlorinated biphenyls,
and radioactive substances; employees and public requirements
regarding hazardous materials and wastes; and certain other
requirements.

9



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In our role as owner and/or operator of our
facilities, we may be subject to liability for investigating and
remediating any hazardous substances that are located on the
property, including any such substances that may have migrated
off, or emitted, discharged, leaked, escaped or been transported
from the property. Part of our operations may involve the
handling, use, storage, transportation, disposal and/or
discharge of hazardous, infectious, toxic, radioactive,
flammable and other hazardous materials, wastes, pollutants or
contaminants. Such activities may result in damage to
individuals, property or the environment; may interrupt
operations and/or increase costs; may result in legal liability,
damages, injunctions or fines; may result in investigations,
administrative proceedings, penalties or other governmental
agency actions; and may not be covered by insurance. There can
be no assurance that we will not encounter such risks in the
future, and such risks may result in material adverse
consequences to our operations or financial condition.

Seasonality

Our business is subject to modest effects of
seasonality that have caused our quarterly operating results to
fluctuate in the past and will continue to do so in the future.
During the calendar fourth quarter holiday periods, nursing home
and assisted living residents are sometimes discharged to join
family celebrations and admission decisions are often deferred.
The first quarter of each calendar year usually coincides with
increased illness among nursing home and assisted living
residents which can result in increased costs or discharges to
hospitals. As a result of these factors, nursing home and
assisted living operations sometimes produce greater earnings in
the second and third quarters of a calendar year and lesser
earnings in the first and fourth quarters.




Item 2.     Properties

Our operations are conducted in owned and leased
facilities located in California and Texas. Our corporate
headquarters and primary administrative facilities are located
in a 19,800 square foot leased facility containing office
space in Foothill Ranch, California. We believe that our current
facilities will be adequate for at least the next
12 months. We operate 53 skilled nursing facilities
and assisted living facilities in California and Texas,
36 of which are owned or subject to a capital lease and
17 of which are leased, with a total of 7,037 licensed
beds. We operate 3 leased pharmacy facilities in California
and Texas.

The following table provides information
concerning the SNFs and ALFs currently operated by
us.

|                             |                       |          |    |        |  |       |    |      |  |  |    |    |  |  |       |       | 
|---------------------------- | --------------------- | -------- | -- | ------ |  | ----- | -- | ---- |  |  | -- | -- |  |  | ----- | ----- | 
|                             |                       | Owned(1) |    | Leased |  | Total |    | Beds
|                             |                       |          |    |        |  |       |    |     
|Skilled Nursing  California |                       |          | 12 |        |  |       | 14 |      |  |  | 26 |    |  |  | 3,045 |      
|Skilled Nursing  Texas      |                       |          | 22 |        |  |       |   |      |  |  | 22 |    |  |  | 3,292 |      
|                             |                       |          |    |        |  |       |    |      |  |  |    |    |  |  |       |      
|                             | Total Skilled Nursing |          |    | 34     |  |       |    | 14   |  |  |    | 48 |  |  |       | 6,337 | 
|Assisted Living  California |                       |          | 2  |        |  |       | 3  |      |  |  | 5  |    |  |  | 700   |      
|                             |                       |          |    |        |  |       |    |      |  |  |    |    |  |  |       |      
|                             | Grand Total           |          |    | 36     |  |       |    | 17   |  |  |    | 53 |  |  |       | 7,037 | 
|                             |                       |          |    |        |  |       |    |      |  |  |    |    |  |  |       |      



---



|    |                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------
|(1) | Includes five nursing facilities in California
    with an aggregate of 449 beds subject to capital leases.




Item 3.     Legal
Proceedings

As is typical in the health care industry, we
have experienced an increasing trend in the number and severity
of litigation claims asserted against us. In addition, there has
been an increase in governmental investigations of long-term
care providers. While we believe that we provide quality care to
our patients and are in compliance with regulatory requirements,
a legal judgment or adverse governmental investigation could
have a material negative effect on us.

On June 8, 1999 Amelia Sandoval, by and through
her successor in Interest, Karen Jones and Karen A. Jones an
individual filed a suit against us and certain individual
employees in the Superior Court of California (Fresno County
case #633197-9 Sandoval v. Summit Corporation, et al.)
alleging twelve causes of action arising from the services
provided by a subsidiary, Summit Care  California,
Inc., at one of our skilled nursing facilities to Amelia
Sandoval. The matter had been stayed by the Bankruptcy
proceedings until the

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unsuccessful mediation was completed pursuant to
stipulation related to the Bankruptcy ADR order, whereupon the
case proceeded to trial in September, 2003 but was settled
before the trials conclusion by confidential settlement
agreement. The matter was fully insured, and the settlement did
not require the use of our funds.


From time to time, we have been a party to other
professional liability claims and other litigation arising in
the ordinary course of business. In the opinion of management,
any liability beyond amounts covered by our insurance programs
and the ultimate resolution of all pending legal proceedings
will not have a material adverse effect on our financial
position or results of operations.



Item 4.     Submission
of Matters to a Vote of Security Holders

We did not submit any matter during the fourth
quarter of the fiscal year covered by this report to a vote of
security holders.



PART II



Item 5.     Market
for Registrants Common Equity and Related Stockholder
Matters

Market Information

There is currently no established public trading
market for any class of our equity securities.

Holders

As of March 15, 2004, there were
approximately 91 holders of our Class A common stock,
4 holders of our Class B common stock, and
4 holders of our Series A preferred stock. Pursuant to
the Plan, holders of our Senior Subordinated Notes satisfied in
the Reorganization are eligible to receive shares of our
Class A common stock upon execution of an agreement to join
our stockholders agreement. 979 shares of our Class A
common stock remain reserved for issuance to an indeterminate
number of such bondholders who have not yet executed this
joinder agreement.

Dividend Policy

Our Series A preferred stock provides for
cumulative dividends that accrue at a rate of 12% per annum. As
of December 31, 2003, accrued cumulative unpaid dividends
on our Series A preferred stock was $13.8 million.

We have not declared or paid a cash dividend on
shares of our capital stock, and we do not anticipate paying any
cash dividends for the foreseeable future. We presently intend
to retain earnings to pay down debt, finance future operations,
expansion and capital investment.

Securities Authorized for Issuance Under
Equity Compensation Plans

The table entitled Securities Authorized
for Issuance Under Equity Compensation Plans in
Item 12, Part III is incorporated herein by reference.

Recent Sales of Unregistered
Securities

The following sets forth information regarding
all securities sold by us during the past three years:

1. We filed our Plan with the Bankruptcy
Court on June 30, 2003. Our Chapter 11 case was
confirmed by an order of the Bankruptcy Court on July 10,
2003. Prior to the consummation of the Plan in August 2003, we
had two classes of capital stock: common stock, $0.01 par
value per share, of which shares were designated class A,
class B and class C common stock, and preferred stock,
$0.01 par value per share, of which shares were designated
series A preferred stock. In addition, we had outstanding
immediately exercisable warrants to purchase our series C
common stock at an exercise price of $0.01 per share.
Pursuant to the Plan, (i) each holder of series A common
stock received 1.1142 shares of new common stock for each
share of series A common stock held by them immediately
prior to the Effective Date; (ii) all shares of
series B common stock

11



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were cancelled; (iii) each holder of
series C common stock received one share of common stock
for each share of series C common stock held by them
immediately prior to the Effective Date, (iv) each holder
of series A preferred stock received one share of new series A
preferred stock for each share of series A preferred stock held
by them immediately prior to the Effective Date and
(v) each holder of a warrant to purchase series C
common stock received a warrant to purchase a number of shares
of common stock that was equal to the number of shares of
series C common stock issuable upon the exercise of
warrants held by them immediately prior to the Effective Date.
This transaction was exempt from registration pursuant to
Section 1145(b) of Chapter 11 of United States
Bankruptcy Code. We did not receive any cash proceeds from the
issuance of our equity securities pursuant to the Plan.


2. Pursuant to the Plan, in August 2003 we
issued to the holders of Senior Subordinated Notes on a pro rata
basis $106.8 million of Increasing Rate Notes and 68,642
shares of common stock. The issuance of such securities was in
satisfaction of our Senior Subordinated Notes. This transaction
was exempt from registration pursuant to Section 1145(b) of
Chapter 11 of United States Bankruptcy Code.




Item 6.     Selected
Financial Data

The following selected consolidated financial and
other operating data should be read in conjunction with
Managements Discussion and Analysis of Financial
Condition and Results of Operations and our consolidated
financial statements and the related notes to those statements
included elsewhere in this annual report. We have derived the
consolidated statement of operations data for each of the five
years in the period ended December 31, 2003 and our
consolidated balance sheet data at December 31, 1999, 2000,
2001, 2002 and 2003 from our audited consolidated financial
statements. The consolidated financial statements as of
December 31, 2003 and 2002 and for each of the three years
in the period ended December 31, 2003 and the independent
auditors report thereon, are included elsewhere in this
Annual Report.

|                                                            |  |                         |         |      |  |      |         |      |  |      |          |   |  |   |         |   |  |   |         |  
|----------------------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | -------- | - |  | - | ------- | - |  | - | ------- | -
|                                                            |  |                        
|                                                            |  | Year Ended December 31,
|                                                            |  |                        
|                                                            |  | 2003                    |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                                            |  |                         |         |      |  |      |         |      |  |     
|Consolidated Statement of Operations
    Data:              |  |                         |         |      |  |      |         |      |  |      |          |   |  |   |         |   |  |   |         |  
|Net revenues                                                |  | $                       | 359,289 |      |  | $    | 341,547 |      |  | $    | 318,420  |   |  | $ | 301,911 |   |  | $ | 273,581 |  
|Total expenses before reorganization and other
    expenses |  |                         | 345,771 |      |  |      | 327,597 |      |  |      | 349,628  |   |  |   | 303,793 |   |  |   | 272,811 |  
|Income (loss) from continuing operations                    |  |                         | 13,518  |      |  |      | 13,950  |      |  |      | (31,208  | ) |  |   | (1,882  | ) |  |   | 770     |  
|Other expenses, net                                         |  |                         | 15,349  |      |  |      | 12,304  |      |  |      | 122,211  |   |  |   |        |   |  |   |        |  
|Cumulative effect of change in accounting
    principle     |  |                         | 12,261  |      |  |      |        |      |  |      |         |   |  |   |        |   |  |   |        |  
|Provision (benefit) for income taxes                        |  |                         | (414    | )    |  |      | 748     |      |  |      | (20,531  | ) |  |   | (37     | ) |  |   | 1,149   |  
|Net income (loss)                                           |  |                         | (13,678 | )    |  |      | 898     |      |  |      | (132,888 | ) |  |   | (1,845  | ) |  |   | (379    | )

|                                 |  |              |         |      |  |      |          |      |  |      |          |   |  |   |          |   |  |   |         | 
|-------------------------------- |  | ------------ | ------- | ---- |  | ---- | -------- | ---- |  | ---- | -------- | - |  | - | -------- | - |  | - | ------- | 
|                                 |  |             
|                                 |  | December 31,
|                                 |  |             
|                                 |  | 2003         |         | 2002 |  | 2001 |          | 2000 |  | 1999
|                                 |  |              |         |      |  |      |          |      |  |     
|Consolidated Balance Sheet Data: |  |              |         |      |  |      |          |      |  |      |          |   |  |   |          |   |  |   |         | 
|Working capital (deficit)        |  | $            | (9,267  | )    |  | $    | (208,421 | )    |  | $    | (226,349 | ) |  | $ | (190,748 | ) |  | $ | 18,823  | 
|Total assets                     |  |              | 260,841 |      |  |      | 257,755  |      |  |      | 254,474  |   |  |   | 385,468  |   |  |   | 395,036 | 
|Long-term debt                   |  |              | 218,430 |      |  |      | 9,867    |      |  |      | 15,708   |   |  |   | 17,409   |   |  |   | 231,867 | 
|Shareholders equity (deficit)    |  |              | (79,961 | )    |  |      | (67,356  | )    |  |      | (68,254  | ) |  |   | 64,634   |   |  |   | 66,479  | 






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion of our financial
condition and results of operations should be read in
conjunction with the Selected Financial Data and the
accompanying consolidated financial statements and notes to

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consolidated financial statements as listed in
Item 8. The terms company, we,
our, and us refer to Skilled Healthcare
Group, Inc. and its consolidated subsidiaries (formerly known as
Fountain View, Inc.).


General

We are an operator of long-term care facilities
and a provider of a broad range of post-acute care services,
with a strategic emphasis on sub-acute specialty medical care.
We operate a network of facilities in California and Texas,
including 48 skilled nursing facilities (SNFs) that
offer sub-acute, rehabilitative and specialty medical skilled
nursing care, as well as five assisted living facilities
(ALFs) that provide room and board and social
services. Sub-acute care is generally short-term, goal-oriented
rehabilitation care intended for individuals who have a specific
illness, injury or disease, but who do not require many of the
services provided in an acute care hospital. Sub-acute care is
typically rendered immediately after, or in lieu of, acute
hospitalization in order to treat such specific medical
conditions. As of December 31, 2003, we had
7,037 licensed beds.

In addition to long-term care, we provide a
variety of high-quality ancillary services such as physical,
occupational and speech therapy in facilities we operate and
unaffiliated facilities. We also operate three institutional
pharmacies (one of which is a joint venture), which serve acute
care hospitals as well as SNFs and ALFs both affiliated and
unaffiliated with us, and an outpatient therapy clinic.

Reorganization under Chapter 11

On October 2, 2001, we and 19 of our
subsidiaries filed voluntary petitions for protection under
Chapter 11 of the U.S. Bankruptcy Code with the U.S.
Bankruptcy Court for the Central District of California, Los
Angeles Division (the Bankruptcy Court). On
November 28, 2001, our remaining three subsidiaries also
filed voluntary petitions for protection under Chapter 11.

Our company and subsidiaries financial
difficulties were attributable to a number of factors. The
federal government had fundamentally changed reimbursement rates
and procedures for medical services provided to individuals in
1999. These changes had a significant adverse effect on the
healthcare industry on the whole as well as our cash flows.
These changes also exacerbated a long-standing problem of
inadequate reimbursement by the states for medical services
provided to indigent persons under the various states
Medicaid programs. At the same time, we experienced significant
increases in our labor costs and professional liability and
other insurance costs.

Following our petition for protection under
Chapter 11, we and our subsidiaries continued to operate
our businesses as debtors-in-possession subject to the
jurisdiction of the Bankruptcy Court through August 19,
2003, the Effective Date, when we emerged from bankruptcy
pursuant to the terms of our Third Amended Joint Plan of
Reorganization dated April 22, 2003 (the Plan).
In connection with emerging from bankruptcy, we changed our name
to Skilled Healthcare Group, Inc. From the date we filed the
petition with the Bankruptcy court through December 31,
2003, we incurred restructuring charges totaling approximately
$30.1 million.

The principal components of reorganization
expenses incurred during the three years ended December 31,
2003 are as follows (in thousands):

|                                         |  |      |        |      |  |      |        |   |  |   |       |  
|---------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ----- | -
|                                         |  | 2003 |        | 2002 |  | 2001
|                                         |  |      |        |      |  |     
|Professional fees                        |  | $    | 7,336  |      |  | $    | 8,181  |   |  | $ | 4,315 |  
|Court-related services                   |  |      | 503    |      |  |      | 711    |   |  |   | 380   |  
|Refinancing costs                        |  |      | 1,990  |      |  |      | 762    |   |  |   |      |  
|Other fees                               |  |      | 3,252  |      |  |      | 2,791  |   |  |   | 110   |  
|Less interest earned on accumulated cash |  |      | (115   | )    |  |      | (141   | ) |  |   | (18   | )
|                                         |  |      |        |      |  |      |        |   |  |   |       |  
|Total                                    |  | $    | 12,966 |      |  | $    | 12,304 |   |  | $ | 4,787 |  
|                                         |  |      |        |      |  |      |        |   |  |   |       |  

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On July 10, 2003, the Bankruptcy Court
confirmed our Plan, which was approved by substantially all or
our creditors and implemented on August 19, 2003. The
principal provisions of the Plan included:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the incurrence by us of (i) approximately
    $32.0 million in indebtedness under new Revolving Credit
    Facilities; (ii) approximately $23.0 million under a
    new Secured Mezzanine Term Loan; and (iii) approximately
    $95.0 million under a new Senior Mortgage Term Loan;                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | the satisfaction of our 11 1/4% Senior
    Subordinated Notes due 2008 (Senior Subordinated
    Notes) upon the issuance or payment by us to the holders
    of Senior Subordinated Notes on a pro rata basis of;
    (i) $106.8 million of new Senior Subordinated Secured
    Increasing Rate Notes due 2008 (Increasing Rate
    Notes) that accrue interest at an initial rate of 9.25%
    and provide for annual rate increases, (ii) 58,642 shares
    of common stock and (iii) cash in the amount of
    $50.0 million, consisting of approximately
    $36.0 million in outstanding interest and approximately
    $14.0 million of principal;
|
| |  | the satisfaction of our $90 million Term
    Loan Facility and $30 million Revolving Credit Facility by
    the payment in full;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | the issuance of one share of new series A
    preferred stock for each share of our existing series A
    preferred stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | the cancellation of our series A common
    stock and the issuance of 1.1142 shares of new common stock for
    each share of cancelled series A common stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | the cancellation of our series B common
    stock and options to purchase series C common stock, with
    no distribution made in respect thereof;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | the cancellation of our series C common
    stock and the issuance of one share of new common stock for each
    share of cancelled series C common stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | the cancellation of outstanding warrants to
    purchase series C common stock and the issuance of new
    warrants, on substantially the same terms, to purchase a number
    of shares of new common stock equal to the number of shares of
    series C common stock that were subject to the existing
    warrants so cancelled;                                                                                                                                                                                                                                                                                                                        
|
| |  | an amendment and restatement of our
    stockholders agreement;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | the impairment of certain secured claims and the
    impairment of certain general unsecured claims; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | the restructuring of our businesses and legal
    structure.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

Critical Accounting Policies and
Estimates

Our discussion and analysis of our financial
condition and results of operations are based upon our
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the
reported amount of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses for
each period.

The following represents a summary of our
critical accounting policies, defined as those policies that we
believe are: (a) the most important to the portrayal of our
financial condition and results of operations, and (b) that
require managements most subjective or complex judgments,
often as a result of the need to make estimates about the
effects of matters that are inherently uncertain.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue
    recognition Our revenues
    are derived primarily from providing long-term healthcare
    services. Approximately 83% of our net revenues are received
    from funds provided under Medicare and state Medicaid assistance
    programs. We record our revenues on an accrual basis as services
    are performed at their estimated net realizable value under
    these governmental programs. These revenues are subject to audit
    and retroactive adjustment by governmental and third-party
    agencies. Retroactive adjustments that are likely to result from
    future audits by third-party payors are accrued on an

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | estimated basis in the period the related
    services are performed. Consistent with the healthcare industry
    accounting practices, any changes to these governmental revenues
    estimates are recorded in the period the change or adjustment
    becomes known based on final settlements. Because of the
    complexity of the laws and regulations governing Medicare and
    state Medicaid assistance programs, our estimates may
    potentially change by a material amount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Allowance for doubtful
    accounts We maintain
    allowances for doubtful accounts for estimated losses resulting
    from non-payment of patient accounts receivable and third-party
    billings, and notes receivable from customers. We record bad
    debt expense monthly using a percentage of revenue approach that
    reflects our historical experience. In evaluating the
    collectibility of accounts receivable, we consider a number of
    factors, including the age of the accounts, changes in
    collection trends, the composition of patient accounts by payor
    the status of ongoing disputes with third-party payors and
    general industry conditions. If the financial condition of our
    customers were to deteriorate, resulting in an impairment of
    their ability to make payments, additional allowances may be
    required. If, at December 31, 2003, we were to recognize an
    increase of 10% in the allowance for our doubtful accounts, our
    total current assets would be decreased by $1.0 million, or
    1.7%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Patient liability
    risks Our general and
    professional liability reserve includes amounts for patient care
    related claims and incurred but not reported claims. General and
    professional liability costs for the long-term care industry
    have become increasingly expensive and difficult to estimate.
    The amount of our reserves is determined based on an estimation
    process that uses information obtained from both
    company-specific and industry data. The estimation process
    requires us to continuously monitor and evaluate the life cycle
    of the claims. Using data obtained from this monitoring and our
    assumptions about emerging trends, we along with our independent
    actuary develop information about the size of ultimate claims
    based on our historical experience and other available industry
    information. The most significant assumptions used in the
    estimate process include determining the trend in costs, and the
    expected cost of claims incurred but not reported and the
    expected costs to settle unpaid claims. Although we believe that
    our reserves are adequate, we cannot not assure you that this
    liability will not require a material adjustment in the future.
    If, at December 31, 2003, we were to recognize an increase
    of 10% in the reserve for general and professional liabilities
    our total liabilities would be increased by $2.7 million,
    or 0.8%.                                                                                                                                                                                                                                                                                                                                                           
|
| |  | Impairment of long-lived assets and
    goodwill We periodically
    evaluate our long-lived assets, primarily consisting of our
    investments in real estate, for impairment indicators. If
    indicators of impairment are present, we evaluate the carrying
    value of the related real estate investments in relation to the
    future discounted cash flows of the underlying operations.
    Measurement of the amount of the impairment, if any, may be
    based on independent appraisals, established market values of
    comparable assets or estimates of future cash flows expected.
    The estimates of these future cash flows are based on
    assumptions and projections believed by management to be
    reasonable and supportable. They require managements
    subjective judgments and take into account assumptions about
    revenue and expense growth rates. These assumptions may vary by
    type of long-lived asset. In accordance with Statement of
    Financial Accounting Standards (SFAS) No. 142, that we
    adopted January 1, 2002, goodwill is not amortized, but
    instead is subject to impairment tests performed at least
    annually. For goodwill, the test is performed at the reporting
    unit level as defined by SFAS No. 142. If we find that the
    carrying value of goodwill to be impaired, we must reduce the
    carrying value to fair value. We believe that our determination
    not to recognize an impairment loss on our long-lived assets and
    goodwill is a critical accounting estimate because this
    determination is susceptible to change, dependent upon events
    that are remote in time and may or may not occur, and because
    recognizing an impairment loss could result in a material
    reduction of the assets reported in our balance sheet.

We make our estimates and judgments based on,
among other things; knowledge of operations, markets, historical
trends and likely futures changes, and when appropriate, the
opinions of advisors with knowledge and experience in certain
fields. However, due to the nature of certain assets and
liabilities, there are risks and uncertainties associated with
some of the estimates and judgments, which are required to be
made. Actual results could differ from these estimates under
different assumptions or conditions.

15



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##### Table of Contents



Recent Accounting Pronouncements

FASB Interpretation No. 46, Consolidation
of Variable Interest Entities (FIN 46) becomes
applicable in our fiscal first quarter of 2004. Variable
interest entities (VIEs) are entities that lack sufficient
equity or whose equity holders lack adequate decision making
ability based on criteria set forth in the interpretation. All
of our VIEs must be evaluated under methods prescribed by this
interpretation to determine the primary beneficiary of the risks
and rewards of the VIE. The primary beneficiary is required to
consolidate the VIE for financial reporting purposes.

We have an equity interest in a limited liability
company that was formed with our joint venture partner American
Pharmaceutical Services, Inc. that is currently not
consolidated, but under current rules are accounted for under
the equity method of accounting. For this entity, we may hold a
variable interest. This entity may be considered a VIE under
FIN 46, and it is possible that we may be required to
consolidate this entity when FIN 46 becomes applicable. We
are currently in the process of analyzing this entity to
determine if it is a VIE and, if so, whether we are the primary
beneficiary in which case consolidation would be required. We
believe that any additional liabilities recognized as a result
of consolidating any VIEs would not represent additional claims
on our general assets; rather, they would represent claims
against the additional assets recognized by us as a result of
consolidating the VIEs. Conversely, we believe that any
additional assets recognized as a result of consolidating any
VIEs would not represent additional assets that we could use to
satisfy claims against our general assets.

In May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity
(Statement 150). This statement was developed in response
to concerns expressed by preparers, auditors, regulators, and
other users of financial statements about issuers
classification in the balance sheet of certain financial
instruments that have characteristics of both liabilities and
equity but that have been presented between the liabilities
section and the equity section of the balance sheet. The
statement requires that financial instruments issued in the form
of shares that are mandatorily redeemable be classified as
liabilities. Mandatorily redeemable shares are defined as shares
for which the issuer has an unconditional obligation to redeem
at a specified or determinable date or upon an event that is
certain to occur. The Company adopted Statement 150 on
July 1, 2003. At that time, the Companys
Series A preferred stock, which is mandatorily redeemable
was classified as a liability, implemented by reporting the
cumulative effect of a change of accounting principle.

Effective July 1, 2003, we recognized
interest expense of $12.3 million related to the adoption
of Statement 150. In accordance with the underlying
provisions of Statement 150, such charge was recorded in
our Consolidated Financial Statements as a cumulative effect of
a change in accounting principle during the third quarter, 2003.

The following table illustrates the effect on net
income (loss) if the Company had recorded interest expense
for the year ended December 31, 2003, 2002 and 2001 (in
thousands):

|                                                                        |  |              |         |      |  |      |        |   |  |   |          |  
|----------------------------------------------------------------------- |  | ------------ | ------- | ---- |  | ---- | ------ | - |  | - | -------- | -
|                                                                        |  |             
|                                                                        |  | December 31,
|                                                                        |  |             
|                                                                        |  | 2003         |         | 2002 |  | 2001
|                                                                        |  |              |         |      |  |     
|Reported net (loss) income                                              |  | $            | (13,678 | )    |  | $    | 898    |   |  | $ | (132,888 | )
|Reversal of cumulative effect                                           |  |              | 12,261  |      |  |      |        |   |  |   |          |  
|Interest expense on mandatorily redeemable
    Series A preferred stock |  |              | (1,502  | )    |  |      | (2,760 | ) |  |   | (2,464   | )
|                                                                        |  |              |         |      |  |      |        |   |  |   |          |  
|Pro forma net loss                                                      |  | $            | (2,919  | )    |  | $    | (1,862 | ) |  | $ | (135,352 | )
|                                                                        |  |              |         |      |  |      |        |   |  |   |          |  

16



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##### Table of Contents



Results of Operations

The following table sets forth the amounts of our
consolidated revenues derived from the various sources of
payment and certain operating data for our SNFs and
ALFs for the three years ended December 31, 2003,
2002 and 2001 are as follows:

|                       |  |      |         |      |  |      |         |  |  |   |         | 
|---------------------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                       |  | 2003 |         | 2002 |  | 2001
|                       |  |      |         |      |  |     
|Medicare               |  | $    | 125,994 |      |  | $    | 136,868 |  |  | $ | 124,777 | 
|Medicaid               |  |      | 155,152 |      |  |      | 141,735 |  |  |   | 130,215 | 
|Private                |  |      | 36,410  |      |  |      | 37,823  |  |  |   | 41,679  | 
|Managed Care and other |  |      | 41,733  |      |  |      | 25,121  |  |  |   | 21,749  | 
|                       |  |      |         |      |  |      |         |  |  |   |         | 
|                       |  | $    | 359,289 |      |  | $    | 341,547 |  |  | $ | 318,420 | 
|                       |  |      |         |      |  |      |         |  |  |   |         | 
|Occupancy(1)           |  |      |         |      |  |      |         |  |  |   |         | 
|Skilled nursing        |  |      | 85.6%   |      |  |      | 82.8%   |  |  |   | 83.8%   | 
|Assisted living        |  |      | 59.0%   |      |  |      | 60.0%   |  |  |   | 64.9%   | 
|Total                  |  |      | 82.8%   |      |  |      | 80.4%   |  |  |   | 81.8%   | 

Our occupancy percentage is computed based on the
number of licensed beds.



| |                                                                          
| | -------------------------------------------------------------------------
| | Year Ended December 31, 2003 Compared
    to Year Ended December 31, 2002

Net revenues increased $17.7 million or 5.2%
to $359.3 million for the year ended December 31, 2003
from $341.5 million for the year ended December 31, 2002.
Net revenues increased due an increase of 2.4% in total average
occupancy to 82.8% for the year ended December 31, 2003
from 80.4% for the year ended December 31, 2002 and
increased Medicaid rates in California, partially offset by the
negative rate variance related to a Medicare rate cut, which was
effective October 1, 2002. Additionally, we acquired five
facilities in northern California in the third and fourth
quarters of 2003, which represented $6.9 million of the
revenue increase. Net revenue for nursing services accounted for
$299.3 million, or 83.3% of total net revenues, for the
year ended December 31, 2003 as compared to
$281.4 million, or 82.4% of total net revenues, for the
year ended December 31, 2002. Net unaffiliated revenue for
therapy services accounted for $17.7 million, or 4.9% of
total net revenues, for the year ended December 31, 2003 as
compared to $21.1 million, or 6.2% of total net revenues,
for the year ended December 31, 2002. Net unaffiliated
revenues from pharmacy services accounted for
$42.4 million, or 11.8% of total net revenues, for the year
ended December 31, 2003 as compared to $40.0 million,
or 11.7% of total net revenues, for the year ended
December 31, 2002. The increase in revenue for the Pharmacy
operations was primarily due to new contracts and volume with
existing contracts.

Expenses, consisting of salaries and benefits,
supplies, purchased services, provision for doubtful accounts
and other expenses as a percent of net revenues remained the
same at 84.3% of net revenue for the year ended
December 31, 2003 and December 31, 2002. Expenses
increased $14.8 million or 5.2% to $302.9 million for
the year ended December 31, 2003 from $288.0 million
for the year ended December 31, 2002. Salaries and benefits
increased to 52.8% of net revenues in the year ended
December 31, 2003 compared to 51.5% for the year ended
December 31, 2002. The increase in salaries and benefits
was largely due to the number of new patients requiring
increased staffing and wage increases.

Income before other expenses, rent, depreciation
and amortization, and interest expense increased by
$2.9 million or 5.4% to $56.4 million for the year
ended December 31, 2003 from $53.5 million for the
year ended December 31, 2002 and was 15.7% of net revenues
for the year ended December 31, 2003 compared to 15.7% for
the year ended December 31, 2002.

Rent, depreciation and amortization and interest
expense increased to $42.9 million in the year ended
December 31, 2003 from $39.5 million for the year
ended December 31, 2002. The increase is primarily due to
interest expense related to higher interest rates associated
with the new debt and interest recorded related to our
Series A preferred stock.

The charge related to decertification of a
facility decreased $2.7 million for the year ended
December 31, 2003 from no charges in the year ended
December 31, 2002. The $2.7 million is the reversal of
charges

17



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##### Table of Contents



recorded in 2000 related to a facility
decertification from the Medicare and Medicaid Programs. The
Company appealed the decision, and in November 2002 a settlement
was reached to provide for an earlier decertification and
recovery of uncompensated care in the amount of approximately
$2.7 million. Of the amount settled, a total of
$2.7 million had been received through December 31,
2003. Financing costs were $4.1 million in the twelve
months ended December 31, 2003 compared to no charges in
the twelve months ended December 31, 2002. As part of our
refinancing, we wrote off $4.1 million of deferred financed
costs associated with debt that has been extinguished.
Reorganization expense increased to $13.0 million for the
year ended December 31, 2003 from $12.3 million for
the year ended December 31, 2002. This increase is
primarily related to greater activity by the various bankruptcy
consultants and attorneys. The change in the fair value in the
interest rate hedge was $1.0 million resulting in a charge
of the same amount for the year ended December 31, 2003.
The hedge was entered into in 2003, therefore there was no
charge for the year ended December 31, 2002. We are
required to reflect the change in the fair market value of the
hedge in operations since the hedge does not qualify for hedge
accounting, During 2003, the fair value of our interest rate
hedge decreased $1.0 million from $2.9 million to
$1.9 million.


We recognized interest expense of
$12.3 million related to the adoption of SFAS 150. In
accordance with the underlying provisions of SFAS 150, such
charge was recorded in the Companys Consolidated Financial
Statements as a cumulative effect of a change in accounting
principle during the third quarter, 2003. The provision for
income taxes decreased to a benefit of $.4 million for the
year ended December 31, 2003 from a provision of
$0.7 million for the year ended December 31, 2002. The
decrease in the provision is based on an over payment of state
income tax.

Our net loss increased $14.6 million to
$13.7 million for the year ended December 31, 2003
from a net income of $.9 million for the year ended
December 31, 2002. The net loss was primarily due to the
cumulative effect of a change in accounting principle related to
the adoption of SFAS 150 for $12.3 million, the
financing costs of extinguished debt written off for
$4.1 million; the increase of reorganization costs of
$0.7 million, which was partially offset by the reversal of
a charge related to the decertification of a facility of
$2.7 million.



| |                                                                          
| | -------------------------------------------------------------------------
| | Year Ended December 31, 2002 Compared
    to Year Ended December 31, 2001

Net revenues increased $23.1 million or 7.3%
to $341.5 million for the year ended December 31, 2002
from $318.4 million for the year ended December 31,
2001. Net revenues increased primarily due to the Medicare
occupancy averaging 2.0% higher to 13.0% for the year ended
December 31, 2002 compared to 11.0% for the year ended
December 31, 2001. Net revenue for nursing services
accounted for $281.4 million, or 82.4% of total net
revenues, for the year ended December 31, 2002 as compared
to $270.2, or 84.8% of total net revenues, for the year ended
December 31, 2001. Net unaffiliated revenue for therapy
services accounted for $21.1 million, or 6.2% of total net
revenues, for the year ended December 31, 2002 as compared
to $19.0 million, or 6.0% of total net revenues, for the
year ended December 31, 2001. Net unaffiliated revenues
from pharmacy services accounted for $40.0 million, or
11.7% of total net revenues, for the year ended
December 31, 2002 as compared to $29.2 million, or
9.2% of total net revenues, for the year ended December 31,
2001. The increase in revenue for the Therapy and Pharmacy
operations were primarily due to new contracts and volume with
existing customers.

Expenses, consisting of salaries and benefits,
supplies, purchased services, provision for doubtful accounts
and other expenses as a percent of net revenues decreased to
84.3% of net revenue for the year ended December 31, 2002
from 94.0% for the year ended December 31, 2001. Expenses
decreased $11.2 million or 3.7% to $288.0 million for
the year ended December 31, 2002 from $299.2 million
for the year ended December 31, 2001. The decrease in
expenses was primarily due to an additional provision for
doubtful accounts in 2001 of $16.0 million. Salaries and
benefits decreased to 51.5% of net revenues in the year ended
December 31, 2002 compared to 53.3% for the year ended
December 31, 2001. The decrease in salaries and benefits as
a percentage of net revenue was largely due to the pharmacy
services division accounting for 47.0% of the revenue increase
which requires significantly less staffing to generate revenue
than the nursing services division.

Income before other expenses, rent, depreciation
and amortization, and interest expense increased by
$34.2 million or 177.8% to $53.5 million for the year
ended December 31, 2002 from $19.3 million for the year

18



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##### Table of Contents



ended December 31, 2001 and was 15.7% of net
revenues for the year ended December 31, 2002 compared to
6.0% for the year ended December 31, 2001.


Rent, depreciation and amortization and interest
expense decreased to $39.5 million in the year ended
December 31, 2002 from $50.5 million for the year
ended December 31, 2001. The decrease is primarily due to
depreciation expense which decreased in 2002 as a result of the
impairment of long-lived assets in the third quarter of 2001 and
the fact that we no longer amortize goodwill effective
January 1, 2002, in accordance with SFAS No. 142.

Reorganization expense increased to
$12.3 million for the year ended December 31, 2002
from $4.8 million for the year ended December 31,
2001. This increase is primarily related to the fact that the
Companys bankruptcy filing was on October 2, 2001 and
thus 2001 reflects only three months of expenses compared to
twelve months in 2002. The provision for the impairment of
long-lived assets decreased to zero in 2002 compared to
$117.4 million in 2001. In the third quarter of 2001, the
Company determined that the Companys liquidity problems
and Chapter 11 filing served as an indication to the Company
that the carrying values of the long-lived assets may be
impaired. As a result, during the third quarter of 2001, the
Company revised its projections of future cash flows and, where
the carrying value of the long-lived assets exceeded the
estimated undiscounted cash flows, the Company estimated the
fair market value of these assets using a discounted cash flow
model. Impairments were recorded based on the excess of the
carrying value over the fair market value of such assets.

The provision for income taxes increased to
$.7 million for the year ending December 31, 2002 from
a benefit of $20.5 million for the year ended
December 31, 2001. The increase in the provision for income
taxes is primarily related to the fact that the Company
recognized a benefit of $17.6 million in 2001 in connection
with the write-off of its long lived assets.

Our net income increased $133.8 million to
$.9 million for the year ended December 31, 2002 from
a net loss of $132.9 million for the year ended
December 31, 2001. The net increase was due primarily to
the impairment of long-lived assets of $117.4 in 2001.
Additionally, the Company recorded a charge to the provision for
doubtful accounts of $16.0 million in 2001. Depreciation
expense decreased $8.3 million in 2002 compared to 2001 due
to the impairment of long-lived assets. This was partially
offset by the increase in reorganization costs of
$7.5 million in 2002 compared to 2001.



| |                                    
| | -----------------------------------
| | Liquidity and Capital
    Resources

As of December 31, 2003, cash and cash
equivalents were $2.7 million compared to
$20.5 million at December 31, 2002. Our principal
sources of liquidity to fund ongoing operations for the year
ended December 31, 2003 were cash provided by operations
and existing cash and cash equivalents.

Cash flow used in operations for the year ended
December 31, 2003 was $15.0 million, a decrease of
$45.4 million compared with cash provided by operations for
the year ended December 31, 2002 of $30.4 million.
Cash was used primarily by a net loss of $13.7 million, a
decrease in accounts payable, accrued liabilities and accrued
interest payable of $28.4 million, and an increase in
accounts receivable of $2.3 million. The decrease in
accounts payable and accrued liabilities includes payments
totaling $12.1 million to our secured creditors upon our
emerging from bankruptcy. Cash provided by operations consisted
of increases in accrued payroll and related of $2.0 million
and prepaid expenses and accrued interest related to the
cumulative effect of adopting SFAS 150 of
$12.3 million, the write-off of $4.1 million in
financing costs associated with the debt we extinguished upon
emerging from bankruptcy, depreciation and amortization of
$9.8 million, a change in the fair value of our interest
rate hedge $1.0 million, and the provision for doubtful
accounts of $3.6 million.

Cash flow used in investing activities for the
year ended December 31, 2003 was $26.3 million, an
increase of $21.3 million compared with cash used for the
year ended December 31, 2002 of $5.0 million. The
principal elements of this increase are additions to property
and equipment of $19.4 million, of which $13.1 million
is property subject to capital lease and our funding of
$4.5 million to our Workers Compensation captive.
Cash provided in investing activities consisted of the proceeds
from the sale of property and equipment of $1.7 million.

Net cash provided by financing activities totaled
$23.5 million for the year ended December 31, 2003.
The source of our cash provided in financing activities was
proceeds from the issuance of long-term debt of

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approximately $132 million and borrowings
under our Revolving Credit Facility, offset by the cash used in
financing activities. Cash used in financing activities includes:




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | an aggregate of $76.6 million to fund the
    payment in full of our pre-petition $30 million Revolving
    Credit Facility and $90 million Term Loan Facility;                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | a $50.0 million payment to holders of our
    Senior Subordinated Notes pursuant to the terms of our Plan
    ($36 million of this payment was for accrued interest);                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | $22.4 million in repayments on long-term
    debt;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | $11.6 million to exercise the option to
    purchase four SNFs;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | $4.3 million in financing costs incurred in
    connection with our emergence from bankruptcy and incurrence of
    associated debt; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | $2.9 million to purchase an interest rate
    hedge in accordance with the terms of our Senior Mortgage Term
    Loan. We purchased the interest rate hedge in August 2003 to
    limit our interest rate risk on the $95 million Senior Mortgage
    Term Loan, under which we will receive payment from the
    counterparty of amounts we are required to pay in the event that
    LIBOR exceeds 4.5%. The hedge is treated as a cash flow hedge
    for accounting purposes, which requires us to adjust the
    carrying value of the hedge asset at each reporting period to
    the current value.

Our Senior Mortgage Term Loan is collateralized
by liens on 30 skilled nursing facilities. Under the terms of
the loan we are required to maintain the following reserve
accounts: (i) a debt service reserve account in the amount
of $2.7 million to cover shortfalls in the cash available
for debt service payments, (ii) a reserve collected monthly
for the payment of real property taxes and certain insurance
programs, (iii) a replacement reserve for reimbursement to
us for capital expenditures made to the secured facilities.

On August 19, 2003, pursuant to the Company
Plan, the Company satisfied the terms of the Senior Subordinated
Notes with a payment to the holders on a pro rata basis of
$50.0 million, consisting of approximately
$36.0 million in outstanding interest and approximately
$14.0 million of principal. At that time, the holders of
the Senior Subordinated Notes received on a pro rata basis in
new Senior Subordinated Secured Increasing Rate Notes due in
August 2008, that accrue interest at an initial rate of 9.25%
and provide for annual rate increases. The Company accrues
interest on the new Senior Subordinated Notes using the
effective interest rate method which straight lines the interest
cost over the loan term. At December 31, 2003, the Company
had accrued approximately $1.3 million in excess of the pay
rate for the semi-annual interest payments.

Our general and professional liability reserve is
estimated based on our independent actuaries quarterly using the
most recent trends of claims, settlements and other relevant
data from our Companys and industry loss history. General
and professional liability costs for the long-term care industry
have become increasingly more difficult to estimate. Based on
the information provided by our independent actuaries, at
December 31, 2003, we have reserved $26.7 million for
these costs. We have estimated approximately $3.0 of the total
to be payable in the coming year, however there are no set
payment schedules and there can be no assurances that the
payment amount in 2004 will not be significantly larger.

Our ability to make acquisitions of new
businesses and capital expenditures is restricted by the terms
of the new refinancing credit agreement. Under these
restrictions we are limited to $5.0 million per year on
acquisitions and $7.0 million on capital expenditures.
Permitted capital expenditures to renovate or improve our
facilities will be funded by the Companys operating cash
flows or borrowings under its revolving credit line.

Based upon our current plans, level of operations
and business conditions, we believe that our cash generated from
operations together with available borrowing under our
$32.0 million revolving credit lines will be sufficient to
meet our capital requirements and working capital needs for the
foreseeable future. However we cannot assure you that we will
not be required to seek other financing sooner or that such
financing, if required, will be available on terms satisfactory
to us.

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##### Table of Contents



Contractual Obligations

The following table sets forth our contractual
obligations as of December 31, 2003 (in thousands):

|                               |  |       |         |                        |  |          |        |          |  |        |        |  |  |   |         |  |  |   |        | 
|------------------------------ |  | ----- | ------- | ---------------------- |  | -------- | ------ | -------- |  | ------ | ------ |  |  | - | ------- |  |  | - | ------ | 
|                               |  |       |         |                       
|                               |  |       |         | Payments Due by Period
|                               |  |       |         |                       
|                               |  |       |         | Less                   |  |          |        | More    
|                               |  |       |         | Than                   |  |          |        | Than    
|                               |  | Total |         | 1 Yr.                  |  | 1-3 Yrs. |        | 3-5 Yrs. |  | 5 Yrs.
|                               |  |       |         |                        |  |          |        |          |  |       
|Long-term debt(1)              |  | $     | 240,869 |                        |  | $        | 24,692 |          |  | $      | 13,628 |  |  | $ | 196,164 |  |  | $ | 6,385  | 
|Capital lease obligations(1)   |  |       | 14,093  |                        |  |          | 11,285 |          |  |        | 312    |  |  |   | 312     |  |  |   | 2,184  | 
|Operating lease obligations(2) |  |       | 67,491  |                        |  |          | 7,161  |          |  |        | 12,133 |  |  |   | 11,458  |  |  |   | 36,739 | 
|                               |  |       |         |                        |  |          |        |          |  |        |        |  |  |   |         |  |  |   |        | 
|                               |  | $     | 322,453 |                        |  | $        | 43,138 |          |  | $      | 26,073 |  |  | $ | 207,934 |  |  | $ | 45,308 | 
|                               |  |       |         |                        |  |          |        |          |  |        |        |  |  |   |         |  |  |   |        | 



---

|    |                                                                                                                                    
|--- | -----------------------------------------------------------------------------------------------------------------------------------
|(1) | See Note 6. to the Consolidated Financial
    Statements for a description of our long-term debt and capital
    lease obligations.
|   
|(2) | See Note 12. to the Consolidated Financial
    Statements for a description of our non-cancellable operating
    lease obligations.

Transactions with Related Parties



| |                  
| | -----------------
| | Leased Facilities

Our former Chief Executive Officer and current
director, and his wife, a former Executive Vice President of the
Company, own the real estate for four of the Companys
leased facilities. Such real estate has not been included in the
financial statements for any of the years presented herein.
Lease payments to these related parties under operating leases
for these facilities for the years ended December 31, 2003,
2002 and 2001 were $1.8 million, $1.9 million and
$1.9 million, respectively.



| |                       
| | ----------------------
| | Medical Supply Company

Our former Executive Vice President, who is also
the wife of the Companys former Chief Executive Officer
and current director, owned approximately 33% of a medical
supply company that provides medical supplies and equipment to
the Company pursuant to a supply contract. In May 2003, this
ownership interest was fully divested. As part of our on-going
effort to review and renegotiate all of our material executory
contracts during the reorganization proceeding, the agreement
was amended, first in September 2002 and subsequently in April
2003. The agreement, as amended, provides for an approximately
5% price reduction on medical supplies and equipment, effective
through April 30, 2008. Billings for medical supplies from
this related company for the year ended December 31, 2003,
2002 and 2001 were $5.4 million, $4.5 million and $4.9
million, respectively. We believe that the terms of this supply
agreement are at least as favorable to the us as could be
obtained from third parties in an arms length transaction.



| |                 
| | ----------------
| | Notes Receivable

We have a limited recourse promissory note
receivable from the Chairman of the Board of Directors in the
amount of approximately $2.5 million with an interest rate
of 5.7%. The Note is due on the earlier of April 15, 2007
or the sale by the Chairman of 20,000 shares of our common stock
pledged as security for the note. We have recourse for payment
up to $1.0 million of the principal amount of the note.

In September 2002, we extended a limited recourse
loan in the principal amount up to $0.5 million to our
Chief Executive Officer. The note, which was secured by a deed
of trust on the residential property of the Chief Executive
Officer, bore interest at a rate of 8.0% per annum and required
monthly payments payable on the first day of each month
beginning on the first day of October 2002. The entire principal
balance of the note together with the accrued interest thereon
was due and payable on the earlier of December 1, 2003 or
upon the sale of the property securing the loan. In October
2003, the outstanding principal and interest on the loan was
paid in full.

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##### Table of Contents



Factors That May Affect Future
Results

FORWARD-LOOKING INFORMATION

This Annual Report on Form 10-K contains
forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as
amended, that are based on current expectations, estimates,
forecasts and projections about us, our future performance, our
business, our beliefs and managements assumptions.
Examples of such forward-looking statements include our
expectations with respect to our strategy, expansion
opportunities, extension of our business model, customer demand
and future growth. We believe that our expectations are based
upon reasonable beliefs, assumptions, and information available
to our management at the time the statements are made, however,
such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause our actual
results, performance or achievements, or industry results, to be
materially different from any future results, performance or
achievements expressed or implied by such forward-looking
statements. Numerous factors may affect our actual results and
may cause results to differ materially from those expressed in
forward-looking statements made by or on our behalf. For this
purpose, any statements contained herein that are not statements
of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, the words,
believes, anticipates,
plans, expects, estimates,
assumes, could, projects,
intends, may, will,
continue and similar expressions are intended to
identify forward-looking statements. Factors that may cause such
differences include those risk factors discussed below. Except
as required by the federal securities laws or the rules and
regulation of the Securities and Exchange Commission, we do not
have any intention or obligation to update publicly any
forward-looking statements after the distribution of this
report, whether as a result of new information, future events
changes in assumptions or otherwise.

RISK FACTORS

We depend heavily on reimbursement from
Medicare, Medicaid and other third-party payors and
reimbursement rates from these payors may be reduced.

We derive a substantial portion of our revenue
from third-party payors, including the Medicare and Medicaid
programs. For the year ended December 31, 2003, we derived
approximately 40%, 43% and 10% of our total revenue from the
Medicare program, the Medicaid program and private third party
payor programs, respectively.

Third-party payor programs are highly regulated
and are subject to frequent and substantial changes. Changes in
the reimbursement rates or methods of payment from third-party
payors, including the Medicare and Medicaid programs, or the
implementation of other measures to reduce reimbursements for
our services, could result in a substantial reduction in our
revenue and operating margins.

Medicare and Medicaid have implemented numerous
initiatives to contain healthcare costs by limiting
reimbursement rates and coverage policies, providing for more
restrictive reimbursement regulations, increasing case
management review and operational requirements and negotiating
reduced contract pricing. Private third-party payors, which are
parties responsible for the payment for medical services
received by others, other than the Medicare and Medicaid
programs, are also continuing their efforts to control
healthcare costs through direct contracts with healthcare
providers, increased utilization reviews, or reviews of the
propriety of, and charges for, services provided, and greater
enrollment in managed care programs and preferred provider
organizations. These private payors increasingly are demanding
discounted fee structures and the assumption by healthcare
providers of all or a portion of the financial risk associated
with the provision of care.

Since the federal Medicare program restricts
coverage to patients who require skilled care and
state-administered Medicaid programs generally provide more
restricted coverage and lower reimbursement rates than private
pay sources, the sources and amounts of our patient revenue are
determined by a number of factors, including licensed bed
capacity of our facilities, occupancy rate, payor mix, type of
services rendered to the patient and rates of reimbursement
among payor categories (private and other payors, Medicare and
Medicaid). Accordingly, changes in the case mix of patients, the
mix of patients by payor type and payment

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methodologies may significantly affect our
profitability. In particular, changes which increase the
percentage of Medicaid residents within our facilities could
have a material adverse effect on our financial operations,
especially in states whose reimbursement levels are below our
operating costs.


We cannot assure you that reimbursement payments
and coverage policies under third-party payor programs will
remain at levels comparable to present levels or will be
sufficient to cover the costs allocable to patients eligible for
reimbursement under these programs. We could be adversely
affected by the continuing efforts of third-party payors,
including the Medicare and Medicaid programs, to contain the
amount of reimbursement we receive for healthcare services.
Future changes in the reimbursement rates or methods of
third-party payors or the implementation of other measures to
reduce reimbursement for our services could result in a
substantial reduction in our revenue and a material adverse
effect on our operations and financial condition.

Our Substantial Leverage Could Adversely
Affect Our Financial Condition.

Our business is highly leveraged. As of
December 31, 2003, we have debt of approximately
$255.0 million, $19.5 million of which is scheduled to
mature in 2004. In addition our mandatorily redeemable
Series A preferred stock and accumulated unpaid dividends
totaled $28.8 million at December 31, 2003. We also
had a stockholders equity deficit of approximately
$80.0 million.

Our substantial indebtedness and the provisions
in our term loan, revolving credit facilities, mezzanine loan
agreement and the indenture relating to our senior subordinated
secured increasing rate notes due 2008, could also have other
important consequences. For example:



| |   |                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | they could increase our vulnerability to general
    adverse economic and industry conditions, including material
    adverse regulatory changes such as reductions in reimbursement;                                                                                                                                                              
|
| |  | they could increase the cost or limit the
    availability of additional financing, if needed or desired, to
    fund future working capital, capital expenditures and other
    general corporate requirements, or to carry out other aspects of
    our business plan;                                                                           
|
| |  | they could require us to dedicate a substantial
    portion of our cash flow from operations to the payment of
    principal of, and interest on, our indebtedness, reducing our
    cash flow available for working capital, capital expenditures or
    other general corporate purposes, or to carry out other aspects
    of our business plan;
|
| |  | they could require us to maintain debt coverage
    and financial ratios at specified levels, reducing our financial
    flexibility;                                                                                                                                                                                                              
|
| |  | they could limit our ability to make material
    acquisitions or take advantage of business opportunities that
    may arise;                                                                                                                                                                                                                     
|
| |  | they could limit our flexibility in planning for,
    or reacting to, changes in our business and the industry; and                                                                                                                                                                                                                                
|
| |  | they could place us at a competitive disadvantage
    compared to our competitors that have less debt.                                                                                                                                                                                                                                             

In addition, most of the agreements relating to
our debt contain financial and other restrictive covenants that
will limit our ability to engage in activities that may be in
our long-term best interest. Our failure to comply with those
covenants could result in an event of default, which, if not
cured or waived, could result in the acceleration of all or a
substantial amount of our debt.

Despite current indebtedness levels, we and our
subsidiaries may still be able to incur substantially more debt.
This could further increase the risks associated with our
substantial leverage.

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##### Table of Contents



We Conduct Business in a Heavily Regulated
Industry, and Compliance with any Changes in Regulations May
Result in Increased Costs that Reduce Our Revenue and
Profitability.

We believe that the regulatory environment
surrounding the long-term care industry remains intense. In the
operation of our business we must comply with extensive
regulations relating to, among other things, licensure, conduct
of operations, ownership of facilities, construction of new and
additions to existing facilities, allowable costs, services and
prices for services. Changes in and compliance with the
extensive laws and regulations applicable to our businesses is
expensive and time consuming. If we fail to comply with these
laws and regulations, we could become ineligible to receive
government program reimbursement, suffer civil or criminal
penalties or be required to make significant changes to our
operations. In addition, we could be forced to expend
considerable resources responding to an investigation or other
enforcement action under these laws or regulations. Furthermore,
should we lose licenses for a number of our facilities as a
result of regulatory action or otherwise, this could result in a
material adverse effect on our operations and financial
condition.

SNF Regulation.Long-term care facilities must comply with certain regulatory
requirements to participate either as a SNF under Medicare or a
nursing facility under Medicaid. Failure to substantially comply
with these requirements may result in termination of the
facilitys Medicare and Medicaid provider agreements, after
which the facility would be unable to receive payment for
services provided to Medicare or Medicaid patients until the
facility reapplies or is otherwise reinstated or recertified to
participate in Medicare or Medicaid. We cannot assure you that
we will be able to maintain compliance with these regulatory
requirements at all times, or that we will not be required to
expend significant resources to do so.

Pharmacy Regulation.Our pharmacies are subject to a variety of state licensing and
other laws governing the storage, handling, selling or
dispensing of drugs, in addition to federal regulation under the
Food, Drug and Cosmetic Act and the Prescription Drug Marketing
Act. Moreover, we are required to register our pharmacies with
the United States Drug Enforcement Administration, and to comply
with requirements imposed by that agency with respect to
security and reporting of inventories and transactions. Medicare
pays for the costs of prescription drugs furnished in a number
of different settings. the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003 (the Medicare
Modernization Act) contains a number of reforms that
revise payment methodologies for outpatient settings, beginning
January 1, 2004. Medicaid Programs reimburse pharmacies for
drugs supplied to patients based on the cost of the drug plus a
mark-up that varies depending on the type of drugs supplied.

The Medicare Modernization Act also establishes a
new Medicare outpatient prescription drug benefit, effective in
2006. The drug benefit will be provided through risk-bearing
private plans contracting with the government (including plans
offering only the drug benefit as well as integrated plans
offering other Medicare benefits). The standard outpatient drug
benefit will have a $250 annual deductible, 25% coinsurance
requirement between the deductible and an initial benefit cap of
$2,250 in drug spending. Then there will be a coverage gap until
catastrophic coverage with a 5 percent copayment begins at
$3,600 in out-of-pocket costs ($5,100 in drug spending).

The Health Insurance Portability and
Accountability Act of 1996 (HIPAA) established
uniform standards governing the conduct of certain electronic
health care transactions and protecting the security and privacy
of individually identifiable health information maintained or
transmitted by health care providers, health plans and health
care clearinghouses. Two standards have been promulgated under
HIPAA with which we currently are required to comply. We must
comply with the Standards for Privacy of Individually
Identifiable Health Information, which restrict our use and
disclosure of certain individually identifiable health
information. We have been required to comply with the Privacy
Standards since April 14, 2003. We must also comply with
the Standards for Electronic Transactions, which establish
standards for common health care transactions, such as claims
information, plan eligibility, referral certification and
authorization, claims status, plan enrollment and disenrollment
and payment and remittance advice. We have been required to
comply with these Standards since October 16, 2003. While
we believe that we were HIPAA compliant by such date, there is a
significant risk that many of the state Medicaid programs from
which we receive Medicaid reimbursement are not and will not be
compliant in the near term, particularly in light of the budget
deficits many of them are facing. In the event that a state is
unable to process our HIPAA compliant requests

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for payment, our liquidity could be adversely
affected. Two other standards relevant to our use of medical
information have been promulgated under HIPAA, although our
compliance with these standards is not yet required. The
Security Standards will require us to implement certain security
measures to safeguard certain electronic health information by
April 21, 2005. In addition, CMS recently published a final
rule, which will require us to adopt unique health identifiers
for use in filing and processing health care claims and other
transactions by May 23, 2007. While the government intended
this legislation to reduce administrative expenses and burdens
for the health care industry, our compliance with this law may
entail significant and costly changes for us. If we fail to
comply with these standards, we could be subject to criminal
penalties and civil sanctions.


HIPAA also created two new federal crimes:
healthcare fraud and false statements relating to healthcare
matters. The healthcare fraud statute prohibits knowingly and
willfully executing a scheme to defraud any healthcare benefit
program, including private payors. A violation of this statute
is a felony and may result in fines, imprisonment or exclusion
from government-sponsored programs such as the Medicare and
Medicaid programs. The false statements statute prohibits
knowingly and willfully falsifying, concealing or covering up a
material fact or making any materially false, fictitious or
fraudulent statement in connection with the delivery of or
payment for healthcare benefits, items or services. A violation
of this statute is a felony and may result in fines or
imprisonment.

Additionally, HIPAA granted expanded enforcement
authority to the Department of Health and Human Services and the
U.S. Department of Justice and provided enhanced resources
to support the activities and responsibilities of the Office of
Inspector General and Department of Justice by authorizing large
increases in funding for investigating fraud and abuse
violations relating to healthcare delivery and payment.

Various laws including antikickback, antifraud
and abuse amendments codified under the Social Security Act
prohibit certain business practices and relationships that might
affect the provision and cost of healthcare services
reimbursable under Medicare and Medicaid, including the payment
or receipt of remuneration for the referral of patients whose
care will be paid by Medicare or other governmental programs.
Sanctions for violating the antikickback, antifraud and abuse
amendments under the Social Security Act include criminal
penalties, civil sanctions, fines and possible exclusion from
government programs such as Medicare and Medicaid.

In addition, the Social Security Act broadly
defines the scope of prohibited physician referrals under the
Medicare and Medicaid programs to providers with which they have
ownership or certain other financial arrangements. Many states
have adopted or are considering similar legislative proposals,
some of which extend beyond the Medicaid program, to prohibit
the payment or receipt of remuneration for the referral of
patients and physician self-referrals regardless of the source
of the payment for the care. These laws and regulations are
complex and limited judicial or regulatory interpretation
exists. We cannot assure you that governmental officials charged
with responsibility for enforcing the provisions of these laws
and regulations will not assert that one or more of our
arrangements are in violation of the provisions of such laws and
regulations.

State and federal governments are devoting
increasing attention and resources to anti-fraud initiatives
against healthcare providers. HIPAA and the Balanced Budget Act
expand the penalties for healthcare fraud, including broader
provisions for the exclusion of providers from the Medicare and
Medicaid programs and the establishment of civil monetary
penalties for violations of the anti-kickback provisions. While
we believe that our practices are consistent with Medicare and
Medicaid guidelines, those guidelines are often vague and
subject to interpretation. There can be no assurance that
aggressive anti-fraud enforcement actions will not adversely
affect our business.

We are unable to predict the future course of
federal, state and local regulation or legislation, including
Medicare and Medicaid statutes and regulations, or the intensity
of federal and state enforcement actions. Changes in the
regulatory framework and sanctions from various enforcement
actions could have a material adverse effect on our financial
position, results of operations and liquidity.

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##### Table of Contents



Recent legislation establishing a competitive
bidding process under Medicare could negatively affect our
business.

Recently, CMS conducted competitive bidding
demonstrations for certain Medicare services. Under the Medicare
Modernization Act, starting in 2007, Medicare will begin a
nationwide competitive bidding program in ten high-population
metropolitan services areas for certain high cost and high
utilization items. The program will expand to cover 80
metropolitan services areas in 2009 and additional areas
thereafter. Competitive bidding will require suppliers to
compete for the exclusive or limited rights to provide items to
beneficiaries in a defined region. Only a limited number of
suppliers will be selected in any given metropolitan services
area, resulting in restricted supplier choices for beneficiaries.

We face periodic reviews, audits and
investigations under our contracts with federal and state
government agencies, and these audits could have adverse
findings that may negatively impact our business.

In the ordinary course of our business, we are
regularly subject to inquiries, investigations and audits by
federal and state agencies to determine whether we are in
compliance with regulations governing the operation of, and
reimbursement for, SNFs, ALFs, pharmacies and therapy services.

Both federal and state government agencies have
heightened and coordinated civil and criminal enforcement
efforts under these regulations as part of numerous ongoing
investigations of health care companies and, in particular,
skilled nursing facilities. This includes investigations of:



| |   |                                                   
| | - | --------------------------------------------------
| |  | cost reporting and billing practices;             
|
| |  | quality of care;                                  
|
| |  | financial relationships with referral sources; and
|
| |  | the medical necessity of services provided.       

In some cases or upon repeat violations, the
reviewing agency may take a number of adverse actions against a
facility. These adverse actions include:



| |   |                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------
| |  | the imposition of fines;                                                                                        
|
| |  | refunding amounts paid to the facility pursuant
    to the Medicare or Medicaid programs or from private payors;
|
| |  | temporary suspension of payment for new patients
    to the facility;                                           
|
| |  | decertification from participation in the
    Medicaid or Medicare programs; or                                 
|
| |  | revocation of a facilitys license.                                                                             

We have been subject to certain of these adverse
actions in the past and could be subject to adverse actions in
the future, which could result in significant penalties, as well
as adverse publicity. Any such penalties or adverse publicity
could have a material adverse effect on our financial condition
and results of operations.

We also are subject to potential lawsuits under a
federal whistleblower statute designed to combat fraud and abuse
in the health care industry. These lawsuits can involve
significant monetary awards to private plaintiffs who
successfully bring these suits.

Insurance is not available to cover losses
resulting from such enforcement and whistleblower actions. Any
adverse determination in a governmental investigation, whether
currently asserted or arising in the future, could have a
material adverse effect on our financial condition. Furthermore,
should we lose licenses or certifications for a number of our
facilities as a result of regulatory action or otherwise, we
could be deemed in default under some of our agreements,
including agreements governing outstanding indebtedness.

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Healthcare reform legislation could affect our
revenues and financial condition.

In addition to extensive existing government
healthcare regulation, there are numerous initiatives at the
federal and state levels for comprehensive reforms affecting the
payment for and availability of healthcare services, including a
number of proposals that would significantly limit reimbursement
under the Medicare and Medicaid programs. It is not clear at
this time what proposals, if any, will be adopted or, if
adopted, what effect these proposals would have on our business.
Aspects of certain of these healthcare proposals, such as
reductions in Medicare and Medicaid program expenditures,
containment of healthcare costs on an interim basis by means
that could include a short-term freeze on prices charged by
healthcare providers, and permitting greater state flexibility
in the administration of Medicaid, could potentially affect our
revenues and financial condition.

Significant legal actions, which are
commonplace in our industry, could subject us to increased
operating costs and substantial uninsured liabilities, which
would materially and adversely affect our results of operations,
liquidity and financial condition.

As is typical in the healthcare industry, we are
and will continue to be subject to claims that our services have
resulted in resident or patient injury or other adverse effects.
We, like our industry peers, have experienced an increasing
trend in the frequency and severity of claims and litigation
asserted against us. In addition we may be subject to punitive
damage awards related to these claims. We cannot assure you that
we have insurance adequate to cover these claims. Any adverse
determination in a legal proceeding, whether currently asserted
or arising in the future, could have a material adverse effect
on our financial condition.

We self insure a significant amount of our
potential liabilities and provisions for losses on our financial
statements may not be adequate.

Due to the rising cost and limited availability
of liability insurance we have an occurrence and aggregate
coverage limit of $4 million and $5 million,
respectively, and our overall company-wide aggregate coverage
limit is $5 million maintain, an unaggregated
$0.3 million and $1.0 million self-insured retention
per claim, in California and Texas, respectively. Additionally,
we self insure the first $0.5 million and $1.0 million
self-insured retention per claim of each employee injury claim,
in California and Texas, respectively. Because we are largely
self-insured on both the personal and general liability and
workers compensation programs, there is no limit on the
maximum number of claims or amount for which we can be liable in
any policy period. Although we base our loss estimates on
independent actuarial analyses, which determine expected
liabilities on an undiscounted basis, including incurred but not
reported losses, based upon the available information to date,
the ultimate amount of the losses could exceed our estimates and
our insurance limits. In the event our actual liability exceeds
our estimates for any given period, our results of operations
and financial condition could be materially adversely impacted.

The cost to replace or retain qualified
nurses, healthcare professionals and other key personnel may
adversely affect our financial performance, and we may not be
able to comply with certain states staffing
requirements.

We could experience significant increases in our
operating costs due to shortages in qualified nurses, healthcare
professionals and other key personnel. The market for these key
personnel is highly competitive. We, like other healthcare
providers, have experienced difficulties in attracting and
retaining qualified personnel, especially facility
administrators, nurses, certified nurses aides and other
important healthcare providers. Our SNFs and ALFs are
particularly dependent on nurses for patient care. There is
currently a shortage of nurses, and trends indicate this
shortage will worsen in the future. The difficulty our SNFs and
ALFs are experiencing in hiring and retaining qualified
personnel has increased our average wage rate. We may continue
to experience increases in our labor costs primarily due to
higher wages and greater benefits required to attract and retain
qualified healthcare personnel. Our ability to control labor
costs will significantly affect our future operating results.

27



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We operate a number of facilities in California,
which has enacted legislation establishing minimum staffing
requirements for facilities operating in this state. Each
facility in California must satisfy established minimum nursing
hours of direct care per resident per day. Our ability to
satisfy these requirements will depend upon our ability to
attract and retain qualified nurses, certified nurses
assistants and other staff. Failure to comply with these
requirements may result in the imposition of fines or other
sanctions. If the state does not appropriate sufficient
additional funds, through Medicaid program appropriations or
otherwise, to pay for any additional operating costs resulting
from minimum staffing requirements, our profitability may be
adversely affected.

Denial of pending change of ownership
applications may have an adverse impact on our
business.

In connection with our emergence from bankruptcy,
we completed a corporate restructuring program that required us
to file change of ownership applications with state governmental
entities in connection with moving certain of our ALFs and SNFs
within our corporate structure. If a sufficient number of change
of ownership applications are rejected by any of these entities,
it could have a material adverse impact on our financial
condition and results of operations.

Insurance coverage is becoming increasingly
expensive and difficult to obtain for long-term care companies,
and our insurance carriers could become insolvent and unable to
reimburse us.

Primarily as a result of patient care liability
costs for long-term care providers, insurance companies are
ceasing to insure long-term care companies, or severely limiting
their capacity to write long-term care general and professional
liability insurance. In addition, in the wake of the
September 11, 2001 events, reduced overall insurance
capacity and increasing insurance company losses, the insurance
environment in general has become unstable, making it
increasingly difficult to obtain coverage for patient care
liabilities and certain other risks. When insurance coverage is
available, insurance carriers are typically requiring companies
to significantly increase their liability retention levels
and/or pay substantially higher premiums for reduced coverage
for most insurance coverages, including workers
compensation, employee healthcare and patient care liability. We
are experiencing higher premiums and retention levels. Our
insurance covering patient care liability comes up for renewal
in the second quarter of 2004. We cannot assure you that we will
be able to renew our patient care liability insurance on terms
as favorable as those we currently have.

We have purchased insurance for workers
compensation, property, casualty and other risks from numerous
insurance companies. In many cases, the policies provide
coverage for events occurring in specific time frames that may
only be determined in later years. We exercise care in selecting
companies from which we purchase insurance, including review of
published ratings by recognized rating agencies, advice from
national brokers and consultants and review of trade information
sources. There exists a risk that any of these insurance
companies may become insolvent and unable to fulfill their
obligation to defend, pay or reimburse us when that obligation
becomes due. Although we believe the companies we have purchased
insurance from are solvent, in light of the dramatic changes
occurring in the insurance industry in recent years, we cannot
assure you that they will remain solvent and able to fulfill
their obligations.

State efforts to regulate the construction or
expansion of health care providers could impair our ability to
expand our operations.

Texas regulations require health care providers
(including skilled nursing facilities, home health agencies,
hospices and assisted living centers) to obtain prior approval,
known as a certificate of need for:



| |   |                                                                       
| | - | ----------------------------------------------------------------------
| |  | the purchase, construction or expansion of health
    care facilities;
|
| |  | capital expenditures exceeding a prescribed
    amount; or            
|
| |  | changes in services or bed capacity.                                  

To the extent that we are required to obtain a
certificate of need or other similar approvals to expand our
operations, either by acquiring facilities or expanding or
providing new services or other changes, our expansion could be
adversely affected by our failure or inability to obtain the
necessary approvals, changes in

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the standards applicable to those approvals, and
possible delays and expenses associated with obtaining those
approvals. We cannot assure you that we will be able to obtain
certificate of need approval for all future projects requiring
this approval.


If we fail to attract patients and residents
and compete effectively with other healthcare providers, our
revenues and profitability may decline.

The long-term healthcare services industry is
highly competitive. Our nursing centers compete on a local and
regional basis with other nursing centers and other long-term
healthcare providers. Some of our competitors facilities
are located in newer buildings and may offer services not
provided by us or are operated by entities having greater
financial and other resources than us. Our facilities compete
based on factors such as our reputation for quality care, the
commitment and expertise of our staff and physicians, the
quality and comprehensiveness of our treatment programs, charges
for services, and the physical appearance, location and
condition of our facilities.

The provision of pharmacy services in the
long-term care industry is highly competitive. In the regions we
sell pharmacy products and services, we compete with multiple
local, regional and national institutional pharmacies. Our
institutional pharmacy services generally compete on price and
quality of the services provided. Several of the competitors to
our pharmacy operations are larger and more established service
providers. We also expect to encounter continued competition in
connection with our physical therapy operations. Generally, this
competition is national, regional and local in nature. Many
companies competing in the therapy industry have greater
financial and other resources than we have. The primary
competitive factors in the rehabilitation business are similar
to those in the inpatient and pharmacy business and include
reputation, the cost of services, the quality of clinical
services, responsiveness to customer needs, and the ability to
provide support in other areas such as third party
reimbursement, information management and patient record-keeping.

We cannot assure you that increased competition
in the future will not adversely affect our financial position,
results of operations or liquidity.

If we fail to cultivate new or maintain
existing relationships with the physicians in the communities in
which we operate, our patient base may decrease.

Our patient base depends in part upon the
admissions and referral practices of the physicians in the
communities in which we operate and our ability to cultivate and
maintain relationships with these physicians. Physicians
referring patients to our facilities are not our employees and
are free to refer their patients to other providers. If we are
unable to successfully cultivate and maintain strong
relationships with these physicians, our patient population may
decline, which, if significant, could have a material adverse
effect on our financial condition and results of operations.

Financial information related to our
post-emergence operations is limited and you may not be able to
accurately determine our future operating results from our
historical results.

We emerged from bankruptcy on August 19,
2003 following a significant restructuring of our debt
obligations and corporate structure. Accordingly we have limited
operating and financial data available from which you may
analyze the operating results and cash flows of our business as
it is currently structured. We have limited operating experience
as a reorganized company.

Future acquisitions may use significant
resources, may be unsuccessful and could expose us to unforeseen
liabilities.

We intend to selectively pursue acquisitions of
nursing centers, pharmacies and other related healthcare
operations. Acquisitions may involve significant cash
expenditures, debt incurrence, additional operating losses,
amortization of certain intangible assets of acquired companies,
dilutive issuances of equity securities

29



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##### Table of Contents



and expenses that could have a material adverse
effect on our financial position, results of operations and
liquidity. Acquisitions involve numerous risks, including:




| |   |                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties integrating acquired operations,
    personnel and information systems,                                                                                        
|
| |  | diversion of managements time from existing
    operations,                                                                                                                
|
| |  | potential loss of key employees or customers of
    acquired companies, and                                                                                                 
|
| |  | assumption of the liabilities and exposure to
    unforeseen liabilities of acquired companies, including
    liabilities for failure to comply with healthcare regulations.

We cannot assure you that we will succeed in
obtaining financing for acquisitions at a reasonable cost, or
that such financing will not contain restrictive covenants that
limit our operating flexibility. We also may be unable to
operate acquired facilities profitably or succeed in achieving
improvements in their financial performance.

A portion of our workforce has unionized and
our operations may be adversely affect by work stoppages,
strikes or other collective actions

In California, certain of our employees are
represented by various unions and covered by collective
bargaining agreements. Certain labor unions have publicly stated
that they are concentrating their organizing efforts within the
long-term health care industry. We cannot predict the effect
that continued union representation or future organizational
activities will have on our business. Although our facilities
have never experienced any material work stoppages and we
believe that our relations with employees and labor
organizations are generally good, we cannot predict the effect
continued union representation or organizational activities will
have on our future operations. We cannot assure you that we will
not experience a material work stoppage in the future.

Our quarterly results are subject to seasonal
fluctuations.

Our business is subject to modest effects of
seasonality that have caused our quarterly operating results to
fluctuate in the past and will continue to do so in the future.
During the calendar fourth quarter holiday periods, nursing home
and assisted living residents are sometimes discharged to join
family celebrations and admission decisions are often deferred.
The first quarter of each calendar year usually coincides with
increased illness among nursing home and assisted living
residents which can result in increased costs or discharges to
hospitals. As a result of these factors, nursing home and
assisted living operations sometimes produce greater earnings in
the second and third quarters of a calendar year and lesser
earnings in the first and fourth quarters.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    about Market Risk

Certain of our debt obligations are sensitive to
changes in interest rates. The rates on our senior debt and
revolving loan facilities, which both bear interest at LIBOR
plus an applicable margin, are reset at various intervals. To
mitigate our risk in an increasing interest rate environment, we
purchased from a highly rated counter party a hedge in August
2003 to limit our exposure to an increase in the interest rate
under our Senior Mortgage Term Loan in the event that LIBOR
exceeds of 4.5%. We have not experienced significant changes in
market risk due to the relative stability of interest rates
during the fiscal 2003.






|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

The financial statement information, including
the report of independent accountants, required by this
Item 8 is set forth on pages F-1 to F-39 of this Annual
Report on Form 10-K and is hereby incorporated into this
Item 8 by reference. The Quarterly Information required by
this Item 8 is set forth on page F-38 of this Annual
Report on Form 10-K and hereby incorporated into this
Item 8 by reference.

30



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##### Table of Contents








|        |                                                                                              
|------- | ---------------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements With
    Accountants on Accounting and Financial
    Disclosures

None.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

We maintain disclosure controls and procedures
that are designed to ensure that information required to be
disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the
Securities and Exchange Commissions rules and forms, and
that such information is accumulated and communicated to our
management, including our Chief Executive Officer and our Chief
Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that
any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the
desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. Also, we have
investments in certain unconsolidated entitles. As we do not
control or mange these entities, our disclosure controls and
procedures with respect to such entities are necessarily
substantially more limited than those we maintain with respect
to our consolidated subsidiaries.

We carried out an evaluation, under the
supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial
Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2003,
the end of the annual period covered by this report. Based on
the forgoing, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures
were effective at the reasonable assurance level.

There have been no significant changes in our
internal controls or in other factors that could significantly
affect the internal controls subsequent to the date we completed
our evaluation.




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

Executive Officers and Directors

The following table sets forth certain
information as of March 15, 2004, about our executive
officers and members of our board of directors.

|                 |  |     |    |          |  |                                                                
|---------------- |  | --- | -- | -------- |  | ---------------------------------------------------------------
|Name             |  | Age |    | Position
|                 |  |     |    |         
|Boyd Hendrickson |  |     | 59 |          |  | Chief Executive Officer and Director                           
|Jose Lynch       |  |     | 34 |          |  | President                                                      
|John H. Harrison |  |     | 43 |          |  | Chief Financial Officer and Treasurer                          
|Roland Rapp      |  |     | 42 |          |  | General Counsel, Chief Administrative Officer and
    Secretary
|William C. Scott |  |     | 67 |          |  | Chairman and Director                                          
|Michael Gilligan |  |     | 48 |          |  | Director                                                       
|Scott Gross      |  |     | 58 |          |  | Director                                                       
|Peter Hermann    |  |     | 49 |          |  | Director                                                       
|Mark J. Jrolf    |  |     | 39 |          |  | Director                                                       
|Tim Parris       |  |     | 47 |          |  | Director                                                       
|Michel Reichert  |  |     | 53 |          |  | Director                                                       
|Robert M. Snukal |  |     | 61 |          |  | Director                                                       

Boyd Hendrickson, 59, Chief Executive
Officer and Director.Mr. Hendrickson has served as
Chief Executive Officer and Director since April of 2002. Before
joining us, Mr. Hendrickson served as President

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and CEO for Evergreen Healthcare from January
2000 to April 2002. From 1988 to January 2000,
Mr. Hendrickson served in various senior management roles,
including President and Chief Operating Officer of Beverly
Enterprises, the nations largest long-term healthcare
company, where he also served on the Board of Directors.
Mr. Hendrickson was also co-founder, President and Chief
Operating Officer of Care Enterprises, and Chairman and Chief
Executive Officer of Hallmark Health Services.


Jose Lynch, 34,
President.Mr. Lynch has served as President
since February of 2002. During his more than 12 years of
executive experience in the nursing home industry, he served as
Senior Vice President of Operations and as Corporate officer of
the Western Region for Mariner Post-Acute Network from November
1999 to February 2002, where he was responsible for the
operation of 30 skilled nursing and assisted living centers in
California. Mr. Lynch also served as Regional Vice
President of Operations for the Western Region for Mariner
Post-Acute Network from May 1998 to November 1999, where he
controlled the operations of 20 skilled nursing and
rehabilitation hospitals and two assisted living centers in
California.

John H. Harrison, 43, Chief Financial
Officer and Treasurer.Mr. Harrison has served as
Chief Financial Officer and Treasurer since July of 2002. Prior
to joining us, John served as Controller and Treasurer of
Evergreen Healthcare Management from April 2001 to June 2002.
From September 1989 to March 2001, Mr. Harrison held
various positions with Beverly Enterprises including Vice
President of Finance for Beverly Care Alliance, served as Chief
Financial Officer for the outpatient clinic division of Beverly,
and was acting Chief Financial Officer for the home care and
contract rehabilitation therapy divisions.

Roland Rapp, 42, General Counsel, Chief
Administrative Officer and Secretary.Mr. Rapp has served as
General Counsel, Chief Administrative Officer and Secretary
since March 2002. He has approximately 21 years of
experience in the healthcare and legal sectors. From June 1993
to March 2002, Mr. Rapp was the Managing Partner of the law
firm of Rapp, Kiepen and Harman, and was Chief Financial Officer
for Vintage Estates from November 1997 to March 2002, both based
in Pleasanton, California. His law practice centered on
healthcare law and primarily focused on long-term care based on
his prior experience as nursing home administrator and director
of operations for a small nursing home chain.

William C. Scott, 67, Chairman and
Director.Mr. Scott has
served as Director and Chairman since March 1998. Mr. Scott
has held various positions with Summit since December 1985,
including Chief Executive Officer and Chief Operating Officer.
Mr. Scott served as Senior Vice President of Summit Health,
Ltd., Summits former parent company, from December 1985
until its acquisition by OrNda Health Corp. in April 1994.

Michael Gilligan, 48, Director.Mr. Gilligan has served as
Director since March 1998. Since December 1993,
Mr. Gilligan has been a General Partner of Heritage
Partners, Inc., a Boston-based private investment firm that is
the advisor and sponsor to Heritage. Prior to 1994,
Mr. Gilligan was a director of BancBoston Capital, Inc., a
private investment firm.

Scott Gross, 58, Director.Mr. Gross has been a Director
since December 1999. Since February 2004, Mr. Gross has
served as the Chief Executive Officer of Rivien Health, LLC, an
operator of out-patient therapy clinics. Prior to joining Rivien
Health, Mr. Gross was a private investor from
January 2001 to January 2004. Mr. Gross was
President and Chief Executive Officer of Primus Management,
Inc., a successor organization to Alpha Hospital Management,
Inc., where he was President and Chief Executive Officer from
1989 to December 2000.

Peter Hermann, 49, Director.Mr. Hermann has served as
Director since March 1998. Since December 1993, Mr. Hermann
has been a General Partner of Heritage Partners, Inc., a
Boston-based private investment firm that is the advisor and
sponsor to Heritage. Prior to 1994, Mr. Hermann was a
Director of BancBoston Capital, Inc., a private investment firm.

Mark J. Jrolf, 39, Director.Mark J. Jrolf has been a Director
since August 1997. Since February 1997, Mr. Jrolf has been
a Partner and Vice President of Heritage Partners, Inc., a
Boston-based private investment firm that is the advisor and
sponsor to Heritage. From September 1993 to September 1996,
Mr. Jrolf was a consultant with McKinsey & Co.,
specializing in healthcare.

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Tim Parris, 47, Director.Mr. Parris has served as
director since June 1999. Since January 2000,
Mr. Parris has served as president of Baylor University
Medical Center in Dallas and executive vice president of Baylor
Health Care System, overseeing operations of Baylor Health
Enterprises and several Baylor facilities, including Baylor
Institute for Rehabilitation, Baylor Specialty Hospital, Our
Childrens House at Baylor and Baylor Medical Center-Ellis
County. From January 1996 to January 2000,
Mr. Parris served as executive vice president and chief
operating officer of Baylor University Medical Center and
administrative assistant and executive director of the Baylor
Institute for Rehabilitation.

Michel Reichert, 53, Director.Michel Reichert has served as
Director since August 1997. Mr. Reichert is the
Managing General Partner of Heritage Partners, Inc., a
Boston-based private investment firm that he formed in 1993. He
is responsible for guiding the overall operating and investment
philosophy from the origination of transactions to the ultimate
disposition of the investments. He is a graduate of the
University of Bourges, France with a specialty in Business
Administration. Mr. Reichert is presently on the Board of Pure
Beauty, Inc., APX, Inc., Advance Group, Inc., Skilled Healthcare
Group, Inc., Diam International, idX Corp., and Enterprise
NewsMedia, LLC.

Robert M. Snukal, 61, Director.Mr. Snukal has served as
Director since August 1997. From August 1997 to
February 2002, Mr. Snukal served as a Director and
President of each of Fountain View, Inc.s then
subsidiaries, which were owned directly by Mr. Snukal and
Mrs. Snukal during that period. Mr. Snukal served as
our Chief Executive Officer from August 1997 to
February 2002.

All of our directors except Boyd Hendrickson, who
joined the board in August 2003, were in office when our
Bankruptcy petition was filed on October 1, 2001.

Composition of the Board of
Directors

Our board of directors has responsibility for our
overall corporate governance and meets regularly throughout the
year. Our bylaws provide that our board of directors may fix the
exact number of directors by resolution of the board of
directors. We currently have nine authorized directors. We have
entered into a stockholders agreement, as amended, which permits
Mr. Snukal, Mr. Scott, Baylor Health Care System and
certain investors who hold a majority of the Class A common
stock held by such investors to nominate designated directors to
serve as members of our board. Any designation of director
nominees to be made by the majority of the certain investors
will be made by Heritage Fund II, L.P. as long as it holds
more shares of Class A common stock than any other
investor. Mr. Snukal and Mr. Scott are serving each as
their own designees. Baylor Health Care System designated
Mr. Parris. Heritage Fund II, L.P. designated
Messrs. Jrolf, Reichert, Hermann and Gilligan. Each of our
directors has served continuously as a director of the Company
since the date indicated in his biography above and is currently
serving a one year term expiring at the Companys next
annual meeting or until his respective successor is elected and
qualified. Executive officers are elected by and serve at the
direction of our board of directors. There are no family
relationships between any of our directors or executive officers.

Committees of the Board of Directors

We are managed under the direction of our board
of directors and do not have committees of the board of
directors. We do not have securities registered with the
Securities and Exchange Commission and are not subject to the
rules and regulations of the Securities and Exchange Commission
regarding audit committees, audit committee financial experts
and director independence.

Stockholder Recommendation of Nominees to
Board of Directors

The board of directors has not established a
policy with respect to the nomination of candidates to our board
of directors. To date, all of our directors have been affiliates
with significant stock holdings in our company and a significant
majority have been nominated pursuant to the stockholder
agreement. Accordingly, we do not believe a policy regarding the
nomination of directors by stockholders is necessary.

33



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##### Table of Contents



Section 16(a) Beneficial Ownership
Reporting Compliance

Section 16(a) of the Securities Exchange Act
of 1934 is not applicable us because we do not have any class of
equity securities registered pursuant to Section 12 of the
Securities Exchange Act of 1934.

Code of Ethics

We have not yet adopted a code of ethics
applicable to us principal executive officer, principal
financial officer, principal accounting officer or controller,
or persons performing similar functions. Our board is currently
considering a code of ethics to be adopted at a future meeting
of the board of directors.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

Summary Compensation Table

The following table sets forth information with
respect to the compensation we paid for services rendered during
the fiscal years ended December 31, 2003, 2002 and 2001 to
our Chief Executive Officer and to our four other most highly
compensated executive officers. We refer to these individuals
collectively as our Named Executive Officers.

|                    |                                       |      |      |                     |  |           |         |                 |  |   |         |         |  |  |        |        | 
|------------------- | ------------------------------------- | ---- | ---- | ------------------- |  | --------- | ------- | --------------- |  | - | ------- | ------- |  |  | ------ | ------ | 
|                    |                                       |      |      |                     |  |          
|                    |                                       |      |      | Annual Compensation |  |          
|                    |                                       |      |      |                     |  | All Other
|Name and Title      |                                       | Year |      | Salary              |  | Bonus     |         | Compensation(1)
|                    |                                       |      |      |                     |  |           |         |                
|Boyd Hendrickson(2) |                                       |      | 2003 |                     |  | $         | 441,346 |                 |  | $ | 250,000 |         |  |  | 25,400 |       
|                    | Chief Executive Officer and Director  |      |      | 2002                |  |           |         | 337,500         |  |   |         | 250,000 |  |  |        | 19,060 | 
|                    |                                       |      |      | 2001                |  |           |         |                |  |   |         |        |  |  |        |       | 
|William C. Scott    |                                       |      | 2003 |                     |  |           | 415,606 |                 |  |   |        |         |  |  | 26,290 |       
|                    | Chairman and Director                 |      |      | 2002                |  |           |         | 423,755         |  |   |         |        |  |  |        | 26,290 | 
|                    |                                       |      |      | 2001                |  |           |         | 478,721         |  |   |         |        |  |  |        | 23,040 | 
|Jose Lynch(3)       |                                       |      | 2003 |                     |  |           | 343,269 |                 |  |   | 136,000 |         |  |  | 25,420 |       
|                    | President                             |      |      | 2002                |  |           |         | 302,884         |  |   |         | 130,000 |  |  |        | 22,240 | 
|                    |                                       |      |      | 2001                |  |           |         |                |  |   |         |        |  |  |        |       | 
|John Harrison(4)    |                                       |      | 2003 |                     |  |           | 225,442 |                 |  |   | 45,000  |         |  |  | 25,400 |       
|                    | Chief Financial Officer and Treasurer |      |      | 2002                |  |           |         | 112,500         |  |   |         | 22,500  |  |  |        | 12,700 | 
|                    |                                       |      |      | 2001                |  |           |         |                |  |   |         |        |  |  |        |       | 
|Roland Rapp(5)      |                                       |      | 2003 |                     |  |           | 222,923 |                 |  |   | 45,000  |         |  |  | 25,400 |       
|                    | General Counsel, Chief Administrative |      |      | 2002                |  |           |         | 167,538         |  |   |         | 33,750  |  |  |        | 19,050 | 
|                    | Officer and Secretary                 |      |      | 2001                |  |           |         |                |  |   |         |        |  |  |        |       | 



---



|    |                                                                                                                                  
|--- | ---------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes perquisites and other personal benefits,
    such as auto allowances, health and other insurance premiums.              
|   
|(2) | Mr. Hendricksons employment with us
    began in April 2002. His annual compensation shown in 2002 is
    based on partial year.
|   
|(3) | Mr. Lynchs employment with us began in
    February 2002. His annual compensation shown in 2002 is based on
    partial year.   
|   
|(4) | Mr. Harrisons employment with us began
    in July 2002. His annual compensation shown in 2002 is based on
    partial year.    
|   
|(5) | Mr. Rapps employment with us began in
    May 2002. His annual compensation shown in 2002 is based on
    partial year.         

Compensation of Directors

We do not pay our directors any fees or
remuneration, as such, for their service on the board of
directors. Messrs. Hendrickson and Scott received
compensation as executive officers of the Company, as set forth
in the Summary Compensation Table in this
Item 11 above.

34



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Employment Contracts and Change of Control
Agreements



| |                      
| | ---------------------
| | Employment Agreements

We entered into amended employment agreements
with Messrs. Hendrickson, Lynch, Harrison and Rapp,
effective March 8, 2004. The agreements cover periods of
employment for these executives ending in March 2007, February
2007, June 2007 and March 2007, respectively. Under each
agreement, the executive receives a stated annual base salary
and is eligible to participate in an annual performance bonus
program. Messrs. Hendrickson and Lynch will receive an
annual cash bonus based on target financial and patient care
goals determined annually by us.

Under each agreement, the executive is eligible
to receive a cash bonus during the period of employment or
within nine months of termination of employment without cause or
due to death or disability, if one of the following trigger
events (each a Trigger Event) occurs and our
terminal equity value, is less than $100 million at the
time of such event:



| |   |                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a sale of all or substantially all of our assets;                                                                                                                                                                                                                             
|
| |  | the closing of an initial public offering of our
    Class A common stock pursuant to an effective registration
    statement and the listing or quotation of such stock on a
    national security exchange or in the Nasdaq National Market
    Quotation System, an IPO; or
|
| |  | a stock sale of at least a majority of our then
    outstanding common stock in a single or a series of
    substantially related transactions.                                                                                                                               

If our terminal equity value at a Trigger Event
is equal to or greater than $100 million, in the
alternative to the cash bonus, the executives shares of
restricted Class B common stock will vest. Shares of such
restricted Class B common stock were granted to each of
Messrs. Hendrickson, Lynch, Harrison and Rapp concurrently
with the execution of the employment agreements pursuant to
separate restricted stock agreements, discussed below under
Restricted Stock Agreements.

Each of these executives is also eligible to
participate in all benefit programs we offer. We will annually
review the performance and terms of employment of
Messrs. Lynch, Harrison and Rapp.

If we terminate Mr. Hendrickson without
cause, he would be entitled to receive a pro-rated annual
performance bonus for the year in which the termination occurs
and twelve months of medical insurance coverage. We will also be
obligated to retain and Mr. Hendrickson will be obligated
to perform exclusive consulting services for us for a period
ending the earlier of the second anniversary of the date his
employment was terminated without cause or March 31, 2007.
Mr. Hendrickson will receive a monthly consulting fee for
such services. During Mr. Hendricksons employment, we
will use reasonable best efforts to cause him to be elected to
our board of directors, or to be named Chairman of the board in
the event that Mr. Scott no longer holds this position.
Mr. Hendrickson has agreed to resign from the board of
directors upon termination of his employment for any reason.
Payments to Mr. Hendrickson upon termination without cause
are contingent upon his resignation from the board of directors
and compliance with certain confidentiality and non-solicitation
obligations. Mr. Hendrickson is also entitled to
participate in a disability plan paid by us under which he would
receive payments if his employment with us terminates due to
disability.

If each of Messrs. Lynch, Harrison and Rapp
is terminated without cause, in the event of a change of control
or due to death or disability, he would be entitled to the
following benefits so long as he is in compliance with certain
confidentiality and non-solicitation obligations:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a severance payment in the amount of two times
    base salary, or $700,000, for Mr. Lynch, $112,500 for
    Mr. Harrison and one and one-half times base salary, or
    $352,500, for Mr. Rapp, except that the severance payments
    in the event of a change of control would be one and one-half
    times base salary, or $525,000, for Mr. Lynch and one-half
    times base salary, or $117,500 for Mr. Rapp;

35



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| |   |                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a pro-rated bonus for the year in which
    termination occurs to the extent each executive is eligible to
    participate in the annual performance bonus program; and
|
| |  | continuation of medical insurance coverage for
    twelve months for Messrs. Lynch and Rapp.                                                                           

If the employment of each of Messrs. Lynch
and Rapp terminates for any reason, other than by us without
cause or in the event of change of control, he would be entitled
to medical insurance coverage for three months and any salary or
bonus payments earned but not yet paid. If each of
Messrs. Lynch, Harrison and Rapp resign on any day other
than the last day of our fiscal year, or if we terminate his
employment for cause, he would not receive any annual
performance bonus, or pro-rated portion of such bonus.



| |                            
| | ---------------------------
| | Restricted Stock Agreements

We entered into restricted stock agreements with
each of Messrs. Hendrickson, Lynch, Harrison and Rapp,
effective March 8, 2004, concurrent with the execution of
the amended employment agreements for each executive. Pursuant
to these agreements we granted shares of our restricted and
non-voting Class B common stock for a purchase price of
$0.05 per share to these executives in the following amounts:

|                 |  |           |        | 
|---------------- |  | --------- | ------ | 
|                 |  | Number of
|                 |  | Shares   
|                 |  |          
|Boyd Hendrickson |  |           | 39,439 | 
|Jose Lynch       |  |           | 19,719 | 
|John Harrison    |  |           | 4,930  | 
|Roland Rapp      |  |           | 6,573  | 

These shares of Class B common stock are
restricted by certain vesting requirements, rights of us to
repurchase the shares, and restrictions on the sale or transfer
of such shares. All such restrictions will lapse in full upon
the occurrence of a Trigger Event, as defined above under
Employment Agreements. Our board of directors may
also elect at any time to remove any or all of these
restrictions.

Vesting.Under each
agreement, the shares of Class B common stock are unvested
and will vest in full upon a Trigger Event. Upon termination of
the executives employment by reason of death or disability
or termination by us without cause, the shares will vest in the
amount of approximately 40-50%, depending on the executive, of
the executives granted shares, plus an additional amount
for each full month elapsed between the grant date of
March 8, 2004 and the date of termination, not to exceed
the number of shares granted to the executive.

If a Trigger Event has not occurred by the end of
the original term of the amended employment agreement for each
executive and the executive is still employed by us, 50% of his
shares will vest if he has complied with the confidentiality and
non-solicitation obligations in his amended employment agreement
and we have met certain financial performance targets. In the
event there is a termination of employment after the term of the
executives amended and restated employment agreement and
50% of his shares of Class B common have vested, the
executive has the right to require us to repurchase such vested
shares at fair market value upon written request within
12 months after the date of his termination. Immediately
prior to an IPO, any such right will expire to the extent not
exercised.

If a Trigger Event occurs within nine months
following the termination of the executives employment for
death or disability or termination by us without cause, or
within nine months following the term of employment under his
amended employment agreement, additional shares of his
Class B common stock will vest in a number so that his
vested shares will equal the amount of shares granted. The
executive will not have the right to require us to purchase any
of his additional shares of Class B common stock that vests
as a result of such a Trigger Event.

Repurchase Rights.Under each agreement, we will have the
right to repurchase at fair market value all vested shares of
Class B common stock held by Messrs. Hendrickson,
Lynch, Harrison and Rapp upon termination of his employment for
death or disability or by us without cause during the term of
his amended employment agreement, or upon termination of his
employment for any reason after the term of his amended

36



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##### Table of Contents



employment agreement. This repurchase right by us
will terminate immediately prior to an IPO to the extent such
right has not been exercised.


If we have repurchased any of the
executives vested Class B common shares and
additional shares held by the executive vest upon the occurrence
of a Trigger Event within nine months following the termination
of the executives employment for death or disability or
termination by us without cause, or within nine months following
the term of employment under his amended employment agreement,
we will pay the executive to repurchase such additional shares
for fair market value. We may also purchase any unvested shares
of Class B common stock from the executive upon termination
of his employment for the lesser of $0.05 per share, the price
he initially paid for the shares, or the fair market value of
the shares at the time of repurchase.

We will not have the right to repurchase any
shares of Class B common stock that vest in connection with
a Trigger Event. However, if our terminal equity value, as such
term is defined in the agreements, is less than the specified
threshold amount upon the occurrence of a Trigger Event, we will
have the right to purchase all vested and unvested shares of the
Class B common stock from the executive for the lesser of
$0.05 per share, the price he initially paid for the shares, or
the fair market value of the shares at the time of repurchase.

We may assign any of our repurchase rights to any
of our stockholders.

Restrictions on Sale or Transfer.Under each agreement,
Messrs. Hendrickson, Lynch, Harrison and Rapp are not
permitted to sell or transfer in any way any of the Class B
common stock granted to him until such shares have vested and
our repurchase rights have terminated.

Employee Benefit Plans



| |                           
| | --------------------------
| | 2004 Equity Incentive Plan

Purpose.Our board
of directors adopted our 2004 equity incentive plan in March
2004 and our stockholders approved it on March 4, 2004. The
equity incentive plan provides for grants of incentive stock
options, as defined in Section 422 of the Internal Revenue
Code of 1986, to our employees, including officers and
directors, as well as non-qualified stock options and restricted
stock to our employees and consultants. The equity incentive
plan is intended to facilitate the attraction and retention of
the best available personnel and to provide incentives for such
persons to exert maximum efforts for our success.

Administration.Our
board of directors administers the equity incentive plan unless
the board of directors delegates administration to a committee
of one or more members of the board. The board of directors, or
the committee if so empowered, has the power to interpret the
equity incentive plan and awards granted pursuant to the equity
incentive plan and to exercise powers and perform acts deemed
necessary or desirable to promote our best interests not in
conflict with the equity incentive plan. Following the first
date upon which our Class A common stock is listed on any
securities exchange or designated on a national market system,
the equity incentive plan will be administered by a committee of
the board consisting solely of two or more independent directors
each of whom is both an outside director, within the
meaning of Section 162(m) of the Internal Revenue Code of 1986,
and a non-employee director within the meaning of
rule 16b-3 under the Exchange Act. The board or such a
committee may delegate to a committee of one or more members of
the board that are not independent directors the authority to
grant awards to individuals that are not covered
employees under Section 162(m) or for whom we do not
wish to comply with Section 162(m). The board or such a
committee may also delegate to a committee of one or more
members of the board that are not non-employee directors the
authority to grant awards to individuals that are not subject to
Section 16 of the Exchange Act.

Securities Reserved and Limits on Awards.The aggregate number of shares of our
common stock issuable under the equity incentive plan is 20,000.
In addition, the maximum number of shares of restricted stock or
options to purchase restricted stock that may be granted to any
individual during any calendar year during the term of the
equity incentive plan is 20,000. However, this limitation on
individual grants does not apply until after the first date upon
which our common stock is listed on any securities exchange or
designated on a national market system and the earliest of the
first material modification of the equity incentive plan, the
issuance of all of the shares of common stock reserved for
issuance under the equity incentive plan, the

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expiration of the equity incentive plan, or the
first meeting of our stockholders at which our board of
directors are to be elected that occurs three years following
the year in which we first registered an equity security under
Section 12 of the Exchange Act.


Grant of Awards.Certain employees, consultants and
directors are eligible to be granted awards under the equity
incentive plan. The board of directors, or the committee if so
empowered, determines:



| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | which employees, consultants, and directors are
    to be granted awards;         
|
| |  | the type of award that is granted;                                                
|
| |  | the number of shares subject to the awards; and                                   
|
| |  | terms and conditions of such award, consistent
    with the equity incentive plan.

The board of directors, or the committee if so
empowered, has the discretion, subject to the limitations of the
equity incentive plan and applicable laws, to grant incentive
stock options, non-qualified stock options, and restricted stock
(except that only our employees may be granted incentive stock
options).

Limitation on Incentive Stock Option
Treatment.Even if an option is
designated as an incentive stock option, no option will qualify
as an incentive stock option if the aggregate fair market value
of the stock (as determined as of the date of grant) with
respect to all of a holders incentive stock options
exercisable for the first time during any calendar year under
the equity incentive plan exceeds $100,000. Any option failing
to qualify as an incentive stock option will be deemed to be a
non-qualified stock option.

Exercise Price.The
board of directors, or the committee if so empowered, shall set
the per share exercise price, subject to the following rules:



| |   |                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | in the case of incentive stock options, the per
    share exercise price shall not be less than 100% of the fair
    market value of shares of our common stock on the grant date;                                                                                                                                                                                                
|
| |  | in the case of non-qualified stock options, the
    exercise price shall not be less than 85% of the fair market
    value of shares of our common stock on the grant date; and                                                                                                                                                                                                   
|
| |  | for the persons owning (within the meaning of
    Section 424(d) of the Internal Revenue Code of 1986) more
    than 10% of the total combined voting power of all classes of
    our capital stock or of any parent or subsidiary, the per share
    exercise price shall be not less than 110% of the fair market
    value of the shares of our common stock on the grant date.

The board of directors, or the committee if so
empowered will determine in good faith the fair market value of
a share of our common stock as of a given date as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | if the common stock is listed on any established
    stock exchange or a national market system, its fair market
    value will be the closing sales price for a share of such stock
    (or the closing bid, if no sales were reported) as quoted on
    such exchange or system on the date of such determination, as
    reported in The Wall Street Journal or such other source as the
    board of directors, of committee if so empowered, deems reliable;
|
| |  | if the common stock is regularly quoted by a
    recognized securities dealer but selling prices are not
    reported, its fair market value will be the mean between the
    high bid and low asked prices for a share of the common stock on
    the last market trading day on the day of determination; or                                                                                                                                                   
|
| |  | in the absence of an established market for the
    common stock, the fair market value will be determined in good
    faith by the board of directors, or the committee if so
    empowered.                                                                                                                                                                                                                                                                    

Expiration of Awards.The term of an award is set by the
board of directors, or the committee if so empowered, subject to
the following conditions: (1) that no award term shall be
longer than ten years from the date of grant; and (2) the
award term for an incentive stock option granted to a person
owning more than 10% of the total combined voting power of all
classes of our capital stock shall not exceed five years from
the date of grant. Upon termination of an outstanding option
holders status as our employee or consultant, the holder
may exercise his or her options within the period of time
specified in the option grant, to the extent that the

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options were vested at the time of termination.
If no time period was specified in the notice of grant, the
option shall remain exercisable for three months following the
holders termination of status as an employee or consultant
other than for death or disability, or until the date of
expiration of the option as set forth in the option agreement,
whichever is earlier. Options granted under the plan must be
exercised within twelve months if the holders employment
ends due to disability or death, or by the date of expiration of
the option as set forth in the option agreement, whichever is
earlier.


Vesting of Options.Options granted under the equity incentive plan will vest
according to the terms of the equity incentive plan and as set
forth set forth in individual option agreements setting forth
the terms of the options. In no event will options granted to
officers, directors or consultants become vested and exercisable
at a rate less than 20% per year over five years from the date
the option is granted, subject to reasonable conditions, such as
continued employment with us.

Exercise of Options.The dates on which options or other awards under the equity
incentive plan first become exercisable will be set forth in
individual award agreements setting forth the terms of the
awards. Only whole shares of common stock may be purchased. An
option may be exercised by full cash payment for the shares in
the form of cash or a check payable to us in the amount of the
aggregate option exercise price. However, the board of
directors, or the committee if so empowered, may in its
discretion allow payment through:



| |   |                                                                                                                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the delivery of other shares acquired from us
    that have been owned by the holder for more than six months and
    have a fair market value on the date of surrender equal to the
    aggregate exercise price of the shares for which options are
    being exercised;                                                                               
|
| |  | the surrender of shares then issuable upon the
    exercise of options having a fair market value on the date of
    exercise equal to the aggregate exercise price of the options or
    exercised portion of such options;                                                                                                                             
|
| |  | the delivery of property of any kind which
    constitutes good and valuable consideration;                                                                                                                                                                                                                                                              
|
| |  | the delivery of a notice that the option holder
    has placed a market sell order with a broker with respect to
    shares of Common Stock then issuable on exercise of the option,
    and that the broker has been directed to pay a sufficient
    portion of the net proceeds of the sale to us in satisfaction of
    the option exercise price; or
|
| |  | any combination of the foregoing.                                                                                                                                                                                                                                                                                                                        

Adjustments of Awards.If the board of directors, or the
committee if so empowered, determines that any dividend or other
distribution, recapitalization, reclassification, stock split,
reverse stock split, reorganization, merger, consolidation,
split-up, spin-off, combination, repurchase, liquidation,
dissolutions, or sale, transfer, exchange or other disposition
of all or substantially all of our assets, or other similar
corporate transaction or event that affects our common stock
which causes dilution or enlargement of benefits under the
equity incentive plan, then the board of directors, or the
committee if so empowered, may appropriately adjust:



| |   |                                                                                             
| | - | --------------------------------------------------------------------------------------------
| |  | the aggregate number of shares of our common
    stock subject to the equity incentive plan;
|
| |  | the number and kind of shares of our common stock
    subject to the outstanding awards; and
|
| |  | the exercise price of outstanding awards.                                                   

The board of directors, or the committee if so
empowered, may also take action immediately prior to such a
transaction or event:



| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to provide for the purchase of options for an
    amount of cash equal to the amount that the holders could have
    obtained upon the exercise of such options had the options been
    currently exercisable or fully vested or the replacement of the
    options with other rights or property;
|
| |  | to provide for the exercisability of options;                                                                                                                                                                                                                                                      
|
| |  | to provide that options be assumed or substituted
    for similar options by any successor or survivor corporation or
    entity;                                                                                                                                                                  

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| |   |                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to make adjustments in the number and type of
    shares of our Common Stock subject to outstanding awards or the
    terms and conditions of outstanding awards or those which may be
    granted in the future; and                                                                       
|
| |  | to provide that upon the consummation of such an
    event, the options will not be exercisable and will terminate,
    provided that for a period of time prior to such event, the
    options shall be exercisable and restrictions on options and
    restricted stock may be terminated.

Amendment and Termination.The board of directors, or the
committee if so empowered, may amend, modify, suspend or
terminate the equity incentive plan at any time, except the
board of directors, or the committee if so empowered, must
obtain approval of our stockholders within twelve months before
or after such action:



| |   |                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------
| |  | to increase the number of shares of our common
    stock that may be issued under the equity incentive plan; or
|
| |  | to extend the limit on the period during which
    options may be granted.                                     

Certain Restrictions on Resale.The board of directors, or the
committee if so empowered, may require any person, as a
condition of exercise or acquiring common stock under a granted
award to give written assurances (1) as to the
persons knowledge and experience in financial and business
matters and/or to employ a representative who is knowledgeable
and experienced in financial and business matters; (2) that
the person is capable of evaluation, along or together with the
representative, the merits and risk of exercising the award; and
(3) that the person is acquiring common stock subject to
the award for the persons own account and not with any
present intention of selling or otherwise distributing the
common stock.

Early Exercise.The
board of directors, or the committee if so empowered, may
provide in our option grants to permit the option holder to
exercise the option prior to vesting at any time before the
holders employment with us terminates. The shares acquired
upon early exercise of the options will be subject to any
restrictions that may be determined in the discretion of the
board of directors, or the committee if so empowered.

Buy-outs.The board
of directors, or the committee if so empowered, may offer to
buyout any option previously granted for payment in cash or
shares of our common stock.

Acceleration and
Extension.At any time prior to the
termination of the employment of any employee, director or
consultant to whom options have been granted, the board of
directors, or the committee if so empowered, may in its
discretion accelerate the vesting period of the granted options,
and may extend the period of exerciseability of the options
prior to his or her termination of employment.

Repurchase Rights.The board of directors, or the
committee if so empowered, may grant restricted stock awards to
employees, directors and consultants pursuant to a restricted
stock agreement. Any such restricted stock agreement will grant
us the right to repurchase the shares of restricted stock upon
the termination of employment of individuals granted such
restricted stock. The board of directors, or the committee if so
empowered, may also provide in the terms of any restricted stock
agreement or option agreement that we may repurchase shares of
restricted stock or shares of Class A common stock acquired
upon exercise of options upon the occurrence of certain events,
including termination of employment, divorce, bankruptcy or
insolvency of the holder of such shares.

Compensation Committee Interlocks and Insider
Participation

We do not have any securities registered with the
Securities and Exchange Commission and are not required to have
a compensation committee. Our board of directors determines
executive compensation. As Chairman of the board, Mr. Scott
is a current executive officer of us. Mr. Snukal is our
former Chief Executive Officer. No executive officer of us
served on the board of directors or compensation committee of
any entity that has one or more executive officers serving as
members of our board of directors.

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Board Report on Executive
Compensation

Our board of directors does not have a
compensation committee. The entire board of directors is charged
with the responsibility to develop and administer compensation
programs for our executive officers. The board of directors
establishes executive compensation packages to attract and
retain the best available personnel, to include a base pay that
is representative of the median amount in the healthcare
industry and to allow for increased compensation through bonus
payments based on our company achieving certain financial
performance goals established by the board of directors on an
annual basis. We compensate our executives through the three
primary sources of base pay, a performance based-annual bonus,
and stock option or restricted stock awards.



| |         
| | --------
| | Base Pay

The Company sets salaries for executives taking
into account the competitive marketplace and a subjective
assessment of the nature of the position. For our company, this
marketplace includes companies in the healthcare industry of
similar size.



| |                                   
| | ----------------------------------
| | Annual Performance Bonus
    Plans

The executive officers may participate in an
annual performance bonus plan. Such plans allows for payment of
annual cash rewards based on the accomplishment of financial
performance goals specified by the board of directors.



| |                                       
| | --------------------------------------
| | Stock Options and Restricted
    Stock

We utilize stock options and restricted stock
awards to promote our companys success and enhance its
value by linking the personal interests of participants to those
of its stockholders by providing an incentive for outstanding
performance. From time to time the board of directors approves
the grant of options or restricted stock to the executives based
on a number of subjective factors, including our performance and
performance of the individual executives functional area
of responsibility. We did not award any stock options or
restricted stock to our executive officers in 2003. In March
2004, we awarded Messrs. Hendrickson, Lynch, Harrison and Rapp
restricted stock pursuant to restricted stock agreements
discussed above Employment Contracts and Change of Control
Agreements  Restricted Stock Agreements.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

Securities Authorized for Issuance Under
Equity Compensation Plans

The following table summarizes information about
Common Stock that may be issued upon the exercise of options,
warrants and rights under all of our equity compensation plans,
as of December 31, 2003:

Securities Authorized For Issuance Under
Equity Compensation Plans

|                                                                  |  |                      |     |                      |  |                      |     |  |  |  |     | 
|----------------------------------------------------------------- |  | -------------------- | --- | -------------------- |  | -------------------- | --- |  |  |  | --- | 
|                                                                  |  |                      |     |                      |  | Number of Securities
|                                                                  |  |                      |     |                      |  | Remaining Available 
|                                                                  |  |                      |     |                      |  | for Future Issuance 
|                                                                  |  | Number of Securities |     |                      |  | Under Equity        
|                                                                  |  | to Be Issued upon    |     | Weighted-average     |  | Compensation Plans  
|                                                                  |  | Exercise of          |     | Exercise Price of    |  | (Excluding          
|                                                                  |  | Outstanding Options, |     | Outstanding Options, |  | Securities Reflected
|                                                                  |  | Warrants and Rights  |     | Warrants and Rights  |  | in Column (a))      
|Plan Category                                                     |  | (a)                  |     | (b)                  |  | (c)                 
|                                                                  |  |                      |     |                      |  |                     
|Equity compensation plans approved by security
    holders(1)     |  |                      | 0   |                      |  |                      | 0   |  |  |  | 0   | 
|Equity compensation plans not approved by
    security holders(2) |  |                      | n/a |                      |  |                      | n/a |  |  |  | n/a | 
|                                                                  |  |                      |     |                      |  |                      |     |  |  |  |     | 
|Total                                                             |  |                      | 0   |                      |  |                      | 0   |  |  |  | 0   | 
|                                                                  |  |                      |     |                      |  |                      |     |  |  |  |     | 

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---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The number of securities to be issued under these
    equity compensation plans does not include those to be issued
    pursuant to our 2004 Equity Incentive Plan. In March 2004, our
    board of directors and the holders of a majority of the voting
    power of the Class A common stock and Series A
    preferred stock, voting together as a single class, approved the
    2004 Equity Incentive Plan, under which 20,000 shares of
    Class A common stock were reserved for issuance upon the
    exercise of stock options or other awards granted pursuant to
    the plan. The Board also approved the grant of stock options to
    purchase a total of 6,475 shares of Class A common stock,
    with an exercise price of $18.30 per share. 13,525 shares remain
    available for future issuance under this equity compensation
    plan, excluding those to be issued upon the exercise of the
    granted options.
|   
|(2) | We do not have any compensation plans under which
    our Common Shares may be issued upon the exercise of options,
    warrants and rights that have not been approved by our
    stockholders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

By Certain Beneficial Owners, Directors and
Executive Officers

The following table sets forth, as of
March 15, 2004, the number of our Class A common
stock, the number of our Series A preferred stock and the
percentage of total voting power which, according to the
information furnished to us, are beneficially owned by:



| |   |                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | each person (or group of affiliated persons)
    known by us to beneficially own 5% or more of our Class A
    common stock and Series A preferred stock;
|
| |  | each of our directors;                                                                                                                                   
|
| |  | our Named Executive Officers as defined on page
    [31]; and                                                                                            
|
| |  | all current executive officers and directors as a
    group.                                                                                             

The number and percentage of shares beneficially
owned is based on 1,193,587 shares of Class A common
stock and 15,000 shares of Series A preferred stock
outstanding as of March 15, 2004. Beneficial ownership
includes any shares as to which the holder has voting power or
investment power and any shares that the holder has the right to
acquire within 60 days of March 15, 2004, through the
exercise of any stock option, warrant or other right. Unless
otherwise indicated in the table or the footnotes, each holder
has sole voting and investment power, or shares these powers
with his spouse, with respect to the shares shown as
beneficially owned. The following table does not include our
Class B common stock, which is non-voting.

|                                                        |                                                                                                   |              |         |                 |  |                             |       |                  |  |  |         |  |  |  |       |  | 
|------------------------------------------------------- | ------------------------------------------------------------------------------------------------- | ------------ | ------- | --------------- |  | --------------------------- | ----- | ---------------- |  |  | ------- |  |  |  | ----- |  | 
|                                                        |                                                                                                   |              |         |                 |  |                            
|                                                        |                                                                                                   |              |         |                 |  | Class A Common Stock and   
|                                                        |                                                                                                   |              |         |                 |  | Series A Preferred Stock(1)
|                                                        |                                                                                                   | Number of    |         | Number of       |  |                            
|                                                        |                                                                                                   | Class A      |         | Series A        |  | Total                       |       | Percent of Total
|Beneficial Owner                                        |                                                                                                   | Common Stock |         | Preferred Stock |  | Number                      |       | Voting Power(2) 
|                                                        |                                                                                                   |              |         |                 |  |                             |       |                 
|Entities affiliated with Heritage Partners,
    Inc.(3) |                                                                                                   |              | 597,991 |                 |  |                             | 2,658 |                  |  |  | 600,649 |  |  |  | 49.7% | 
|                                                        | 30 Rowes Wharf, Suite 300
    Boston, MA 02110                                                    |              |         |                 |  |                             |       |                  |  |  |         |  |  |  |       |  | 
|Robert and Sheila Snukal(4)                             |                                                                                                   |              | 166,555 |                 |  |                             |      |                  |  |  | 166,555 |  |  |  | 13.8% | 
|                                                        | 10284 Century Woods Drive
    Los Angeles, CA 90067                                               |              |         |                 |  |                             |       |                  |  |  |         |  |  |  |       |  | 
|Entities affiliated with Goldman Sachs &
    Co.(5)     |                                                                                                   |              | 88,057  |                 |  |                             |      |                  |  |  | 88,057  |  |  |  | 7.1%  | 
|                                                        | 32 Old Slip, 21st Floor
    New York, NY 10005                                                    |              |         |                 |  |                             |       |                  |  |  |         |  |  |  |       |  | 
|Mac & Co.                                               |                                                                                                   |              | 66,043  |                 |  |                             |      |                  |  |  | 66,043  |  |  |  | 5.3%  | 
|                                                        | Windjammer Capital Investors
    610 Newport Center Drive, Suite 1100
    Newport Beach, CA 92660 |              |         |                 |  |                             |       |                  |  |  |         |  |  |  |       |  | 

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|                                                                 |  |              |         |                 |  |                             |       |                  |  |  |         |  |  |  |       | 
|---------------------------------------------------------------- |  | ------------ | ------- | --------------- |  | --------------------------- | ----- | ---------------- |  |  | ------- |  |  |  | ----- | 
|                                                                 |  |              |         |                 |  |                            
|                                                                 |  |              |         |                 |  | Class A Common Stock and   
|                                                                 |  |              |         |                 |  | Series A Preferred Stock(1)
|                                                                 |  | Number of    |         | Number of       |  |                            
|                                                                 |  | Class A      |         | Series A        |  | Total                       |       | Percent of Total
|Beneficial Owner                                                 |  | Common Stock |         | Preferred Stock |  | Number                      |       | Voting Power(3) 
|                                                                 |  |              |         |                 |  |                             |       |                 
|Directors and Named Executive
    Officers                       |  |              |         |                 |  |                             |       |                  |  |  |         |  |  |  |       | 
|William C. Scott(6)                                              |  |              | 34,938  |                 |  |                             |      |                  |  |  | 34,938  |  |  |  | 2.9%  | 
|Michael Gilligan(7)                                              |  |              | 597,991 |                 |  |                             | 2,658 |                  |  |  | 600,649 |  |  |  | 49.7% | 
|Scott Gross                                                      |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | *     | 
|Peter Hermann(8)                                                 |  |              | 597,991 |                 |  |                             | 2,658 |                  |  |  | 600,649 |  |  |  | 49.7% | 
|Mark Jrolf                                                       |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | *     | 
|Tim Parris                                                       |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | *     | 
|Michel Reichert(9)                                               |  |              | 597,991 |                 |  |                             | 2,658 |                  |  |  | 600,649 |  |  |  | 49.7% | 
|Robert Snukal(10)                                                |  |              | 166,555 |                 |  |                             |      |                  |  |  | 166,555 |  |  |  | 13.8% | 
|Boyd Hendrickson                                                 |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | *     | 
|Jose Lynch                                                       |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | *     | 
|John Harrison                                                    |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | *     | 
|Roland Rapp                                                      |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | *     | 
|All directors and executive officers as a Group
    (12 persons) |  |              |        |                 |  |                             |      |                  |  |  |        |  |  |  | 66.4% | 



---



|  |                       
|- | ----------------------
|* | Less than 1% of total.



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Beneficial ownership is determined in accordance
    with the rules of the Securities and Exchange Commission and
    includes voting and investment power with respect to shares.
    Unless otherwise indicated, the persons named in the table have
    sole voting and sole investment control with respect to all
    shares beneficially owned.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | (2) | Percent of total voting power reflects the
    entitlement of each share of Class A common stock to one
    vote on all matters and each share of Series A preferred
    stock to one tenth of one vote on all matters.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | (3) | Includes 585,660 shares of Class A
    common stock, 11,843 shares of Class A common stock
    issuable upon the exercise of a warrant to purchase such shares
    and 2,656 shares of Series A preferred stock held by
    Heritage Fund II L.P. and 478 shares of Class A
    common stock, 10 shares of Class A common stock
    issuable upon the exercise of a warrant to purchase such shares
    and 2 shares of Series A preferred stock held by
    Heritage Investors II, L.L.C. According to information
    provided to us by Heritage Partners, Inc., Michel Reichert,
    Peter Hermann and Michael Gilligan are the only partners of
    Heritage Partners Management Company, LLP, which is the sole
    general partner of Heritage Fund II L.P., and the only
    managers of HF Partners II, L.L.C., which is the sole
    managing member of Heritage Investors II, L.L.C. In such
    capacity, Messrs. Reichert, Hermann and Gilligan exercise
    shared investment discretion and control over the shares held by
    Heritage Fund II L.P. and Heritage Investors II,
    L.L.C., and beneficially owned by Heritage Fund II L.P. has
    been granted voting power by the other investors pursuant to the
    stockholders agreement. Messrs. Reichert, Hermann and
    Gilligan serve on our board of directors. Also for so long as
    Heritage Fund II L.P. holds more shares of our Class A
    common stock than any other investor, pursuant to our
    stockholders agreement, all of our stockholders have agreed to
    vote for Heritage Fund II L.P.s nominees to our board
    of directors.
|
| | (4) | Pursuant to our stockholders agreement described
    in this Annual Report, all of our stockholders have agreed to
    vote for Mr. Snukals nominees to our board of
    directors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | (5) | Includes 59,490 shares of Class A
    common stock held by GS Private Equity Partners, L.P. and
    28,567 shares of Class A common stock held by GS
    Private Equity Partners Offshore, L.P. According to information
    provided to us by such holders, Goldman Sachs Group, Inc. is the
    sole managing member of GSAM GEN-PAR, L.L.C, which itself is the
    sole managing member of GS Private Equity Management, L.L.C,
    which is the sole general partner of GS Private Equity
    Partners, L.P. In such capacity,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

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##### Table of Contents



| |  |                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Goldman Sachs Group, Inc. exercises investment
    discretion and control over the shares held by GS Private Equity
    Partners, L.P. GS Private Equity Management Offshore, Inc.
    is the sole general partner of GS Private Equity Partners
    Offshore, L.P. and, in such capacity, exercises investment
    discretion and control of the shares held by GS Private Equity
    Management Offshore, Inc.



| |     |                                                                                                                                                                                                                                                                                                                    
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (6) | Pursuant to our stockholders agreement described
    in this Annual Report, all of our stockholders have agreed to
    vote for Mr. Scotts nominee to our board of directors.                                                                                                                                     
|
| | (7) | Includes 597,991 shares beneficially owned
    by Mr. Gilligan as a partner of Heritage Partners
    Management Company, LLP, which is the sole general partner of
    Heritage Fund II L.P. and as a manager of
    HF Partners II, L.L.C., which is the sole managing
    member of Heritage Investors II, L.L.C.
|
| | (8) | Includes 597,991 shares beneficially owned
    by Mr. Hermann as a partner of Heritage Partners Management
    Company, LLP, which is the sole general partner of Heritage Fund
    II L.P. and as a manager of HF Partners II, L.L.C., which is the
    sole managing member of Heritage Investors II, L.L.C.     
|
| | (9) | Includes 597,991 shares beneficially owned by
    Mr. Reichert as a partner of Heritage Partners Management
    Company, LLP, which is the sole general partner of Heritage
    Fund II L.P. and as a manager of HF Partners II,
    L.L.C., which is the sole managing member of Heritage
    Investors II, L.L.C.



|     |                                                                                                                              
|---- | -----------------------------------------------------------------------------------------------------------------------------
|(10) | These shares of Class A common stock are
    held directly in the name of both Robert and Sheila Snukal, who
    are spouses.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

Transactions with Related Parties



| |                       
| | ----------------------
| | Stockholders Agreement

We are party to an amended and restated
stockholders agreement executed in August 2003 pursuant to our
Third Amended Joint Plan of Reorganization date April 22,
2003 (the Plan). All holders of our Class A
common stock and Series A preferred stock must agree to be
bound by the terms of the stockholders agreement through the
execution of a joinder agreement.

Voting.Our
stockholders agreement provides that at all meetings at which
our directors are to be elected, each stockholder will vote all
of such stockholders shares in favor of the election of
two nominees of Mr. Snukal, a member of our board of
directors and former Chief Executive Officer, one nominee of
Mr. Scott, our Chairman of the board of directors, and one
nominee of Baylor Health Care System, for so long as each of
them holders any shares of our capital stock or any equity
interest or security convertible or exchangeable into our
capital stock. The number of nominees designated by Mr. Snukal
will be increased if necessary to ensure that his nominees do
not constitute less than 25% of the total number of our
directors. The stockholders agreement also provides that each
stockholder will vote in favor of the election of the number of
nominees of the holders of a majority of our Class A common
stock held by certain investors named in our stockholders
agreement as may be designated by such a majority of investors,
up to the maximum number of directors that constitute the
remaining director positions after taking into account the
directors designated by Messrs. Snukal and Scott and Baylor
Heath Care System. For so long as Heritage Fund II, L.P.
holds more shares of our Class A common stock than any
other investor named in the stockholders agreement, Heritage
Fund II, L.P. will determine the number and make the designation
of such director nominees for the majority of investors and all
stockholders agree to vote their shares on all matters to be
voted upon by the holders of our securities as directed by
Heritage Fund II, L.P., unless the effect of such matter on
the stockholders differs materially and adversely from the
effect on Heritage Fund II, L.P. Each stockholder has
granted Heritage Fund II, L.P. an irrevocable proxy to vote
such stockholders securities as provided by the
stockholders agreement.

Preemptive Rights.The stockholders agreement grants
certain of our qualified stockholders, as such term is defined
in the agreement, preemptive rights to acquire a proportionate
percentage of securities that we propose to sell or issue,
excluding issuances to current employees, consultants and
directors, the issues of

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shares upon the conversion or exercise of stock
equivalents, and issuances that the board of directors
determines in good faith should not, in our best interests, be
subject to this preemptive right, provided none of the
securities are being issued to Heritage Fund II, L.P. of
its affiliates. We will provide notice of any issuance to the
qualified stockholders, including an offer for their
proportionate percentages of the securities. If the qualified
stockholders do not subscribe for all of the offered securities,
we may sell all or any part of such securities for which an
offer was not accepted to any third party at a price and on
terms and conditions that are no more favorable to such other
third parties or less favorable to us than those set forth in
the offer to the qualified stockholders.


Restrictions on Transfer.Under the stockholders agreement, a
stockholder wishing to sell, pledge, give, assign, distribute,
hypothecate, mortgage or transfer any of its securities must
first offer all such securities to us and our other qualified
stockholders. We are entitled to purchase any or all of the
offered securities. Any securities not acquired by us may be
acquired in a proportionate percentage by each of the qualified
stockholders. If any qualified stockholder does not acquire its
proportionate percentage of such securities, the other qualified
stockholders may acquire a pro rata portion of the remaining
balance of securities. If we and the other qualified
stockholders do not elect to acquire all of the securities
offered by the transferring stockholder within 30 days of
receiving notice, then such stockholder may transfer the
securities to a third party within 120 days after the
30-day offer period has expired. Holders of our Class A
common stock that received such stock pursuant to the Plan as
holders of our Senior Subordinated Secured Increasing Rate Notes
may only transfer securities under these provisions to other
current stockholders, or to a person that is not a stockholder
if the number of shares to be transferred is at least 7,500 or
the total number of shares held by the transferring stockholder,
whichever is less.

These restrictions on transfer do not apply to
certain permitted transfers of securities, including:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | transfers to a revocable trust, the beneficiaries
    of which consist of the transferring stockholder and certain
    family members of such stockholder;                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | transfer to a stockholders guardian or
    conservator;                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | transfers to a deceased stockholders
    executors, administrators or trustees;                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | transfers to certain family members of a
    stockholder;                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | certain transfers by a corporation, partnership
    limited liability company or other entity stockholder to an
    owner of affiliate;                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | transfers of warrants to purchase our
    Class A common stock held by Baylor Health Care System or
    Buckner Foundation to any broker or agent, or transfers of
    securities by Baylor Health Care System to Baylor Health Care
    System Foundation;                                                                                                                                                                                                                                                                        
|
| |  | transfers by Heritage Fund II Investment
    Corporation to any other person; and                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | transfers by holders of our Class A common
    stock that received such stock pursuant to the Plan as holders
    of our Senior Subordinated Secured Increasing Rate Notes that
    hold such shares as nominee, depository, agent, trustee or
    custodian for the benefit of another person or that has
    investment authority over such shares for the benefit of another
    person, to another nominee, depository, agent, trustee or
    custodian for such person or that will investment authority over
    such shares.

Co-Sale Rights in Transfers by Heritage
Fund II, L.P.If Heritage
Fund II, L.P. decides to transfer all or a portion of the
shares of our Class A common stock held by it, Heritage
Fund II, L.P. will give notice to the other qualifying
stockholders, which will have the right to include in such
transfer the same portion each class of stock or stock
equivalents held by such stockholders as transferred by Heritage
Fund II, L.P. If the party acquiring such shares does not
wish to purchase all the shares to be transferred by Heritage
Fund II, L.P. and the qualifying stockholders, the
securities to be transferred will be reduced pro rata among
Heritage Fund II, L.P. and the qualifying stockholders.

If Heritage Fund II, L.P. decides to transfer all
or a portion of the shares of our Class A common stock held
by it to another person or entity, other than an affiliate of
it, in any transaction constituting, or after a

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transaction constituting, a registered
underwritten public offering of our Class A common stock,
the sale of our capital stock as a result of which a majority of
the outstanding capital stock will not be held by the initial
parties to our stockholders agreement or holders that acquired
our capital stock pursuant to certain permitted transfers
discussed above, or an approved sale of all or substantially all
of our assets, the stockholders agreement provides that each
holder of our securities will be required to transfer at the
request of Heritage Fund II., L.P. the same proportion of
its holdings of each class of securities as Heritage
Fund II, L.P. transfers in such a transaction. The holders
of our Series A preferred stock may elect in such a
transaction to transfer all shares of Series A preferred
stock held by them.


Public Offering.Pursuant to the stockholders
agreement, all holders of our securities have agreed not to sell
or otherwise dispose of any securities for a period as may be
reasonably requested by a managing underwriter in connection
with a registered underwritten public offering of our
Class A common stock, not to exceed 180 days for an
initial public offering or 90 days for any other registered
offering. This does not apply to securities included in the
registered offering. The rights and obligations of any party to
the stockholders agreement will terminate automatically upon the
consummation of an initial public offering of our Class A
common stock.

Restrictions Relating to Series A
Preferred Stock.So long as any shares
of our Series A preferred stock are outstanding, we are
restricted from issuing any shares of preferred stock or other
equity securities having rights or preferences that are senior
or equal to those of the Series A preferred stock without
the prior consent of the holders of majority of the outstanding
shares of Series A preferred stock, unless we meet certain
conditions regarding our outstanding indebtedness. We also may
not make certain redemptions or repurchase of shares of our
capital stock or pay any dividend or distribution to holders of
our capital stock unless we meet certain payment obligations
with respect to accrued dividends to the holders of the
Series A preferred stock.



| |                  
| | -----------------
| | Leased Facilities

Our former Chief Executive Officer and current
director, and his wife, a former Executive Vice President of our
company, own the real estate for four of the Companys
leased facilities. Such real estate has not been included in the
financial statements for any of the years presented herein.
Lease payments to these related parties under operating leases
for these facilities for the years ended December 31, 2003,
2002 and 2001 were $1.8 million, $1.9 million and
$1.9 million, respectively.



| |                       
| | ----------------------
| | Medical Supply Company

Our former Executive Vice President, who is also
the wife of our former Chief Executive Officer and current
director, owned approximately 33% of a medical supply company
that provides medical supplies and equipment to us pursuant to a
supply contract. In May 2003, this ownership interest was fully
divested. As part of our on-going effort to review and
renegotiate all of its material executory contracts during the
reorganization proceeding, the agreement was amended, first in
September 2002 and subsequently in April 2003. The agreement, as
amended, provides for an approximately 5% price reduction on
medical supplies and equipment, effective through April 30,
2008. Billings for medical supplies from this related company
for the year ended December 31, 2003, 2002 and 2001 were
$5.5 million $4.5 million and $4.9 million,
respectively. We believe that the terms of this supply agreement
are at least as favorable to the us as could be obtained from
third parties in an arms length transaction.



| |                 
| | ----------------
| | Notes Receivable

We have a limited recourse promissory note
receivable from the Chairman of the board of directors in the
amount of approximately $2.5 million with an interest rate
of 5.7%. The Note is due on the earlier of April 15, 2007
or the sale by the Chairman of 20,000 shares of our common stock
pledged as security for the note. We have recourse for payment
up to $1.0 million of the principal amount of the note.

In September 2002, we extended a limited recourse
loan in the principal amount up to $0.5 to our Chief Executive
Officer. The note, which was secured by a deed of trust on the
residential property of the Chief Executive Officer, bore
interest at a rate of 8.0% per annum and required monthly
payments payable on the

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##### Table of Contents



first day of each month beginning on the first
day of October 2002. The entire principal balance of the note
together with the accrued interest thereon was due and payable
on the earlier of December 1, 2003 or upon the sale of the
property securing the loan. In October 2003, the outstanding
principal and interest on the loan was paid in full.







|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees and
    Services

Independent Auditor Fees

Aggregate fees billed to us for the fiscal years
ended December 31, 2003 and December 31, 2002, by our
independent auditor are as follows:

|                      |  |      |         |      |  |   |         | 
|--------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|Type of Fees          |  | 2003 |         | 2002
|                      |  |      |         |     
|Audit Fees(1)         |  | $    | 240,892 |      |  | $ | 435,390 | 
|Audit-Related Fees(2) |  |      | 232,708 |      |  |   | 151,564 | 
|Tax Fees(3)           |  |      | 471,418 |      |  |   | 324,106 | 
|All Other Fees(4)     |  |      | 47,103  |      |  |   | 35,440  | 
|                      |  |      |         |      |  |   |         | 
|Total                 |  | $    | 992,121 |      |  | $ | 946,500 | 
|                      |  |      |         |      |  |   |         | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Represents the aggregate fees and expense related
    to the fiscal year audit of our annual consolidated financial
    statements and for the reviews of the consolidated financial
    statements included in our Form 10-Q filings for each
    fiscal quarter, not withstanding when the fees and expenses were
    billed or when the services were rendered to us by Ernst &
    Young LLP.         
|   
|(2) | Represents the aggregate fees billed to us by
    Ernst & Young LLP for assurance and related services that
    are reasonably related to the performance of the audit and
    review of our financial statements that are not already reported
    in Audit Fees. These services benefit plan audits, attestation
    services that are not required by statue or regulation and
    pension plan audits.
|   
|(3) | Represents the aggregate fees billed to us by
    Ernst & Young LLP for professional services relating to tax
    compliance, tax advice and expatriate tax services.                                                                                                                                                                                                                                     
|   
|(4) | Includes fees paid relating to employee benefits
    compliance and consulting services.                                                                                                                                                                                                                                                                                                                  

Auditor Independence

The board of directors has considered whether the
provision of the above noted services is compatible with
maintaining the independent auditors independence and has
determined that the provision of such services has not adversely
affected the independent auditors independence.

Policy on Audit Committee
Pre-Approval

The board of directors has not adopted a policy
and procedures for the pre-approval of audit and non-audit
services rendered by the Companys independent auditors,
Ernst & Young LLP. During the period the Company operated in
the pendancy of the Bankruptcy, the Bankruptcy Court approved
all fees paid to Ernst & Young LLP. Effective
August 19, 2003, the date the Company emerged from
Bankruptcy, all audit services performed by the independent
auditors must be pre-approved by the board of directors.

47



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##### Table of Contents








|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibit, Financial Statement Schedules, and
    Reports on Form 8-K

(a) 1. Consolidated Financial Statements
and Supplementary Data

The following Financial Statements are included
herein under Item 8:

|                                                                                                                               |  |        |     | 
|------------------------------------------------------------------------------------------------------------------------------ |  | ------ | --- | 
|                                                                                                                               |  | Page  
|                                                                                                                               |  | Number
|                                                                                                                               |  |       
|Independent Auditors Report                                                                                                   |  |        | F-1 | 
|Consolidated Balance Sheets at December 31,
    2003 and December 31, 2002                                                     |  |        | F-2 | 
|Consolidated Statements of Operations for Each of
    the Years in the Three Year Period Ended December 31, 2003               |  |        | F-3 | 
|Consolidated Statements of Stockholders
    Equity for Each of the Years in the Three Year Period Ended
    December 31, 2003 |  |        | F-4 | 
|Consolidated Statements of Cash Flows for Each of
    the Years in the Three Year Period Ended December 31, 2003               |  |        | F-5 | 
|Notes to Consolidated Financial Statements                                                                                     |  |        | F-6 | 

(a) 2. Financial Statement Schedules:

|                                 |  |        |      | 
|-------------------------------- |  | ------ | ---- | 
|                                 |  | Page  
|                                 |  | Number
|                                 |  |       
|Schedule II  Valuation Accounts |  |        | F-26 | 

All other schedules have been omitted for the
reason that the required information is presented in financial
statements or notes thereto, the amounts involved are not
significant or the schedules are not applicable.

(a) 3. Exhibits:

The exhibits listed below are hereby filed with
the Securities and Exchange Commission as part of this Report.

INDEX OF EXHIBITS

|        |       |             |  |                                                                                                                                                                                                                                      
|------- | ----- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 2.1   |             |  | Debtors Third Amended Joint Plan of
    Reorganization(1)                                                                                                                                                                           
|        | 2.2   |             |  | Debtors Disclosure Statement(1)                                                                                                                                                                                                     
|        | 3.1   |             |  | Restated Certificate of Incorporation                                                                                                                                                                                                
|        | 3.2   |             |  | Bylaws(2)                                                                                                                                                                                                                            
|        | 4.1   |             |  | Indenture dated as of August 19, 2003 among
    the Company, the Guarantors (as defined therein) and U.S. Bank
    National Association(3)                                                                                           
|        | 4.2   |             |  | Amended and Restated Stockholders Agreement(3)                                                                                                                                                                                       
|        | 4.3   |             |  | Amendment No. 1 to Amended and Restated
    Stockholders Agreement(3)                                                                                                                                                                
|        | 4.4.1 |             |  | Form of New Common Stock Certificate(3)                                                                                                                                                                                              
|        | 4.4.2 |             |  | Form of New Series A Preferred Stock
    Certificate(3)                                                                                                                                                                              
|        | 4.5   |             |  | Form of Warrant to Purchase Common Stock(3)                                                                                                                                                                                          
|        | 10.1  |             |  | Revolving Credit and Security Agreement among the
    Subsidiary Borrowers listed on Schedule 1 annexed thereto
    and the Company, as borrowers, and CapitalSource Finance LLC, as
    administrative agent and collateral agent(3)
|        | 10.2  |             |  | $20,000,000 Revolving Note dated as of
    August 19, 2003 made by the Company and the companies
    listed on the signature page thereto in favor of CapitalSource
    Finance LLC, as administrative agent and collateral agent(3) 

48



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##### Table of Contents



|        |       |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                     
|------- | ----- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 10.3  |             |  | $1,000,000 Revolving Note dated as of
    August 19, 2003 ,made by the Company and the companies
    listed on the signature page thereto in favor of CapitalSource
    Finance LLC, as administrative agent and collateral agent(3)                                                                                                                                                                                
|        | 10.4  |             |  | Revolving Credit and Security Agreement among the
    Borrowers listed on Schedule 1 annexed thereto, as
    borrowers, and CapitalSource Finance LLC, as administrative
    agent and collateral agent for Lenders, and Lenders party
    thereto(3)                                                                                                                                                               
|        | 10.5  |             |  | $11,000,000 Revolving Note dated as of
    August 19, 2003 made by the companies listed on the
    signature page thereto in favor of CapitalSource Finance LLC, as
    administrative agent and collateral agent(3)                                                                                                                                                                                                
|        | 10.6  |             |  | Loan Agreement dated as of August 19, 2003
    between the entities listed on Schedule I annexed thereto,
    as Borrower, and Column Financial, Inc., as Lender(3)                                                                                                                                                                                                                                                 
|        | 10.7  |             |  | $85,000,000 Promissory Note A dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                          
|        | 10.8  |             |  | $5,000,000 Promissory Note B-1 dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                         
|        | 10.9  |             |  | $2,500,000 Promissory Note B-2 dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                         
|        | 10.10 |             |  | $2,500,000 Promissory Note B-3 dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                         
|        | 10.11 |             |  | Guaranty Agreement dated August 19, 2003 by
    the Company for the benefit of Column Financial, Inc.(3)                                                                                                                                                                                                                                                                                                            
|        | 10.12 |             |  | Mezzanine Loan Agreement dated as of
    August 19, 2003 between SHG Property Resources, LLC and SHG
    Investments, LLC, collectively, as Borrower, and CapitalSource
    Finance LLC, Fortress Credit Opportunities I, L.P. and
    Highbridge/Zwirn Special Opportunities Fund, L.P., collectively,
    as Lender, and CapitalSource Finance LLC, as administrative
    agent and collateral agent for Lender(3)
|        | 10.13 |             |  | $11,500,000 Promissory Note dated as of
    August 19, 2003 made by SHG Property Resources, LLC and SHG
    Investments, LLC in favor of CapitalSource Finance LLC(3)                                                                                                                                                                                                                                               
|        | 10.14 |             |  | $5,750,000 Promissory Note dated as of
    August 19, 2003 made by SHG Property Resources, LLC and SHG
    Investments, LLC in favor of Highbridge/Zwirn Special
    Opportunities Fund, L.P.(3)                                                                                                                                                                                                                    
|        | 10.15 |             |  | $5,750,000 Promissory Note dated as of
    August 19, 2003 made by SHG Property Resources, LLC and SHG
    Investments, LLC in favor of Fortress Credit
    Opportunities I, L.P.(3)                                                                                                                                                                                                                                
|        | 10.16 |             |  | Pledge and Security Agreement dated
    August 19, 2003 by and among SHG Property Resources, LLC
    and SHG Investments, LLC, as Borrowers, Summit Care Corporation,
    Summit Care Texas, L.P., Summit Care Texas Management, LLC and
    Skilled Healthcare, LLC, as Pledgor Guarantors, and
    CapitalSource Finance LLC, as Agent(3)                                                                         
|        | 10.17 |             |  | Environmental Indemnity Agreement dated
    August 19, 2003 by SHG Property Resources, LLC and SHG
    Investments, LLC, as Borrowers in favor of CapitalSource Finance
    LLC, as Agent(3)                                                                                                                                                                                                                        
|        | 10.18 |             |  | Guaranty of Payment dated August 19, 2003 by
    the Company in favor of CapitalSource Finance LLC, as Agent(3)                                                                                                                                                                                                                                                                                                     
|        | 10.19 |             |  | Guaranty of Payment (Pledgor) dated
    August 19, 2003 by Summit Care Corporation, Summit Care
    Texas, L.P., Summit Care Texas Management, LLC and Skilled
    Healthcare, LLC, as Pledgor Guarantors in favor of CapitalSource
    Finance LLC, as Agent(3)                                                                                                                                                    
|        | 10.20 |             |  | Security Agreement dated August 19, 2003
    among the Company, those subsidiaries a party thereto and
    CapitalSource Finance LLC, as Agent(3)                                                                                                                                                                                                                                                                   
|        | 10.21 |             |  | B Note Guaranty dated August 19, 2003 by the
    Company in favor of Column Financial, Inc.(3)                                                                                                                                                                                                                                                                                                                      
|        | 10.22 |             |  | Amendment No. 1 to Revolving Credit and
    Security Agreement dated October 30, 2003 among the
    Subsidiary Borrowers signatory thereto, Skilled Healthcare
    Group, Inc. and CapitalSource Finance LLC, as administrative
    agent for Lenders, and Lenders party thereto(3)                                                                                                                                 

49



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##### Table of Contents



|        |       |             |  |                                                                                                                                                                                                                                                   
|------- | ----- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 10.23 |             |  | Amendment No. 1 to Revolving Credit and
    Security Agreement dated October 30, 2003 among the
    Borrowers signatory thereto and CapitalSource Finance LLC, as
    administrative agent and Agent for Lenders, and Lenders party
    thereto(3)
|        | 10.24 |             |  | Commercial Lease dated August 25, 2003
    between Matmel Enterprises, Inc. and the Company(3)                                                                                                                                                    
|        | 10.25 |             |  | Skilled Healthcare Group, Inc. 2004 Equity
    Incentive Plan*                                                                                                                                                                                    
|        | 31.1  |             |  | Certification of Chief Executive Officer of
    Skilled Healthcare Group, Inc., Pursuant to Section 302 of
    the Sarbanes-Oxley Act of 2002.                                                                                                    
|        | 31.2  |             |  | Certification of Chief Financial Officer of
    Skilled Healthcare Group, Inc., Pursuant to Section 302 of
    the Sarbanes-Oxley Act of 2002.                                                                                                    
|        | 32.1  |             |  | Certification of Chief Executive Officer and
    Chief Financial Officer of Skilled Healthcare Group, Inc.,
    Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                     



---



|    |                                                                                                                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Each of these exhibits is incorporated herein by
    reference to the Companys Form T-3 filed with the
    Securities and Exchange Commission on July 16, 2003.                                                   
|   
|(2) | Each of these exhibits is incorporated by
    reference to the Companys Registration Statement on
    Form S-4 (No. 333-57279) filed with the Securities and
    Exchange Commission on June 19, 1998, as amended.
|   
|(3) | Each of these exhibits is incorporated by
    reference to the Companys Report on Form 10-Q for the
    Quarter ended September 30, 2003.                                                                         



| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| | * | Management contract or compensatory plan,
    contract or arrangement required to be filed as an exhibit
    pursuant to Item 14(c) of Form 10-K.

(b) Reports on Form 8-K.

The following Current Reports on Form 8-K
were filed during the three-month period ended December 31,
2003:



| |         
| | --------
| | (i) None

(c) Item 601 Exhibits.

Reference is made to the Index of Exhibits under
Item 15(a)(3) of this report.

50



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) 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.



| |                               
| | ------------------------------
| | SKILLED HEALTHCARE GROUP, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ BOYD HENDRICKSON

| |                                     
| | ------------------------------------
| |                                     
| | Boyd Hendrickson                    
| | Chief Executive Officer and Director
| | (Authorized Signatory,              
| | Principal Executive Officer)        

March 25, 2004

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the Registrant and in the
capacities and on the date indicated.

|    |  |                                          |  |                                                                              |  |                 
|--- |  | ---------------------------------------- |  | ---------------------------------------------------------------------------- |  | ----------------
|   
|By: |  | /s/ BOYD HENDRICKSONBoyd Hendrickson     |  | Chief Executive Officer
    and Director
    (Principal Executive Officer)   |  | March 30, 2004  
|   
|By: |  | /s/ JOHN H. HARRISONJohn H. Harrison     |  | Chief Financial Officer
    (Principal Financial Officer)                    |  | March 30, 2004  
|   
|By: |  | /s/ SCOTT A. PETTERSONScott A. Petterson |  | Vice President-Finance
    and Controller
    (Principal Accounting Officer) |  | March 30, 2004  
|   
|By: |  | /s/ WILLIAM SCOTTWilliam Scott           |  | Chairman of the Board and Director                                           |  | March 30, 2004  
|   
|By: |  | Robert Snukal                            |  | Director                                                                     |  | March [  ], 2004
|   
|By: |  | Peter Hermann                            |  | Director                                                                     |  | March [  ], 2004
|   
|By: |  | Michael Gilligan                         |  | Director                                                                     |  | March [  ], 2004
|   
|By: |  | /s/ MARK JROLFMark Jrolf                 |  | Director                                                                     |  | March 30, 2004  
|   
|By: |  | /s/ MICHEL REICHERTMichel Reichert       |  | Director                                                                     |  | March 30, 2004  
|   
|By: |  | /s/ SCOTT GROSSScott Gross               |  | Director                                                                     |  | March 30, 2004  
|   
|By: |  | Tim Parris                               |  | Director                                                                     |  | March [  ], 2004

51



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

The Board of Directors

Skilled Healthcare Group, Inc.


We have audited the accompanying consolidated
balance sheets of Skilled Healthcare Group, Inc. as of
December 31, 2003 and 2002, and the related consolidated
statements of operations, shareholders equity (deficit),
and cash flows for each of the three years in the period ended
December 31, 2003. Our audits also included the financial
statement schedule listed in the Index at Item 15(a). These
financial statements and financial statement schedule are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the consolidated financial position of Skilled
Healthcare Group, Inc. at December 31, 2003 and 2002, and
the consolidated results of its operations and its cash flows
for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles
generally accepted in the United States.

As discussed in Note 2 to the consolidated
financial statements, the Company adopted Statement of Financial
Accounting Standards No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities
and Equity, during 2003. Also, in our opinion, the related
financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.



| |                  
| | -----------------
| | ERNST & YOUNG LLP

Los Angeles, California

March 25, 2004


F-1



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.

CONSOLIDATED BALANCE SHEETS

|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |          |         |  
|------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------------ | ------- | - | ------- | -------- | ------- | -
|                                                                                           |                                                                                                                                                                             | December 31,                               |         | December 31,
|                                                                                           |                                                                                                                                                                             | 2003                                       |         | 2002        
|                                                                                           |                                                                                                                                                                             |                                            |         |             
|                                                                                           |                                                                                                                                                                             |                                           
|                                                                                           |                                                                                                                                                                             | (Dollars in thousands)                    
|ASSETS                                                                                    
|Current assets:                                                                            |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           | Cash and cash equivalents                                                                                                                                                   |                                            | $       | 2,670        |         |   | $       | 20,498   |        
|                                                                                           | Accounts receivable, net of allowance for
    doubtful accounts of $10,033 in 2003 and $17,315 in 2002                                                                      |                                            |         | 42,592       |         |   |         | 43,821   |        
|                                                                                           | Other current assets                                                                                                                                                        |                                            |         | 15,277       |         |   |         | 11,337   |        
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           |                                                                                                                                                                             | Total current assets                       |         |              | 60,539  |   |         |          | 75,656  |  
|Property and equipment, net                                                                |                                                                                                                                                                             |                                            | 157,580 |              |         |   | 147,801 |         
|Other assets:                                                                              |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           | Notes receivable, net of allowance for doubtful
    accounts of $1,847 in 2003 and $2,035 in 2002                                                                           |                                            |         | 5,221        |         |   |         | 2,049    |        
|                                                                                           | Deferred financing costs                                                                                                                                                    |                                            |         | 4,064        |         |   |         | 5,411    |        
|                                                                                           | Goodwill and other intangible assets, net                                                                                                                                   |                                            |         | 20,519       |         |   |         | 20,312   |        
|                                                                                           | Other assets                                                                                                                                                                |                                            |         | 12,918       |         |   |         | 6,526    |        
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           |                                                                                                                                                                             | Total other assets                         |         |              | 42,722  |   |         |          | 34,298  |  
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           |                                                                                                                                                                             | Total assets                               |         | $            | 260,841 |   |         | $        | 257,755 |  
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|LIABILITIES AND SHAREHOLDERS EQUITY
    (DEFICIT)                                        
|Current liabilities:                                                                       |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           | Accounts payable and accrued liabilities                                                                                                                                    |                                            | $       | 20,283       |         |   | $       | 8,715    |        
|                                                                                           | Borrowings payable under line of credit                                                                                                                                     |                                            |         | 16,124       |         |   |         |         |        
|                                                                                           | Employee compensation and benefits                                                                                                                                          |                                            |         | 13,913       |         |   |         | 11,922   |        
|                                                                                           | Current portion of long-term debt and capital
    leases                                                                                                                    |                                            |         | 19,486       |         |   |         | 92,959   |        
|                                                                                           | Current liabilities subject to compromise                                                                                                                                   |                                            |         |             |         |   |         | 170,481  |        
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           |                                                                                                                                                                             | Total current liabilities                  |         |              | 69,806  |   |         |          | 284,077 |  
|Long-term liabilities:                                                                     |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           | General and professional liability                                                                                                                                          |                                            |         | 23,717       |         |   |         | 16,167   |        
|                                                                                           | Long-term liabilities and capital leases, net of
    current portion                                                                                                        |                                            |         | 218,430      |         |   |         | 9,867    |        
|                                                                                           | Preferred Stock, Series A, mandatorily
    redeemable 15,000 shares issued and outstanding                                                                                  |                                            |         | 28,849       |         |   |         |         |        
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|Total liabilities:                                                                         |                                                                                                                                                                             |                                            | 340,802 |              |         |   | 310,111 |         
|Preferred Stock, Series A, mandatorily
    redeemable 15,000 shares issued and outstanding |                                                                                                                                                                             |                                            |        |              |         |   | 15,000  |         
|Shareholders equity (deficit):                                                            |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           | Common stock  1,500,000 shares
    authorized with no par value; 1,193,587 shares issued and
    outstanding at December 31, 2003                                          |                                            |         |             |         |   |         |         |        
|                                                                                           | Common stock (Series A, B &
    C)  An aggregate of 3,000,000 shares authorized with
    $0.01 par value; 1,134,944 shares issued and
    outstanding at December 31, 2002 |                                            |         |             |         |   |         | 11       |        
|                                                                                           | Additional paid-in-capital                                                                                                                                                  |                                            |         | 107,572      |         |   |         | 106,488  |        
|                                                                                           | Accumulated deficit                                                                                                                                                         |                                            |         | (184,993     | )       |   |         | (171,315 | )      
|                                                                                           | Due from shareholder                                                                                                                                                        |                                            |         | (2,540       | )       |   |         | (2,540   | )      
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           |                                                                                                                                                                             | Total shareholders equity (deficit)       |         |              | (79,961 | ) |         |          | (67,356 | )
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         
|                                                                                           |                                                                                                                                                                             | Total liabilities and shareholders equity |         | $            | 260,841 |   |         | $        | 257,755 |  
|                                                                                           |                                                                                                                                                                             |                                            |         |              |         |   |         |         

The accompanying notes are an integral part of
these consolidated financial statements.

F-2



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                                                    |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |         | 
|--------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------- | ------- | ------- | - | ---- | ------- | ------- |  | - | -------- | ------- | 
|                                                                                                    |                                                                                                                                                      | 2003                   |         | 2002    |   | 2001
|                                                                                                    |                                                                                                                                                      |                        |         |         |   |     
|                                                                                                    |                                                                                                                                                      |                       
|                                                                                                    |                                                                                                                                                      | (Dollars in thousands)
|Net revenues                                                                                        |                                                                                                                                                      | $                      | 359,289 |         |   | $    | 341,547 |         |  | $ | 318,420  |        
|Expenses:                                                                                           |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        
|                                                                                                    | Salaries and benefits                                                                                                                                |                        |         | 189,625 |   |      |         | 175,844 |  |   |          | 169,722 | 
|                                                                                                    | Supplies                                                                                                                                             |                        |         | 49,168  |   |      |         | 50,674  |  |   |          | 45,755  | 
|                                                                                                    | Purchased services                                                                                                                                   |                        |         | 30,456  |   |      |         | 24,562  |  |   |          | 30,509  | 
|                                                                                                    | Provision for doubtful accounts                                                                                                                      |                        |         | 3,559   |   |      |         | 3,960   |  |   |          | 20,006  | 
|                                                                                                    | Other expenses                                                                                                                                       |                        |         | 30,084  |   |      |         | 33,008  |  |   |          | 33,168  | 
|                                                                                                    | Rent                                                                                                                                                 |                        |         | 7,326   |   |      |         | 7,098   |  |   |          | 7,281   | 
|                                                                                                    | Depreciation and amortization                                                                                                                        |                        |         | 9,790   |   |      |         | 9,766   |  |   |          | 18,108  | 
|                                                                                                    | Interest expense, net of interest income
    (includes interest expense of $1,588 related to the Mandatorily
    redeemable preferred stock in 2003) |                        |         | 25,763  |   |      |         | 22,685  |  |   |          | 25,079  | 
|                                                                                                    |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        
|Total expenses before reorganization and other
    items                                            |                                                                                                                                                      |                        | 345,771 |         |   |      | 327,597 |         |  |   | 349,628  |        
|                                                                                                    |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        
|Income (loss) from continuing operations                                                            |                                                                                                                                                      |                        | 13,518  |         |   |      | 13,950  |         |  |   | (31,208  | )      
|Other income and expenses:                                                                          |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        
|                                                                                                    | Change in fair value of interest rate hedge                                                                                                          |                        |         | 1,006   |   |      |         |        |  |   |          |        | 
|                                                                                                    | Reversal of charge related to decertification of
    a facility                                                                                      |                        |         | (2,734  | ) |      |         |        |  |   |          |        | 
|                                                                                                    | Provision for the impairment of long-lived assets                                                                                                    |                        |         |        |   |      |         |        |  |   |          | 117,424 | 
|                                                                                                    | Write-off of deferred financing costs of
    extinguished debt                                                                                       |                        |         | 4,111   |   |      |         |        |  |   |          |        | 
|                                                                                                    | Reorganization expenses                                                                                                                              |                        |         | 12,966  |   |      |         | 12,304  |  |   |          | 4,787   | 
|                                                                                                    |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        
|Total other income and expenses, net                                                                |                                                                                                                                                      |                        | 15,349  |         |   |      | 12,304  |         |  |   | 122,211  |        
|                                                                                                    |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        
|(Loss) income before income taxes and the
    cumulative effect of a change in accounting principle |                                                                                                                                                      |                        | (1,831  | )       |   |      | 1,646   |         |  |   | (153,419 | )      
|Provision for (benefit from) income taxes                                                           |                                                                                                                                                      |                        | (414    | )       |   |      | 748     |         |  |   | (20,531  | )      
|Cumulative effect of a change in accounting
    principle                                           |                                                                                                                                                      |                        | 12,261  |         |   |      |        |         |  |   |         |        
|                                                                                                    |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        
|Net (loss) income                                                                                   |                                                                                                                                                      | $                      | (13,678 | )       |   | $    | 898     |         |  | $ | (132,888 | )      
|                                                                                                    |                                                                                                                                                      |                        |         |         |   |      |         |         |  |   |          |        

The accompanying notes are an integral part of
these consolidated financial statements.

F-3



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY (DEFICIT)

|                             |                                                                                      |                        |           |              |   |              |    |              |   |            |         |             |   |          |   |        |   |         |        |         |   |             |   |       |  |  |           |           |  |   |   |   |  |   |         |       |  |   |          |          |   |   |        |   |  |   |         |          |  
|---------------------------- | ------------------------------------------------------------------------------------ | ---------------------- | --------- | ------------ | - | ------------ | -- | ------------ | - | ---------- | ------- | ----------- | - | -------- | - | ------ | - | ------- | ------ | ------- | - | ----------- | - | ----- |  |  | --------- | --------- |  | - | - | - |  | - | ------- | ----- |  | - | -------- | -------- | - | - | ------ | - |  | - | ------- | -------- | -
|                             |                                                                                      |                        |           |              |   |              |    |              |   |            |         |             |   |          |   |        |   |         |        |         |   |            
|                             |                                                                                      |                        |           |              |   |              |    | New          |   |            |         |             |   |          |   |       
|                             |                                                                                      | Series A               |           | Series B     |   | Series C     |    | Reorganized  |   |            |         |             |   |          |   |       
|                             |                                                                                      | Common Stock           |           | Common Stock |   | Common Stock |    | Common Stock |   | Additional |         |             |   |          |   |       
|                             |                                                                                      |                        |           |              |   |              |    |              |   | Paid-In    |         | Accumulated |   | Due From |   |       
|                             |                                                                                      | Shares                 |           | Amount       |   | Shares       |    | Amount       |   | Shares     |         | Amount      |   | Shares   |   | Amount |   | Capital |        | Deficit |   | Shareholder |   | Total
|                             |                                                                                      |                        |           |              |   |              |    |              |   |            |         |             |   |          |   |        |   |         |        |         |   |             |   |      
|                             |                                                                                      |                       
|                             |                                                                                      | (Dollars in thousands)
|Balance at December 31, 2000 |                                                                                      |                        | 1,000,000 |              |   | $            | 10 |              |   |            | 114,202 |             |   | $        | 1 |        |   |         | 20,742 |         |   | $           |  |       |  |  |          |           |  | $ |  |   |  | $ | 106,488 |       |  | $ | (39,325  | )        |   | $ | (2,540 | ) |  | $ | 64,634  |         
|                             | Net loss                                                                             |                        |           |             |   |              |    |             |   |            |         |            |   |          |   |       |   |         |        |        |   |             |   |      |  |  |           |          |  |   |   |  |  |   |         |      |  |   |          | (132,888 | ) |   |        |  |  |   |         | (132,888 | )
|                             |                                                                                      |                        |           |              |   |              |    |              |   |            |         |             |   |          |   |        |   |         |        |         |   |             |   |       |  |  |           |           |  |   |   |   |  |   |         |       |  |   |          |          |   |   |        |   |  |   |         |         
|Balance at December 31, 2001 |                                                                                      |                        | 1,000,000 |              |   |              | 10 |              |   |            | 114,202 |             |   |          | 1 |        |   |         | 20,742 |         |   |             |  |       |  |  |          |           |  |   |  |   |  |   | 106,488 |       |  |   | (172,213 | )        |   |   | (2,540 | ) |  |   | (68,254 | )       
|                             | Net income                                                                           |                        |           |             |   |              |    |             |   |            |         |            |   |          |   |       |   |         |        |        |   |             |   |      |  |  |           |          |  |   |   |  |  |   |         |      |  |   |          | 898      |   |   |        |  |  |   |         | 898      |  
|                             |                                                                                      |                        |           |              |   |              |    |              |   |            |         |             |   |          |   |        |   |         |        |         |   |             |   |       |  |  |           |           |  |   |   |   |  |   |         |       |  |   |          |          |   |   |        |   |  |   |         |         
|Balance at December 31, 2002 |                                                                                      |                        | 1,000,000 |              |   |              | 10 |              |   |            | 114,202 |             |   |          | 1 |        |   |         | 20,742 |         |   |             |  |       |  |  |          |           |  |   |  |   |  |   | 106,488 |       |  |   | (171,315 | )        |   |   | (2,540 | ) |  |   | (67,356 | )       
|                             | Cancellation and issuance of new common stock in
    Reorganized Fountain View, Inc. |                        |           | (1,000,000   | ) |              |    | (10          | ) |            |         | (114,202    | ) |          |   | (1     | ) |         |        | (20,742 | ) |             |   |      |  |  |           | 1,134,945 |  |   |   |  |  |   |         | 11    |  |   |          |         |   |   |        |  |  |   |         |         |  
|                             | Issuance of new common stock to holders of
    indenture notes                       |                        |           |              |   |              |    |             |   |            |         |            |   |          |   |       |   |         |        |        |   |             |   |      |  |  |           | 58,642    |  |   |   |  |  |   |         | 1,073 |  |   |          |          |   |   |        |  |  |   |         | 1,073    |  
|                             | Net loss                                                                             |                        |           |             |   |              |    |             |   |            |         |            |   |          |   |       |   |         |        |        |   |             |   |      |  |  |           |          |  |   |   |  |  |   |         |      |  |   |          | (13,678  | ) |   |        |  |  |   |         | (13,678  | )
|                             |                                                                                      |                        |           |              |   |              |    |              |   |            |         |             |   |          |   |        |   |         |        |         |   |             |   |       |  |  |           |           |  |   |   |   |  |   |         |       |  |   |          |          |   |   |        |   |  |   |         |         
|Balance at December 31, 2003 |                                                                                      |                        |          |              |   | $            |   |              |   |            |        |             |   | $        |  |        |   |         |       |         |   | $           |  |       |  |  | 1,193,587 |           |  | $ |  |   |  | $ | 107,572 |       |  | $ | (184,993 | )        |   | $ | (2,540 | ) |  | $ | (79,961 | )       
|                             |                                                                                      |                        |           |              |   |              |    |              |   |            |         |             |   |          |   |        |   |         |        |         |   |             |   |       |  |  |           |           |  |   |   |   |  |   |         |       |  |   |          |          |   |   |        |   |  |   |         |         

The accompanying notes are an integral part of
these consolidated financial statements.

F-4



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |         |         |  
|------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------ | ---------------------------------------------------------------------- | ------- | ------ | ------- | ---- | ------- | ------ | ------ | - | -------- | ------- | ------- | -
|                                                                                                       |                                                                                |                                                                       
|                                                                                                       |                                                                                | Year Ended December 31,                                               
|                                                                                                       |                                                                                |                                                                       
|                                                                                                       |                                                                                | 2003                                                                   |         | 2002   |         | 2001
|                                                                                                       |                                                                                |                                                                        |         |        |         |     
|                                                                                                       |                                                                                |                                                                       
|                                                                                                       |                                                                                | (Dollars in thousands)                                                
|Cash Flows From Operating Activities                                                                   |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Net (loss) income                                                                                      |                                                                                | $                                                                      | (13,678 | )      |         | $    | 898     |        |        | $ | (132,888 | )      
|Adjustments to reconcile net (loss) income
    to net cash provided by (used in) operating activities: |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|                                                                                                       | Depreciation and amortization                                                  |                                                                        |         | 9,790  |         |      |         | 9,766  |        |   |          | 18,108  |        
|                                                                                                       | Reorganization costs, net                                                      |                                                                        |         | 12,966 |         |      |         | 12,304 |        |   |          | 4,787   |        
|                                                                                                       | Provision for doubtful accounts                                                |                                                                        |         | 3,559  |         |      |         | 3,960  |        |   |          | 20,006  |        
|                                                                                                       | Provision for impairment of goodwill and
    long-lived assets                 |                                                                        |         |       |         |      |         |       |        |   |          | 117,424 |        
|                                                                                                       | Accrued interest expense related to cumulative
    effect of adopting SFAS 150 |                                                                        |         | 12,261 |         |      |         |       |        |   |          |        |        
|                                                                                                       | Gain on disposal of property and equipment                                     |                                                                        |         | (201   | )       |      |         | (479   | )      |   |          |        |        
|                                                                                                       | Write off deferred financing costs of
    extinguished debt                    |                                                                        |         | 4,111  |         |      |         |       |        |   |          |        |        
|                                                                                                       | Change in fair value of interest rate hedge                                    |                                                                        |         | 1,006  |         |      |         |       |        |   |          |        |        
|                                                                                                       | Changes in operating assets and liabilities:                                   |                                                                        |         |        |         |      |         |        |        |   |          |         |        
|                                                                                                       |                                                                                | Accounts receivable                                                    |         |        | (2,330  | )    |         |        | (2,170 | ) |          |         | (10,752 | )
|                                                                                                       |                                                                                | Other current assets                                                   |         |        | (3,287  | )    |         |        | 258    |   |          |         | (4,373  | )
|                                                                                                       |                                                                                | Accounts payable, accrued liabilities and accrued
    interest payable |         |        | (28,409 | )    |         |        | 19,384 |   |          |         | 28,623  |  
|                                                                                                       |                                                                                | Employee compensation and benefits                                     |         |        | 1,991   |      |         |        | 1,577  |   |          |         | 2,386   |  
|                                                                                                       |                                                                                | Deferred income taxes                                                  |         |        | 0       |      |         |        | 0      |   |          |         | (19,778 | )
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Total adjustments                                                                                      |                                                                                |                                                                        | (11,457 | )      |         |      | 44,600  |        |        |   | 156,431  |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Net cash (used in) provided by operating
    activities before reorganization costs                    |                                                                                |                                                                        | (2,221  | )      |         |      | 45,498  |        |        |   | 23,543   |        
|Net cash paid for reorganization costs                                                                 |                                                                                |                                                                        | (12,746 | )      |         |      | (15,120 | )      |        |   | (628     | )      
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Net cash (used in) provided by operating
    activities                                                |                                                                                |                                                                        | (14,967 | )      |         |      | 30,378  |        |        |   | 22,915   |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Cash Flows From Investing Activities                                                                   |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Principal payments and (additions) on notes
    receivable                                             |                                                                                |                                                                        | (1,931  | )      |         |      | 788     |        |        |   | 474      |        
|Additions to notes receivable                                                                          |                                                                                |                                                                        |        |        |         |      | (400    | )      |        |   |         |        
|Proceeds from disposal of property and equipment                                                       |                                                                                |                                                                        | 1,732   |        |         |      | 779     |        |        |   |         |        
|Additions to property and equipment                                                                    |                                                                                |                                                                        | (19,373 | )      |         |      | (5,902  | )      |        |   | (4,411   | )      
|Changes in other assets                                                                                |                                                                                |                                                                        | (6,775  | )      |         |      | (296    | )      |        |   | (2,336   | )      
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Net cash used in investing activities                                                                  |                                                                                |                                                                        | (26,347 | )      |         |      | (5,031  | )      |        |   | (6,273   | )      
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Cash Flows From Financing Activities                                                                   |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Borrowings under line of credit                                                                        |                                                                                |                                                                        | 16,124  |        |         |      |        |        |        |   |         |        
|Repayments on long-term debt                                                                           |                                                                                |                                                                        | (22,483 | )      |         |      | (15,760 | )      |        |   | (1,114   | )      
|Repayments on long-term debt through refinancing                                                       |                                                                                |                                                                        | (96,084 | )      |         |      |        |        |        |   |         |        
|Proceeds from long-term debt                                                                           |                                                                                |                                                                        | 132,070 |        |         |      |        |        |        |   |         |        
|Purchase interest rate hedge                                                                           |                                                                                |                                                                        | (2,900  | )      |         |      |        |        |        |   |         |        
|Additions to deferred financing costs of new debt                                                      |                                                                                |                                                                        | (4,314  | )      |         |      | (37     | )      |        |   | (1,798   | )      
|Charge related to issuance of new common stock                                                         |                                                                                |                                                                        | 1,073   |        |         |      |         |        |        |   |          |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Net cash provided by (used in) financing
    activities                                                |                                                                                |                                                                        | 23,486  |        |         |      | (15,797 | )      |        |   | (6,040   | )      
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Increase (decrease) in cash and cash
    equivalents                                                   |                                                                                |                                                                        | (17,828 | )      |         |      | 9,550   |        |        |   | 10,602   |        
|Cash and cash equivalents at beginning of period                                                       |                                                                                |                                                                        | 20,498  |        |         |      | 10,948  |        |        |   | 346      |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Cash and cash equivalents at end of period                                                             |                                                                                | $                                                                      | 2,670   |        |         | $    | 20,498  |        |        | $ | 10,948   |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Supplemental disclosure of cash flow
    information:                                                  |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Cash paid for:                                                                                         |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Interest expense                                                                                       |                                                                                | $                                                                      | 10,808  |        |         | $    | 10,808  |        |        | $ | 13,772   |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Income taxes                                                                                           |                                                                                | $                                                                      | 826     |        |         | $    | 105     |        |        | $ | 32       |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Non-cash item:                                                                                         |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Reclassification of accounts receivable to notes
    receivable                                        |                                                                                | $                                                                      | 4,670   |        |         | $    |        |        |        | $ | 1,342    |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        
|Capital lease transactions                                                                             |                                                                                | $                                                                      | 13,170  |        |         | $    |        |        |        | $ |         |        
|                                                                                                       |                                                                                |                                                                        |         |        |         |      |         |        |        |   |          |        

The accompanying notes are an integral part of
these consolidated financial statements.

F-5



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

December 31, 2003


1.     Description of
Business



| |                 
| | ----------------
| | Current Business

Skilled Healthcare Group, Inc., formerly known as
Fountain View, Inc. (the Company) through its
subsidiaries, is an operator of long-term care facilities and a
provider of a wide range of post-acute care services, with a
strategic emphasis on sub-acute specialty medical care. The
Company operates a network of facilities in California and
Texas, including 48 skilled nursing facilities (SNFs) that offer
sub-acute, rehabilitative and specialty medical skilled nursing
care, as well as five assisted living facilities (ALFs) that
provide room and board and social services in a secure
environment. In addition, the Company provides a variety of
ancillary services such as physical, occupational and speech
therapy in Company-operated facilities and unaffiliated
facilities. The Company also operates three institutional
pharmacies (one of which is a joint venture), which serve acute
care hospitals as well as SNFs and ALFs, both affiliated and
unaffiliated with the Company.



| |                                    
| | -----------------------------------
| | Reorganization under
    Chapter 11

On October 2, 2001, the Company and 19 of
its subsidiaries filed voluntary petitions for protection under
Chapter 11 of the U.S. Bankruptcy Code with the
U.S. Bankruptcy Court for the Central District of
California, Los Angeles Division (the Bankruptcy
Court). On November 28, 2001, the Companys
remaining three subsidiaries also filed voluntary petitions for
protection under Chapter 11.

The Companys and its subsidiaries
financial difficulties were attributable to a number of factors.
The federal government had fundamentally changed reimbursement
rates and procedures for medical services provided to
individuals in 1999. These changes had a significant adverse
effect on the healthcare industry on the whole as well as on the
Companys cash flows. These changes also exacerbated a
long-standing problem of inadequate reimbursement by the states
for medical services provided to indigent persons under the
various states Medicaid programs. At the same time, the
Company experienced significant increases in its labor costs and
professional liability and other insurance costs.

Following its petition for protection under
Chapter 11, the Company and its subsidiaries continued to
operate their businesses as debtors-in-possession subject to the
jurisdiction of the Bankruptcy Court through August 19,
2003 (the Effective Date), when they emerged from
bankruptcy pursuant to the terms of the Companys Third
Amended Joint Plan of Reorganization dated April 22, 2003
(the Plan). In connection with emerging from
bankruptcy, the Company changed its name to Skilled Healthcare
Group, Inc. From the date the Company filed the petition with
the Bankruptcy court through December 31, 2003, the Company
incurred reorganization expenses totaling approximately
$30.1 million.

The principal components of reorganization
expenses incurred during the years ended December 31, 2003,
2002 and 2001 are as follows (in thousands):

|                                         |  |      |        |      |  |      |        |   |  |   |       |  
|---------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ----- | -
|                                         |  | 2003 |        | 2002 |  | 2001
|                                         |  |      |        |      |  |     
|Professional fees                        |  | $    | 7,336  |      |  | $    | 8,181  |   |  | $ | 4,315 |  
|Court-related services                   |  |      | 503    |      |  |      | 711    |   |  |   | 380   |  
|Refinancing Costs                        |  |      | 1,990  |      |  |      | 762    |   |  |   |      |  
|Other fees                               |  |      | 3,252  |      |  |      | 2,791  |   |  |   | 110   |  
|Less interest earned on accumulated cash |  |      | (115   | )    |  |      | (141   | ) |  |   | (18   | )
|                                         |  |      |        |      |  |      |        |   |  |   |       |  
|Total                                    |  | $    | 12,966 |      |  | $    | 12,304 |   |  | $ | 4,787 |  
|                                         |  |      |        |      |  |      |        |   |  |   |       |  

F-6



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

On July 10, 2003, the Bankruptcy Court
confirmed the Companys Plan, which was approved by
substantially all creditors and implemented on the Effective
Date. The principal provisions of the Plan included:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the incurrence by the Company of
    (i) approximately $32.0 million in indebtedness
    available under new Revolving Credit Facilities;
    (ii) approximately $23.0 million under a new Secured
    Mezzanine Term Loan; and (iii) approximately
    $95.0 million under a new Senior Mortgage Term Loan;                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | the satisfaction of the Companys
    11 1/4% Senior Subordinated Notes due 2008 (Senior
    Subordinated Notes) upon the issuance or payment by us to
    the holders of Senior Subordinated Notes on a pro rata basis of
    (i) approximately $106.8 million of new Senior
    Subordinated Secured Increasing Rate Notes due 2008
    (Increasing Rate Notes) that accrue interest at an
    initial rate of 9.25% and provide for annual rate increases,
    (ii) 58,642 shares of common stock and (iii) cash in
    the amount of $50.0 million, consisting of approximately
    $36.0 million in outstanding interest and approximately
    $14.0 million of principal;
|
| |  | the payment in full of amounts outstanding under
    our $90 million Term Loan Facility and $30 million
    Revolving Credit Facility;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | the issuance of one share of new series A
    preferred stock for each share of the Companys existing
    series A preferred stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | the cancellation of the Companys series A
    common stock and the issuance of 1.1142 shares of new common
    stock for each share of cancelled series A common stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | the cancellation of the Companys series B
    common stock and options to purchase series C common stock, with
    no distribution made in respect thereof;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | the cancellation of the Companys series C
    common stock and the issuance of one share of new common stock
    for each share of cancelled series C common stock;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | the cancellation of outstanding warrants to
    purchase series C common stock and the issuance of new warrants,
    on substantially the same terms, to purchase a number of shares
    of new common stock equal to the number of shares of series C
    common stock that were subject to the existing warrants so
    cancelled;                                                                                                                                                                                                                                                                                                                                               
|
| |  | an amendment and restatement of the
    Companys stockholders agreement;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | the impairment of certain secured claims and the
    impairment of certain general unsecured claims; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | the restructuring of the Companys and its
    subsidiaries businesses and legal structure.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

2.     Summary of
Significant Accounting Policies



| |                      
| | ---------------------
| | Basis of Presentation

Although operating under the jurisdiction of the
United States Bankruptcy Court as a debtor-in-possession through
August 19, 2003, the Company continued to operate and
control its subsidiaries. Therefore the consolidated financial
statements of the Company include the accounts of the
Companys wholly-owned subsidiaries. All significant
intercompany transactions have been eliminated in consolidation.



| |                          
| | -------------------------
| | Estimates and Assumptions

The preparation of consolidated financial
statements in conformity with generally accepted accounting
principles in the United States requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the

F-7



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

financial statements and the reported amounts of
revenues and expenses during the reporting period. The most
significant estimates in the Companys consolidated
financial statements relate to net revenues, allowance for
doubtful accounts, and general and professional liability
claims. Actual results could differ from those estimates.



| |                    
| | -------------------
| | Revenue Recognition

Revenues are recorded on an accrual basis as
services are performed at their estimated net realizable value.
The Company derived approximately 78%, 82% and 80% of its
revenues in 2003, 2002 and 2001 from funds under federal
Medicare and state Medicaid assistance programs, the
continuation of which are dependent upon governmental policies.
Differences between final settlement and the estimated net
realizable value accrued in prior years are reported as
adjustments to the current years net revenues. These
revenues are based, in certain cases, upon cost reimbursement
principles and are subject to audit.

In 1999, one of the Companys Medicare
fiscal intermediaries performed focused audits as part of the
normal annual audit process at a number of the Companys
SNF facilities. The auditors identified certain matters that
represented a departure from prior practices of the fiscal
intermediary. In 2000, the Company received notification of
proposed adjustments for certain of these audits. The
adjustments, which originally were assessed to be approximately
$2.8 million, were subsequently revised to approximately
$1.4 million. The Company has appealed these adjustments
and believes that the ultimate resolution of these items will
not have a material adverse effect on its financial position or
results of operations, notwithstanding the fact that the Company
has not recorded a receivable related to the appeals. In July
2002, an adjustment relating to one of these audited facilities
was settled for $109,000. The settlement was approved and
entered in the Bankruptcy Court on July 10, 2002. As of
December 31, 2003, the adjustments, after giving effect to
the settlement of $109,000, were approximately $1.3 million.

The Companys net revenue is derived from
services provided to patients in the following payer classes (in
thousands):

|                       |  |      |         |      |  |      |         |  |  |   |         | 
|---------------------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                       |  | 2003 |         | 2002 |  | 2001
|                       |  |      |         |      |  |     
|Medicare               |  | $    | 125,994 |      |  | $    | 136,868 |  |  | $ | 124,777 | 
|Medicaid               |  |      | 155,152 |      |  |      | 141,735 |  |  |   | 130,215 | 
|Private                |  |      | 36,410  |      |  |      | 37,823  |  |  |   | 41,679  | 
|Managed Care and other |  |      | 41,733  |      |  |      | 25,121  |  |  |   | 21,749  | 
|                       |  |      |         |      |  |      |         |  |  |   |         | 
|                       |  | $    | 359,289 |      |  | $    | 341,547 |  |  | $ | 318,420 | 
|                       |  |      |         |      |  |      |         |  |  |   |         | 



| |                          
| | -------------------------
| | Cash and Cash Equivalents

Cash and cash equivalents consist of cash and
short-term investments with original maturities of three months
or less. The Company places its temporary cash investments with
high credit quality financial institutions.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost
(first-in, first-out method) or market and are included in other
current assets in the accompanying consolidated financial
statements.

F-8



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost. Major
renewals or improvements are capitalized, whereas ordinary
maintenance and repairs are expensed as incurred. Depreciation
and amortization is computed using the straight-line method over
the estimated useful lives of the assets as follows:

|                           |  |                                                                         
|-------------------------- |  | ------------------------------------------------------------------------
|Buildings and improvements |  | 15-40 years                                                             
|Leasehold improvements     |  | Shorter of lease term or estimated useful life,
    generally 5-10 years
|Furniture and equipment    |  | 3-10 years.                                                             

Depreciation and amortization of property and
equipment under capital leases is included in depreciation and
amortization expense. For leasehold improvements, where the
Company has acquired the right of first refusal to purchase or
to renew the lease, amortization is based on the lesser of the
estimated useful lives or the period covered by the right.



| |                  
| | -----------------
| | Intangible Assets

Goodwill represents the excess of the purchase
price over the fair value of identifiable net assets acquired in
business combinations accounted for as purchases. The Company
adopted Statement of Financial Accounting Standards, (SFAS)
No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, on January 1,
2002.

Goodwill, which was previously amortized on a
straight-line basis over 35 years, is no longer amortized to
earnings but instead is subject to periodic testing for
impairment. Goodwill of a reporting unit is tested for
impairment on an annual basis or between annual testing dates if
an event occurs or circumstances change that would reduce the
fair value of a reporting unit below its carrying amount. As
provided under SFAS No. 142, the initial testing of
goodwill for possible impairment was completed within the first
six months of 2002 and no impairment was identified. As of
December 31, 2003, the carrying value of goodwill was
approximately $20.8 million and no impairment was recorded
at December 31, 2003 or 2002.

Deferred financing costs substantially relate to
the Companys Senior Mortgage Term Loan and Increasing Rate
Notes (see Note 6) and are being amortized over the
maturity periods using an effective-interest method. At
December 31, 2003, deferred financing costs, net of
accumulated amortization was approximately $4.1 million.



| |             
| | ------------
| | Income Taxes

The Company utilizes the liability method of
accounting for income taxes as set forth in FASB Statement
No. 109, Accounting for Income Taxes. Under the
liability method, deferred taxes are determined based on the
differences between the financial statement and tax bases of
assets and liabilities using currently enacted tax rates.



| |                                    
| | -----------------------------------
| | Impairment of Long-Lived
    Assets

The Company periodically evaluates the carrying
value of long-lived assets other than goodwill in relation to
the future undiscounted cash flows of the underlying businesses
to assess recoverability of the assets. If the estimated
undiscounted future cash flows are less than the carrying
amount, an impairment loss, which is determined based on the
difference between the fair value and the carrying value of the
assets, is recognized.

On January 1, 2002, the Company adopted SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets(SFAS 144), which supersedes SFAS
121, Accounting for Long-Lived Assets and for Long-Lived
Assets to be Disposed of. SFAS 144 addresses financial
accounting and reporting requirements for the impairment or
disposal of long-lived assets. This statement also expands the
definition of a discontinued

F-9



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

operation to include a component of an entity,
and eliminates the current exemption to consolidation when
control over a subsidiary is likely to be temporary. The
Companys adoption of SFAS 144 did not have a material
impact on its financial position or results of operations.



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

FASB Interpretation No. 46, Consolidation
of Variable Interest Entities (FIN 46) becomes
effective beginning January 1, 2004. Variable interest
entities (VIEs) are entities that lack sufficient equity or
whose equity holders lack adequate decision making ability based
on criteria set forth in the interpretation. All of a
companys VIEs must be evaluated under methods prescribed
by this interpretation to determine the primary beneficiary of
the risks and rewards of the VIE. The primary beneficiary is
required to consolidate the VIE for financial reporting purposes.

The Company has an equity interest in a limited
liability company that was formed with its joint venture
partner, American Pharmaceutical Services, Inc. that is
currently not consolidated, but under current rules are
accounted for under the equity method of accounting. For this
entity, the Company may hold a variable interest. This entity
may be considered a VIE under FIN 46, and it is possible
that the Company may be required to consolidate this entity when
FIN 46 becomes applicable. The Company is currently in the
process of analyzing this entity to determine if it is a VIE
and, if so, whether the Company is the primary beneficiary in
which case consolidation would be required. The Company believes
that any additional liabilities recognized as a result of
consolidating any VIEs would not represent additional claims on
the general assets of the Company; rather, they would represent
claims against the additional assets recognized by the Company
as a result of consolidating the VIEs. Conversely, we believe
that any additional assets recognized as a result of
consolidating any VIEs would not represent additional assets of
the Company that could be used to satisfy claims against the
Companys general assets.

In May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity
(SFAS 150). This statement was developed in response to
concerns expressed by preparers, auditors, regulators, and other
users of financial statements about issuers classification
in the balance sheet of certain financial instruments that have
characteristics of both liabilities and equity but that have
been presented between the liabilities section and the equity
section of the balance sheet. The statement requires that
financial instruments issued in the form of shares that are
mandatorily redeemable be classified as liabilities. Mandatorily
redeemable shares are defined as shares for which the issuer has
an unconditional obligation to redeem shares at a specified or
determinable date or upon an event that is certain to occur. The
Company adopted SFAS 150 on July 1, 2003. At that
time, the Companys Series A preferred stock, which is
mandatorily redeemable was classified as a liability and the
Company recognized interest expense of $12.3 million
related to the adoption of SFAS 150. In accordance with the
underlying provisions of SFAS 150, such charge was recorded
in the Consolidated Financial Statements as a cumulative effect
of a change in accounting principle during the third quarter,
2003.

The following table illustrates the effect on net
income (loss) if the Company had recorded interest expense for
the years ended December 31, 2003, 2002 and 2001 (in
thousands):

|                                                                        |  |      |         |      |  |      |        |   |  |   |          |  
|----------------------------------------------------------------------- |  | ---- | ------- | ---- |  | ---- | ------ | - |  | - | -------- | -
|                                                                        |  | 2003 |         | 2002 |  | 2001
|                                                                        |  |      |         |      |  |     
|Reported net (loss) income                                              |  | $    | (13,678 | )    |  | $    | 898    |   |  | $ | (132,888 | )
|Reversal of cumulative effect                                           |  |      | 12,261  |      |  |      |       |   |  |   |         |  
|Interest expense on mandatorily redeemable
    Series A preferred stock |  |      | (1,502  | )    |  |      | (2,760 | ) |  |   | (2,464   | )
|                                                                        |  |      |         |      |  |      |        |   |  |   |          |  
|Pro forma net loss                                                      |  | $    | (2,919  | )    |  | $    | (1,862 | ) |  | $ | (135,352 | )
|                                                                        |  |      |         |      |  |      |        |   |  |   |          |  

F-10



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

3.     Fair Value of
Financial Instruments

The following methods and assumptions were used
by the Company in estimating fair value of each class of
financial instruments for which it is practicable to estimate
this value.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

The carrying amount approximates fair value
because of the short maturity of these instruments.



| |                                   
| | ----------------------------------
| | Interest Rate Derivative
    Hedge

Fair value for the Companys interest rate
derivative hedge is based on an estimate obtained from a broker.



| |               
| | --------------
| | Long-Term Debt

The Companys senior subordinated notes are
currently trading at par, however, there has not been a
significant amount of activity in the notes since the Company
emerged from bankruptcy in August 2003. Consequently, the
Company considers the carrying value of the senior subordinated
notes to approximate its fair value. The carrying value of the
Companys remaining long-term debt, and its accounts
receivable revolving credit facility is considered to
approximate the fair value of such debt since the interest rates
and terms approximate the interest rates and terms of similar
debt the Company believes that it can obtain currently.

4.     Impairment of
Goodwill and Long-Lived Assets

As discussed in Note 2, on January 1, 2002,
the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets and SFAS No. 144, Accounting
for Long-Lived Assets and for Long-Lived Assets to be Disposed
of. Under SFAS 142, goodwill and other intangible
assets with indefinite lives, are no longer being amortized.
Instead, the carrying amount will be subject to testing for
possible impairment. Similarly, SFAS 144 requires
impairment losses to be recognized for long-lived assets used in
operations when indications of impairment are present and the
estimate of undiscounted future cash flows is not sufficient to
recover long-lived asset carrying amounts. No impairment was
recognized for the years ended December 31, 2003 and 2002.

In the third quarter of 2001, the Company
determined that the Companys liquidity problems and
Chapter 11 filing served as an indication to the Company
that the carrying values of the long-lived assets of its
nursing, pharmacy and therapy services business segments may be
impaired. As a result, during the third quarter of 2001, the
Company revised its projections of future cash flows for its
various business segments and, where the carrying value of the
long-lived assets exceeded the estimated undiscounted cash
flows, the Company estimated the fair value of these assets
using a discounted cash flow model. This analysis was done at
the lowest level where cash flows were identified to be
independent of the cash flows of other groups of assets.
Impairments were recorded based on the excess of the carrying
value over the fair value of such assets.

F-11



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following is a summary of the impairment loss
by business segment for the year ended December 31, 2001
(in thousands):

|                  |  |          |        |           |  |       |        |  |  |   |         | 
|----------------- |  | -------- | ------ | --------- |  | ----- | ------ |  |  | - | ------- | 
|                  |  |          |        | Property, |  |      
|                  |  |          |        | Equipment |  |      
|                  |  | Goodwill |        | and Other |  | Total
|                  |  |          |        |           |  |      
|Nursing services  |  | $        | 28,051 |           |  | $     | 82,429 |  |  | $ | 110,480 | 
|Therapy services  |  |          |       |           |  |       | 10     |  |  |   | 10      | 
|Pharmacy services |  |          | 4,894  |           |  |       | 2,040  |  |  |   | 6,934   | 
|                  |  |          |        |           |  |       |        |  |  |   |         | 
|Total             |  | $        | 32,945 |           |  | $     | 84,479 |  |  | $ | 117,424 | 
|                  |  |          |        |           |  |       |        |  |  |   |         | 

5.     Business
Segments

The Company has three reportable segments:



| |   |                      
| | - | ---------------------
| |  | nursing services;    
|
| |  | therapy services; and
|
| |  | pharmacy services.   

Nursing services are provided by 48 SNFs
that offer sub-acute, rehabilitative and specialty medical
skilled nursing care, as well as five ALFs that provide room and
board and social services in a secure environment. Therapy
services include ancillary services such as physical,
occupational and speech therapy provided in Company-operated
facilities, unaffiliated facilities and acute care hospitals.
Pharmacy services are provided by three institutional pharmacies
(one of which is a joint venture), which serve acute care
hospitals as well as SNFs and ALFs, both affiliated and
unaffiliated with the Company. The Companys reportable
segments are business units that offer different services and
products. The reportable segments are each managed separately
due to the nature of the services provided or the products sold.

The Companys management evaluates
performance based on operating contribution, where segment
revenues are reduced by those costs that are allowable to the
segments. Management evaluates performance and allocates
resources to each segment based on an operating model that is
designed to maximize profitability and the quality of care
provided across the Companys entire facility network.
Certain of the Companys facilities are leased, under
operating leases, and not owned. Accordingly, earnings before
interest, taxes, depreciation, amortization, rent and
extraordinary items are used to determine and evaluate segment
profit or loss. Corporate overhead is not allocated to any
segment for purposes of determining segment profit or loss, and
is included, along with the Companys durable medical
equipment subsidiary, whose operations ceased during 2002, in
the all other category in the selected segment
financial data that follows. Goodwill and deferred financing
costs are also not allocated to any segment for purposes of
determining segment assets and are included in the all
other category. The accounting policies of the reportable
segments are the same as those described in the summary of
significant accounting policies. Intersegment sales and
transfers are recorded at the Companys cost plus standard
mark-up; intersegment profit and loss has been eliminated in
consolidation.

F-12



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                        
| | -----------------------
| | Selected Financial Data

The following table sets forth selected financial
data by business segment (in thousands):

|                                 |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|-------------------------------- |  | -------- | ------- | -------- |  | -------- | ------ | --------- |  | ------ | ------ | - |  | - | ------- | - |  | - | ------- | 
|                                 |  | Nursing  |         | Therapy  |  | Pharmacy |        |           |  |       
|                                 |  | Services |         | Services |  | Services |        | All Other |  | Totals
|                                 |  |          |         |          |  |          |        |           |  |       
|Year ended December 31, 2003     |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Revenues from external customers |  | $        | 299,314 |          |  | $        | 17,678 |           |  | $      | 42,350 |   |  | $ | (53     | ) |  | $ | 359,289 | 
|Intersegment revenues            |  |          |        |          |  |          | 24,621 |           |  |        | 9,195  |   |  |   | 2,000   |   |  |   | 35,816  | 
|                                 |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Total revenues                   |  | $        | 299,314 |          |  | $        | 42,299 |           |  | $      | 51,545 |   |  | $ | 1,947   |   |  | $ | 395,105 | 
|                                 |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Segment profit (loss)            |  | $        | 61,170  |          |  | $        | 6,194  |           |  | $      | 4,923  |   |  | $ | (16,091 | ) |  | $ | 56,196  | 
|Segment assets                   |  |          | 193,315 |          |  |          | 28,863 |           |  |        | 22,001 |   |  |   | 16,662  |   |  |   | 260,841 | 
|Capital expenditures             |  |          | 6,064   |          |  |          | 290    |           |  |        | 307    |   |  |   | 704     |   |  |   | 7,365   | 
|Year ended December 31, 2002     |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Revenues from external customers |  | $        | 281,447 |          |  | $        | 21,098 |           |  | $      | 39,980 |   |  | $ | (978    | ) |  | $ | 341,547 | 
|Intersegment revenues            |  |          |        |          |  |          | 21,495 |           |  |        | 7,766  |   |  |   | 2,976   |   |  |   | 32,237  | 
|                                 |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Total revenues                   |  | $        | 281,447 |          |  | $        | 42,593 |           |  | $      | 47,746 |   |  | $ | 1,998   |   |  | $ | 373,784 | 
|                                 |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Segment profit (loss)            |  | $        | 61,302  |          |  | $        | 3,935  |           |  | $      | 4,897  |   |  | $ | (16,636 | ) |  | $ | 53,498  | 
|Segment assets                   |  |          | 95,420  |          |  |          | 52,205 |           |  |        | 21,773 |   |  |   | 134,044 |   |  |   | 303,442 | 
|Capital expenditures             |  |          | 4,729   |          |  |          | 94     |           |  |        | 265    |   |  |   | 513     |   |  |   | 5,601   | 
|Year ended December 31, 2001     |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Revenues from external customers |  | $        | 270,162 |          |  | $        | 18,997 |           |  | $      | 29,171 |   |  | $ | 90      |   |  | $ | 318,420 | 
|Intersegment revenues            |  |          |        |          |  |          | 23,496 |           |  |        | 6,120  |   |  |   | 8,856   |   |  |   | 38,472  | 
|                                 |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Total revenues                   |  | $        | 270,162 |          |  | $        | 42,493 |           |  | $      | 35,291 |   |  | $ | 8,946   |   |  | $ | 356,892 | 
|                                 |  |          |         |          |  |          |        |           |  |        |        |   |  |   |         |   |  |   |         | 
|Segment profit (loss)            |  | $        | 42,285  |          |  | $        | 2,917  |           |  | $      | (2,747 | ) |  | $ | (23,195 | ) |  | $ | 19,260  | 
|Segment assets                   |  |          | 172,426 |          |  |          | 39,598 |           |  |        | 16,032 |   |  |   | 69,148  |   |  |   | 297,204 | 
|Capital expenditures             |  |          | 3,793   |          |  |          | 90     |           |  |        | 253    |   |  |   | 275     |   |  |   | 4,411   | 

6.     Debt

As a result of the Chapter 11 filing, a
significant amount of the Companys short-term and
long-term debt as of the Companys petition date were
classified as liabilities subject to compromise in
the Companys consolidated balance sheets in accordance
with SOP 90-7. Pursuant to the Seventh Interim Order, the
Company was authorized to make payments to reduce the principal
amounts of certain secured debts and capital leases.

On August 19, 2003, the Company successfully
consummated its Plan of Reorganization and emerged from
Chapter 11 protection. To effectuate the plan, the Company
entered into new credit facilities in an aggregate amount of
approximately $250 million. The proceeds of the credit
facilities, along with $30 million of the Companys
cash were used to restructure its previous existing debt. The
holders of the Senior Subordinated Notes received a
$50 million payment, $14 million of which was a
principal payments, and notes for approximately
$106 million. The notes accrue interest initially at a rate
of 9.25%, and provide for annual rate increases. The outstanding
balances on the $30 million Revolving Credit Facility and
$90 million Term Loan Facility were paid in full.

F-13



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Long-term debt consists of the following at
December 31, 2003 and 2002 (in thousands):

|                                                                                                                                                                                                                                                                                                            |  |                   |         |                   |  |   |         | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ----------------- |  | - | ------- | 
|                                                                                                                                                                                                                                                                                                            |  | December 31, 2003 |         | December 31, 2002
|                                                                                                                                                                                                                                                                                                            |  |                   |         |                  
|Senior Subordinated Notes, interest rate
    initially 9.25%, with annual increases to 15.00%, due 2008                                                                                                                                                                                                     |  | $                 | 106,762 |                   |  | $ |        | 
|First Mortgage adjustable rate multi-property
    loan, interest based on the one-month LIBOR plus 4.50%,
    collateralized by real property                                                                                                                                                               |  |                   | 84,150  |                   |  |   |        | 
|Mezzanine Loans, interest based on LIBOR plus
    18.875%, collateralized by all tangible and intangible assets                                                                                                                                                                                             |  |                   | 22,375  |                   |  |   |        | 
|$32 million Accounts Receivable Revolving
    Credit Facility, interest based on the WSJ Prime rate plus 2.5%,
    collateralized by accounts receivable                                                                                                                                                    |  |                   | 16,124  |                   |  |   |        | 
|Mortgage and other notes payable, fixed interest
    rates from 6.0% to 9.0%, due in various monthly installments
    through August 2010, collateralized by property and equipment
    with a book value of approximately $6.9 million at
    December 31, 2003                                            |  |                   | 11,458  |                   |  |   |        | 
|Present value of capital lease obligations at
    effective interest rates from 6.25%, collateralized by property
    and equipment with a book value of approximately $13,255 at
    December 31, 2003                                                                                                     |  |                   | 13,171  |                   |  |   |        | 
|Senior Subordinated Notes, fixed interest rate of
    11.25%, interest only payable semiannually, principal due 2008,
    unsecured                                                                                                                                                                         |  |                   |        |                   |  |   | 120,000 | 
|$90 million Term Loan Facility, interest
    based on LIBOR plus the applicable margin, principal due in
    quarterly installments through December 2003, remaining unpaid
    principal due March 2004, collateralized by all tangible and
    intangible assets                                          |  |                   |        |                   |  |   | 63,796  | 
|$30 million Revolving Credit Facility,
    interest based on LIBOR plus the applicable margin, principal
    due April 2004, collateralized by all tangible and intangible
    assets                                                                                                                       |  |                   |        |                   |  |   | 22,848  | 
|Present value of capital lease obligations at
    effective interest rates from 8.4% to 9.0%, secured by property
    and equipment with a book value of approximately $14,616 at
    December 31, 2002                                                                                                     |  |                   |        |                   |  |   | 11,527  | 
|Mortgage and other notes payable, fixed interest
    rates from 7.75% to 9.0%, due in various monthly installments
    through January 2026, collateralized by property and equipment
    with a book value of approximately $7,242 at December 31,
    2002                                                |  |                   |        |                   |  |   | 5,412   | 
|Mortgage note payable, interest based on LIBOR
    plus the applicable margin, originally due in March 2001
    (negotiations to extend terms were not completed prior to the
    Filing Date), collateralized by property and equipment with a
    book value of approximately $5,221 at December 31, 2002 |  |                   |        |                   |  |   | 823     | 
|                                                                                                                                                                                                                                                                                                            |  |                   |         |                   |  |   |         | 

F-14



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                                 |  |                   |         |                   |  |   |          |  
|---------------------------------------------------------------- |  | ----------------- | ------- | ----------------- |  | - | -------- | -
|                                                                 |  | December 31, 2003 |         | December 31, 2002
|                                                                 |  |                   |         |                  
|Long-term debt                                                   |  |                   | 254,040 |                   |  |   | 224,406  |  
|Less current portion of long-term debt subject to
    compromise |  |                   |        |                   |  |   | (121,580 | )
|Less remaining amounts due within one year                       |  |                   | (35,610 | )                 |  |   | (92,959  | )
|                                                                 |  |                   |         |                   |  |   |          |  
|Long-term debt and capital leases, net of current
    portion    |  | $                 | 218,430 |                   |  | $ | 9,867    |  
|                                                                 |  |                   |         |                   |  |   |          |  



| |                          
| | -------------------------
| | Senior Subordinated Notes

In April 1998, the Company successfully completed
a Senior Subordinated Note Offering for an aggregate principal
amount of $120 million, with an interest rate of 11.25% due
in 2008. Interest was payable semiannually in April and October
of each year. The Notes constituted general, unsecured
obligations of the Company, subordinate to all senior debt. In
2001, the Company was unable to make the semiannual interest
payments required under the Notes. An agreement in principle
between the Company and the holders of the Notes was agreed to
such that during the pendancy of the bankruptcy proceeding, the
Notes would accrue interest at an abated rate of 9.5%.

In July 2001, the Company received an
acceleration notice from the holders of its Notes. However, as a
result of the Chapter 11 filing, claims against the Company
in existence prior to the Filing Date were automatically stayed.
The Company classified the obligations with respect to the
Notes, including the accrued interest thereon, as current
liabilities and included them as part of liabilities subject to
compromise in the Companys consolidated balance sheet as
of December 31, 2002.

On August 19, 2003, pursuant to the Plan,
the Company satisfied the terms of the Senior Subordinated Notes
with a payment to the holders on a pro rata basis of
$50.0 million, consisting of approximately
$36.0 million in outstanding interest and approximately
$14.0 million of principal. At that time, the holders of
the Senior Subordinated Notes received on a pro rata basis new
Senior Subordinated Secured Increasing Rate Notes due in August
2008, that accrue interest at an initial rate of 9.25 and
provide for annual rate increases. The Company accrues interest
on the new Senior Subordinated Notes using the effective
interest method which straight lines the interest over the term
of the notes. At December 31, 2003, the Company had accrued
approximately $1.3 million in excess of the pay rate for
the semi-annual interest payments.



| |                         
| | ------------------------
| | First Mortgage Term Loan

In August 2003, the Company entered into a First
Mortgage Term Loan facility in the aggregate principal amount of
$85 million payable in monthly installments with a final
maturity in August 2008. The loan bears interest at LIBOR plus a
margin of 4.5%.



| |                          
| | -------------------------
| | Revolving Credit Facility

The Revolving Credit Facility is available for
general borrowing purposes, including working capital and
permitted capital expenditures. The Revolving Credit Facility,
which matures on August 19, 2008, is subject to a borrowing
base calculation based upon a percentage of the Companys
eligible accounts receivable. Borrowings bear interest at the
WSJ Prime rate plus 2.5%.

F-15



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                
| | ---------------
| | Mezzanine Loans

The Mezzanine loans were entered into as a Second
Mortgage note for $10 million and collateralized note for
$23 million. The Second Mortgage note is an interest only
loan for 30 months, and beginning on the 31st month equal
installments of $333,333 are due plus interest. The
collateralized note has principal payments of $208,333 for two
years plus interest, and requires interest only payments for the
remaining three years. The interest rate is LIBOR plus a margin
of 18.875%. The Company is required to make additional principal
payments under the terms of the mezzanine loans up to
$10 million annually based on excess cash flow as defined
in the loan agreement. As of March 2004, the interest rate on
these notes is LIBOR plus a margin of 15.0%.



| |                                           
| | ------------------------------------------
| | Scheduled Maturities of Long-Term
    Debt

The scheduled maturities of long-term debt and
capital lease obligations are as follows (in thousands):

|                                   |  |         |        |           |  |       |         |  |  |   |         |  
|---------------------------------- |  | ------- | ------ | --------- |  | ----- | ------- |  |  | - | ------- | -
|                                   |  | Capital |        | Long Term |  |      
|                                   |  | Leases  |        | Debt      |  | Total
|                                   |  |         |        |           |  |      
|2004(1)                            |  | $       | 11,285 |           |  | $     | 24,692  |  |  | $ | 35,977  |  
|2005                               |  |         | 156    |           |  |       | 6,987   |  |  |   | 7,143   |  
|2006                               |  |         | 156    |           |  |       | 6,641   |  |  |   | 6,797   |  
|2007                               |  |         | 156    |           |  |       | 7,618   |  |  |   | 7,774   |  
|2008                               |  |         | 156    |           |  |       | 188,546 |  |  |   | 188,702 |  
|Thereafter                         |  |         | 2,184  |           |  |       | 6,385   |  |  |   | 8,569   |  
|                                   |  |         |        |           |  |       |         |  |  |   |         |  
|                                   |  |         | 14,093 |           |  |       | 240,869 |  |  |   | 254,962 |  
|Less: amount representing interest |  |         | (922   | )         |  |       |        |  |  |   | (922    | )
|                                   |  |         |        |           |  |       |         |  |  |   |         |  
|                                   |  | $       | 13,171 |           |  | $     | 240,869 |  |  | $ | 254,040 |  
|                                   |  |         |        |           |  |       |         |  |  |   |         |  



---



|    |                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes a debt obligation related to a capital
    lease that becomes first exercisable in April 2004, and
    continues for a 18 month period.

7.     Other
Assets

Other assets are comprised of the following at
December 31, 2003 and 2002 (in thousands):

|                                                             |  |                   |        |                   |  |   |       | 
|------------------------------------------------------------ |  | ----------------- | ------ | ----------------- |  | - | ----- | 
|                                                             |  | December 31, 2003 |        | December 31, 2002
|                                                             |  |                   |        |                  
|Equity investment in Pharmacy Joint Venture                  |  | $                 | 3,636  |                   |  | $ | 3,373 | 
|Debt service reserves (amounts on deposit with a
    lender) |  |                   | 8,610  |                   |  |   |      | 
|Restricted cash                                              |  |                   | 4,512  |                   |  |   |      | 
|Deposits                                                     |  |                   | 2,695  |                   |  |   | 3,153 | 
|                                                             |  |                   |        |                   |  |   |       | 
|                                                             |  |                   | 19,453 |                   |  |   | 6,526 | 
|Less current portion                                         |  |                   | 6,535  |                   |  |   |      | 
|                                                             |  |                   |        |                   |  |   |       | 
|                                                             |  | $                 | 12,918 |                   |  | $ | 6,526 | 
|                                                             |  |                   |        |                   |  |   |       | 



| |                                                
| | -----------------------------------------------
| | Equity Investment in Pharmacy Joint
    Venture

The Company has a joint-venture relationship with
American Pharmaceutical Services, Inc. to service its
pharmaceutical needs for a limited number of its Texas
operations. The joint venture, a limited liability company, was
formed in 1995, and was funded through the contribution by the
Company of $1.5 million of cash, and the contribution by
American Pharmaceutical Services of $3.0 million of
tangible assets. Immediately after the formation and funding of
the joint venture, a distribution of $1.5 million in cash
was made to American Pharmaceutical Partners such that each of
the joint venture partners retained a 50% equity interest in the
partnership after the distribution. The joint venture operates a
pharmacy in Austin, Texas and the Company pays market value for
prescription drugs and receives a 50% share of the net income
related to

F-16



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

this joint-venture. Based on the Companys
lack of any controlling financial interest, the investment in
the joint-venture is accounted for under the equity method of
accounting.



| |                      
| | ---------------------
| | Debt Service Reserves

In connection with the Senior Mortgage Term Loan,
the Company is required to maintain reserves on deposit with the
lender. At December 31, 2003 the following amounts were on
reserve: $2.0 million for general insurance,
$1.4 million for property insurance and taxes,
$1.2 million for professional liability reserves,
$1.0 million for deferred maintenance and improvements,
$0.6 million for workers compensation costs, and
$2.4 million for debt service coverage in the event of
default.



| |                
| | ---------------
| | Restricted Cash

In August 2003, the Company formed Fountain View
Reinsurance, Ltd., (the captive) a wholly owned
off-shore captive for the purposes of insuring its workers
compensation liability in California. In connection with the
formation of this subsidiary, the Company funded the captive
with approximately $4.5 million.



| |         
| | --------
| | Deposits

In the normal course of business the Company is
required to post security deposits with respect to its our
leased properties and to many of the vendors with which it
conducts business.

8.     Reversal of
Charge Related to Decertification of a Facility

In November 1999, one of the Companys SNFs
was decertified from the Medicare and Medicaid Programs as a
result of surveys conducted by the California Department of
Health Services. In December 2000, the Company obtained new
provider agreements from both the Medicare and Medicaid
Programs. During the period through December 2000, the Company
recorded a charge relating to this decertification totaling
approximately $4,865,000. The Company appealed this
decertification with a Federal Government Administrative Law
Judge and filed a claim against the State of California.

In November 2002, a settlement was reached to
provide for an earlier recertification of the facility and a
recovery of uncompensated care in the amount totaling
approximately $3.1 million. A Bankruptcy Court order
approving the settlement agreement was entered in December 2002.
Due to the on-going contingency related to the payment of these
services the Company did not record the reversal of the charge
until the cash was received. Of the amount settled, a total of
approximately $2.7 million has been received through
December 31, 2003.



|   |                       
|-- | ----------------------
|9. | Property and Equipment

Property and equipment is comprised of the
following at December 31, 2003 and 2002 (in thousands):

|                                               |                                      |                   |         |                   |  |   |         |         | 
|---------------------------------------------- | ------------------------------------ | ----------------- | ------- | ----------------- |  | - | ------- | ------- | 
|                                               |                                      | December 31, 2003 |         | December 31, 2002
|                                               |                                      |                   |         |                  
|Property and equipment, at cost:               |                                      |                   |         |                   |  |   |         |        
|                                               | Land and land improvements           |                   | $       | 18,501            |  |   | $       | 17,558  | 
|                                               | Buildings and leasehold improvements |                   |         | 170,052           |  |   |         | 156,220 | 
|                                               | Furniture and equipment              |                   |         | 30,202            |  |   |         | 27,924  | 
|                                               | Construction in progress             |                   |         | 1,210             |  |   |         | 587     | 
|                                               |                                      |                   |         |                   |  |   |         |        
|                                               |                                      |                   | 219,965 |                   |  |   | 202,289 |        
|Less accumulated depreciation and amortization |                                      |                   | (62,385 | )                 |  |   | (54,488 | )      
|                                               |                                      |                   |         |                   |  |   |         |        
|                                               |                                      | $                 | 157,580 |                   |  | $ | 147,801 |        
|                                               |                                      |                   |         |                   |  |   |         |        



| |               
| | --------------
| | Capital Leases

Property and equipment includes
$13.3 million related to land and building for the lease of
five facilities that have been capitalized.

F-17



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |             
|--- | ------------
|10. | Income Taxes

The provision for (benefit from) income taxes
consists of the following (in thousands):

|         |          |                        |      |      |   |      |     |     |  |   |         |         |  
|-------- | -------- | ---------------------- | ---- | ---- | - | ---- | --- | --- |  | - | ------- | ------- | -
|         |          |                       
|         |          | Year Ended December 31
|         |          |                       
|         |          | 2003                   |      | 2002 |   | 2001
|         |          |                        |      |      |   |     
|Federal: |          |                        |      |      |   |      |     |     |  |   |         |        
|         | Current  |                        | $    |     |   |      | $   | 9   |  |   | $       | (406    | )
|         | Deferred |                        |      |     |   |      |     |    |  |   |         | (16,908 | )
|State:   |          |                        |      |      |   |      |     |     |  |   |         |        
|         | Current  |                        |      | (414 | ) |      |     | 739 |  |   |         | (347    | )
|         | Deferred |                        |      |     |   |      |     |    |  |   |         | (2,870  | )
|         |          |                        |      |      |   |      |     |     |  |   |         |        
|         |          | $                      | (414 | )    |   | $    | 748 |     |  | $ | (20,531 | )      
|         |          |                        |      |      |   |      |     |     |  |   |         |        

A reconciliation of the provision for (benefit
from) income taxes with the amount computed using the federal
statutory rate is as follows (in thousands):

|                                        |  |                        |        |      |  |      |     |   |  |   |         |  
|--------------------------------------- |  | ---------------------- | ------ | ---- |  | ---- | --- | - |  | - | ------- | -
|                                        |  |                       
|                                        |  | Year Ended December 31
|                                        |  |                       
|                                        |  | 2003                   |        | 2002 |  | 2001
|                                        |  |                        |        |      |  |     
|Federal rate (35%)                      |  | $                      | (4,932 | )    |  | $    | 576 |   |  | $ | (53,433 | )
|State taxes, net of federal tax benefit |  |                        | (269   | )    |  |      | 61  |   |  |   | (2,091  | )
|Valuation allowance                     |  |                        | 5      |      |  |      | (5  | ) |  |   | 22,695  |  
|Goodwill                                |  |                        |       |      |  |      |    |   |  |   | 12,165  |  
|Preferred Stock, Series A dividends     |  |                        | 4,847  |      |  |      |    |   |  |   |        |  
|Other, net                              |  |                        | (65    | )    |  |      | 116 |   |  |   | 133     |  
|                                        |  |                        |        |      |  |      |     |   |  |   |         |  
|                                        |  | $                      | (414   | )    |  | $    | 748 |   |  | $ | (20,531 | )
|                                        |  |                        |        |      |  |      |     |   |  |   |         |  

Deferred income taxes result from temporary
differences between the tax basis of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. Temporary differences are primarily attributable to
reporting for income tax purposes the excess of book over tax
depreciation due to purchase accounting adjustments, allowance
for uncollectible accounts, accrued expenses and accrued
vacation benefits.

F-18



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Significant components of the Companys
deferred tax assets and liabilities are as follows (in
thousands):

|                                      |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |        |  
|------------------------------------- | ------------------------------------ | ----------- | ------- | ----------- | - | ------- | ------- | ----------- | - | - | ------- | ------ | - | - | ------- | ------ | -
|                                      |                                      |            
|                                      |                                      | December 31
|                                      |                                      |            
|                                      |                                      |             |         |            
|                                      |                                      | 2003        |         | 2002       
|                                      |                                      |             |         |            
|                                      |                                      | Current     |         | Non-Current |   | Current |         | Non-Current
|                                      |                                      |             |         |             |   |         |         |            
|Deferred tax assets:                  |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |       
|                                      | Vacation and other accrued expenses  |             | $       | 3,120       |   |         |         |            |   |   | $       | 8,026  |   |   | $       |       |  
|                                      | Allowance for uncollectible accounts |             |         | 4,736       |   |         |         |            |   |   |         | 7,659  |   |   |         |       |  
|                                      | Professional liability accrual       |             |         | 10,659      |   |         |         |            |   |   |         | 8,368  |   |   |         |       |  
|                                      | Net operating loss carryforward      |             |         | 5,612       |   |         |         |            |   |   |         | 318    |   |   |         |       |  
|                                      | Other                                |             |         | 34          |   |         |         | 20,357      |   |   |         | 961    |   |   |         | 18,979 |  
|                                      |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |       
|Total deferred tax assets             |                                      |             | 24,161  |             |   |         | 20,357  |             |   |   | 25,332  |        |   |   | 18,979  |       
|Deferred tax liabilities:             |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |       
|                                      | Tax over book depreciation           |             |         |            |   |         |         | (8,625      | ) |   |         |       |   |   |         | (9,376 | )
|                                      | Step-up of assets acquired           |             |         |            |   |         |         | (2,900      | ) |   |         |       |   |   |         | (3,214 | )
|                                      | Other                                |             |         | (145        | ) |         |         | (1,053      | ) |   |         | (1,230 | ) |   |         | (289   | )
|                                      |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |       
|Total deferred tax liabilities        |                                      |             | (145    | )           |   |         | (12,578 | )           |   |   | (1,230  | )      |   |   | (12,879 | )     
|                                      |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |       
|Net deferred tax assets (liabilities) |                                      |             | 24,016  |             |   |         | 7,779   |             |   |   | 24,102  |        |   |   | 6,100   |       
|Valuation allowance                   |                                      |             | (24,016 | )           |   |         | (7,779  | )           |   |   | (24,102 | )      |   |   | (6,100  | )     
|                                      |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |       
|Net deferred tax assets (liabilities) |                                      | $           |        |             |   | $       |        |             |   | $ |        |        |   | $ |        |       
|                                      |                                      |             |         |             |   |         |         |             |   |   |         |        |   |   |         |       

As of December 31, 2003, the Company has
federal net operating loss carryforwards of approximately
$14.7 million, which begin to expire in 2012. The Company
also has federal general business tax credit
(GBC) carryforwards of approximately $1.7 million that
begin to expire in 2012. Current California state law suspends
the use of NOL carryforwards for tax years 2002 and 2003. As
such, the Company was not able to utilize the existing state NOL
carryforwards to offset taxable income generated in 2002 with
respect to income taxes due in California. This suspension will
not apply to tax years beginning on or after 2004. The change in
valuation allowance of $1.6 million is attributable to
increases in deferred tax assets primarily related to loss
carryforwards.

Utilization of the net operating loss may be
subject to an annual limitation due to ownership change
constraints set forth under Internal Revenue Code
Section 382 and similar state tax provisions.



|    |                     
|--- | --------------------
|11. | Shareholders Equity



| |                                           
| | ------------------------------------------
| | Mandatorily Redeemable Preferred
    Stock

The Companys series A preferred stock is
subject to mandatory redemption by the Company upon the earlier
of (i) an underwritten initial public offering of the
Companys common stock for cash pursuant to a registration
statement filed under the Securities Act of 1933, as amended or
(ii) May 1, 2010. The series A preferred stock is also
redeemable by the Company, out of funds legally available
therefore, at the option of the Company at any time by payment
of the per share Base Amount plus all unpaid dividends accrued
on such shares. The Base Amount is initially equal to $1,000 per
share of series A preferred stock, provided that any dividends
that have accrued but are not paid on March 31 of each year
are automatically added to the Base Amount. The series A
preferred stock entitles the holder to a dividend at an annual
rate of 12% of the Base Amount of each share of series A
preferred stock from the date of issuance of such share,
provided that all outstanding shares of series A preferred stock
are deemed to have been issued as of March 27, 1998 for
purposes of determining the amount of dividends that have
accrued. As of December 31, 2003, the aggregate

F-19



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Base Amount of the series A preferred stock was
$15.0 million and there was approximately
$13.8 million of undeclared and unpaid dividends on the
series A preferred stock, which has been accrued as interest
expense under FSAS 150 Statement.

Pursuant to the Company Plan, the Company issued
new shares of series A preferred stock in exchange for existing
shares of series A preferred stock. The holders of new shares of
series A preferred stock have substantially the same rights and
privileges as the holders of previously outstanding series A
preferred stock; provided that each share of new series A
preferred stock is entitled to one vote per share and is
entitled, except as otherwise required by law to vote together
with our common stock on all matters put before our stockholders.



| |             
| | ------------
| | Common Stock

In 1998, the Company issued 1,000,000 shares of
series A common stock, 114,202 shares of series B
common stock and 20,742 shares of series C common stock.

Pursuant to the Companys Plan, each share
of series A common stock was cancelled and replaced with 1.1142
shares of new common stock, each share of series B common stock
was cancelled for no consideration and each share of series C
common stock was replaced with one share of new common stock.



| |         
| | --------
| | Warrants

In 1998, the Company issued 71,119 warrants to
purchase the Companys Series C Common Stock at an
exercise price of $.01 per share. The warrants were exercisable
beginning April 16, 1998, and expired in April 2008. During
2003 and 2002, no warrants were exercised.

Pursuant to the Companys Plan, the
Companys outstanding warrants of 50,377 were cancelled and
replaced with an equivalent number of new warrants to purchase
common stock. Other than the security for which the warrant may
be exercised, the terms of the new warrants are substantially
similar to the terms of the cancelled warrants.



| |              
| | -------------
| | Stock Options

In 1998, the Company adopted a stock option plan
which provided for the grant of stock options to certain
directors, employees and consultants of the Company to purchase
up to 49,388 shares of series C common stock. At December 31,
2002, a total of 39,226 options had been granted to employees
and consultants of the Company. Out of the 39,226 options
granted, 12,422 and 9,996 options were cancelled in 2002 and
2001, respectively, leaving a total of 11,062 options
outstanding at December 31, 2002.

In August 2003, the Companys Plan cancelled
all options to purchase the Companys series C common stock
without consideration.



|    |                              
|--- | -----------------------------
|12. | Commitments and Contingencies



| |       
| | ------
| | Leases

The Company leases certain of its facilities
under noncancelable operating leases. The leases generally
provide for payment of property taxes, insurance and repairs,
and have rent escalation clauses, principally based upon the
Consumer Price Index or other fixed annual adjustments.

F-20



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The future minimum rental payments under
noncancelable operating leases that have initial or remaining
lease terms in excess of one year as of December 31, 2003,
are as follows (in thousands):

|           |  |         |        |       |  |       |        |  |  |   |        | 
|---------- |  | ------- | ------ | ----- |  | ----- | ------ |  |  | - | ------ | 
|           |  | Related |        |       |  |      
|           |  | Party   |        | Other |  | Total
|           |  |         |        |       |  |      
|2004       |  | $       | 2,077  |       |  | $     | 5,084  |  |  | $ | 7,161  | 
|2005       |  |         | 2,077  |       |  |       | 4,076  |  |  |   | 6,153  | 
|2006       |  |         | 2,077  |       |  |       | 3,903  |  |  |   | 5,980  | 
|2007       |  |         | 2,077  |       |  |       | 3,742  |  |  |   | 5,819  | 
|2008       |  |         | 2,077  |       |  |       | 3,562  |  |  |   | 5,639  | 
|Thereafter |  |         | 17,824 |       |  |       | 18,915 |  |  |   | 36,739 | 
|           |  |         |        |       |  |       |        |  |  |   |        | 
|           |  | $       | 28,209 |       |  | $     | 39,282 |  |  | $ | 67,491 | 
|           |  |         |        |       |  |       |        |  |  |   |        | 



| |           
| | ----------
| | Litigation

As is typical in the health care industry, the
Company has experienced an increasing trend in the number and
severity of litigation claims asserted against the Company. In
addition, there has been an increase in governmental
investigations of long-term care providers. While the Company
believes that it provides quality care to its patients and is in
compliance with regulatory requirements, a legal judgment or
adverse governmental investigation could have a material
negative effect on the Company.

During the pendency of the Companys
petition for protection of creditors under Chapter 11 of
the United States Bankruptcy Code, all litigation matters
brought against the Company were stayed by the Bankruptcy Court.
Matters that were resolved during the pendency of the petition
were subject to compromise in the bankruptcy proceedings.

At various times prior to July 31, 2002, the
Texas Department of Human Services (TDHS) conducted several
surveys of certain of the Companys facilities in Texas. As
a result of these surveys, TDHS assessed civil monetary
penalties against the Company totaling approximately
$1.0 million and in some cases withdrew approval of its
Nurse Aide Training and Competency Evaluation Program (NATCEP),
for alleged licensure violations. The Company filed an appeal of
the imposition of each of the above referenced sanctions. On
April 14, 2003, the parties reached an agreement, which
settled the matter for approximately $0.3 million. The
amount was accrued in the Companys consolidated financial
statements as of December 31, 2002. Pursuant to the
agreement, the amount is payable in equal monthly installments
over a period of twelve months beginning on July 23, 2003.
Interest at a rate of ten percent will begin to accrue on any
outstanding balance thirty days following the due date of the
first payment. The remaining payments of $0.2 million are
accrued in the Companys consolidated financial statements
as of December 31, 2003.

The Company follows the provision of Statement of
Financial Accounting Standards No. 5 (SFAS No. 5),
Accounting for Contingencies. SFAS No. 5 requires
that an estimated loss from a loss contingency be accrued for by
a charge to income if its both probable that an asset has been
impaired or that a liability has been incurred and that the
amount of the loss can be reasonably estimated.



| |          
| | ---------
| | Insurance

We maintain insurance for general and
professional liability, workers compensation and
employers liability, employee benefits liability,
property, casualty, directors and officers, inland marine,
crime, boiler and machinery, automobile, employment practices
liability, earthquake and flood, We believe that our insurance
programs are adequate and where there has been a direct transfer
of risk to the insurance carrier, we do not recognize a
liability in our consolidated financial statements.

F-21



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                      
| | ---------------------
| | Workers Compensation

Our Texas operations have medical only coverage
and an excess employers liability policy with a $1,000,000
per occurrence self-insured retention. Our California operations
have a fully insured high-deductible workers compensation
policy with a $500,000 per occurrence deductible.



| |                                       
| | --------------------------------------
| | General and Professional
    Liability

Our skilled nursing services subject us to
certain liability risks. Malpractice claims may be asserted
against us if our services are alleged to have resulted in
patient injury or other adverse effects, the risk of which is
greater for higher-acuity patients, such as those receiving
specialty and sub-acute services, than for traditional long-term
care patients. We have from time to time been subject to
malpractice claims and other litigation in the ordinary course
of business.

Effective April 10, 2001, we obtained a
retrospectively rated claims-made policy with a self-insured
retention of $250,000 for our California and Arizona facilities
and $1,000,000 for our Texas facilities. Each facility has an
occurrence and aggregate coverage limit of $4,000,000 and
$5,000,000, respectively, and our overall company-wide aggregate
coverage limit is $5,000,000. We do not carry any excess general
and professional liability insurance coverage.

Additional insurance for periods prior to
April 10, 2001 is provided through a claims-made umbrella
policy with limits of $15,000,000 per occurrence and in the
aggregate for the period March 1, 1999 to March 1,
2000 and $25,000,000 per occurrence and in the aggregate for the
policy period March 1, 2000 to April 10, 2001 over
primary general and professional liability policies. Coverage
was extended for all incidents occurring from March 1, 2000
to April 10, 2001, under the March 1, 2000 policy,
through June 9, 2003. This extension takes us beyond the
statute of limitations in all applicable jurisdictions for any
incident occurring prior to April 10, 2001.

Our liabilities for professional and
workers compensation risks are estimated by our
independent actuaries quarterly and semi-annually, respectively,
using the most recent trends of claims, settlements and other
relevant data. Our liabilities have been estimated on an
undiscounted basis. We believe adequate provision has been made
in the financial statements for liabilities that may arise out
of patient care and compensable employee injuries.



| |                         
| | ------------------------
| | Hallmark Indemnification

Hallmark Therapy Group, LLC (Hallmark), the
Companys wholly owned rehabilitation services subsidiary,
provides physical, occupational and speech therapy services to
various unaffiliated skilled nursing facilities. These skilled
nursing facilities are reimbursed for these services from the
Medicare Program and other third party payors. Hallmark has
indemnified these skilled nursing facilities from certain
disallowances of these services. The accompanying financial
statements do not include an estimate of these potential
disallowances as management has concluded that they are not
determinable.

13.     Material
Transactions with Related Entities



| |                  
| | -----------------
| | Leased Facilities

Our former Chief Executive Officer and current
director, and his wife, a former Executive Vice President of the
Company, own the real estate for four of the Companys
leased facilities. Such real estate has not been included in the
financial statements for any of the years presented herein.
Lease payments to these related parties under operating leases
for these facilities for the years ended December 31, 2003,
2002 and 2001 were $1.8 million, $1.9 million and $1.9
million, respectively.

F-22



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                       
| | ----------------------
| | Medical Supply Company

Our former Executive Vice President, who is also
the wife of the Companys former Chief Executive Officer
and current director, owned approximately 33% of a medical
supply company that provides medical supplies and equipment to
the Company pursuant to a supply contract. In May 2003, this
ownership interest was fully divested. As part of our on-going
effort to review and renegotiate all of its material executory
contracts during the reorganization proceeding, the agreement
was amended, first in September 2002 and subsequently in April
2003. The agreement, as amended, provides for an approximately
5% price reduction on medical supplies and equipment, effective
through April 30, 2008. Billings for medical supplies from
this related company for the years ended December 31, 2003,
2002 and 2001 were $5.5 million $4.5 million and $4.9
million, respectively. We believe that the terms of this supply
agreement are at least as favorable to the us as could be
obtained from third parties in an arms length transaction.



| |                 
| | ----------------
| | Notes Receivable

We have a limited recourse promissory note
receivable from the Chairman of the Board of Directors in the
amount of approximately $2.5 million with an interest rate
of 5.7%. The Note is due on the earlier of April 15, 2007
or the sale by the Chairman of 20,000 shares of our common stock
pledged as security for the note. We have recourse for payment
up to $1.0 million of the principal amount of the note.

In September 2002, we extended a limited recourse
loan in the principal amount up to $0.5 million to our
Chief Executive Officer. The note, which was secured by a deed
of trust on the residential property of the Chief Executive
Officer, bore interest at a rate of 8.0% per annum and required
monthly payments payable on the first day of each month
beginning on the first day of October 2002. The entire principal
balance of the note together with the accrued interest thereon
was due and payable on the earlier of December 1, 2003 or
upon the sale of the property securing the loan. In October
2003, the outstanding principal and interest on the loan was
paid in full.



|    |                          
|--- | -------------------------
|14. | Defined Contribution Plan

As of December 31, 2003, the Company
sponsored a defined contribution plan covering substantially all
employees who meet certain eligibility requirements. The company
does not contribute to this plan.

F-23



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                                
|--- | -----------------------------------------------
|15. | Quarterly Financial Information
    (unaudited)

The following table summarizes unaudited
financial data for the year ended December 31, 2003 and
2002 (in thousands):

|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------ |  | ------------------- | ------ | -------- |  | ------------- | ------ | ------------ |  | - | ------- | - |  | - | ------ | -
|                                                                         |  |                    
|                                                                         |  | Three Months Ended,
|                                                                         |  |                    
|                                                                         |  | March 31,           |        | June 30, |  | September 30, |        | December 31,
|                                                                         |  |                     |        |          |  |               |        |             
|Year ended December 31, 2003:                                            |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Net operating revenue                                                    |  | $                   | 85,101 |          |  | $             | 86,239 |              |  | $ | 90,584  |   |  | $ | 97,365 |  
|Total costs and expenses                                                 |  |                     | 82,311 |          |  |               | 82,608 |              |  |   | 88,476  |   |  |   | 92,376 |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Income (loss) from continuing operations                                 |  |                     | 2,790  |          |  |               | 3,631  |              |  |   | 2,108   |   |  |   | 4,989  |  
|Other expenses                                                           |  |                     | 2,404  |          |  |               | 1,074  |              |  |   | 9,658   |   |  |   | 2,213  |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Income (loss) before income taxes and change in
    accounting principle |  |                     | 386    |          |  |               | 2,557  |              |  |   | (7,550  | ) |  |   | 2,776  |  
|Income tax provision (benefit)                                           |  |                     |       |          |  |               |       |              |  |   |        |   |  |   | (414   | )
|Cumulative effect of change in accounting
    principle                  |  |                     |       |          |  |               |       |              |  |   | 12,261  |   |  |   |       |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Net income (loss)                                                        |  | $                   | 386    |          |  | $             | 2,557  |              |  | $ | (19,811 | ) |  | $ | 3,190  |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Year ended December 31, 2002:                                            |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Net operating revenue                                                    |  | $                   | 80,672 |          |  | $             | 86,901 |              |  | $ | 87,249  |   |  | $ | 86,725 |  
|Total costs and expenses                                                 |  |                     | 78,789 |          |  |               | 82,646 |              |  |   | 83,214  |   |  |   | 82,948 |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Income (loss) from continuing operations                                 |  |                     | 1,883  |          |  |               | 4,255  |              |  |   | 4,035   |   |  |   | 3,777  |  
|Other expenses                                                           |  |                     | 3,385  |          |  |               | 2,913  |              |  |   | 2,548   |   |  |   | 3,458  |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Income (loss) before income taxes                                        |  |                     | (1,502 | )        |  |               | 1,342  |              |  |   | 1,487   |   |  |   | 319    |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  
|Income tax provision (benefit)                                           |  |                     | (683   | )        |  |               | 610    |              |  |   | 676     |   |  |   | 145    |  
|Net income (loss)                                                        |  | $                   | (819   | )        |  | $             | 732    |              |  | $ | 811     |   |  | $ | 174    |  
|                                                                         |  |                     |        |          |  |               |        |              |  |   |         |   |  |   |        |  



|    |                  
|--- | -----------------
|16. | Subsequent Events

The Company entered into restricted stock
agreements with each of Messrs. Hendrickson, Lynch, Harrison and
Rapp, effective March 8, 2004, concurrent with the
execution of the amended employment agreements for each
executive. Pursuant to these agreements we granted shares of our
restricted and non-voting Class B common stock for a
purchase price of $0.05 per share to these executives in the
following amounts:

|                 |  |           |        | 
|---------------- |  | --------- | ------ | 
|                 |  | Number of
|                 |  | Shares   
|                 |  |          
|Boyd Hendrickson |  |           | 39,439 | 
|Jose Lynch       |  |           | 19,719 | 
|John Harrison    |  |           | 4,930  | 
|Roland Rapp      |  |           | 6,573  | 

These shares of Class B common stock are
restricted by certain vesting requirements, rights of the
Company to repurchase the shares, and restrictions on the sale
or transfer of such shares. All such restrictions will lapse in
full upon the occurrence of a Trigger Event, as defined above
under Employment Agreements. Our board of directors
may also elect at any time to remove any or all of these
restrictions.

F-24



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##### Table of Contents



SKILLED HEALTHCARE GROUP, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Vesting.Under each
agreement, the shares Class B common stock are unvested and
will vest in full upon a Trigger Event. Upon termination of the
executives employment by reason of death or disability or
termination by the Company without cause, as these terms are
defined in the agreements, the shares will vest in the amount of
approximately 40-50%, depending on the executive, of the
executives granted shares, plus an additional amount for
each full month elapse between the grant date of March 8,
2004 and the date of termination, not to exceed the number of
shares granted to the executive.

If a Trigger Event has not occurred by the end of
the original term of the amended employment agreement for each
executive and the executive is still employed by the Company,
50% of his shares will vest if the executive has complied with
the confidentiality and non-solicitation obligations in his
amended employment agreement and the Company has met certain
financial performance targets. In the event there is a
termination of employment after the term of the executives
amended and restated employment agreement and 50% of his shares
of Class B common have vested, the executive has the right
to require the Company to repurchase such vested shares at fair
market value upon written request within 12 months after
the date of his termination. Immediately prior to an IPO, any
such right will expired to the extent not exercised.

If a trigger event occurs within nine months
following the termination of the executives employment for
death or disability or termination by the Company without cause,
or within nine months following the term of employment under his
amended employment agreement, additional shares of his
Class B common stock will vest in a number so that his
vested shares will equal the amount of shares granted. The
executive will not have the right to require the Company to
purchase any of his shares of Class B common stock that
vests as a result of such a Trigger Event.

Repurchase Rights.Under each agreement, the Company will
have the right to repurchase at fair market value all vested
shares of Class B common stock held by
Messrs. Hendrickson, Lynch, Harrison and Rapp upon
termination of his employment for death or disability or by the
Company without cause during the term of his amended employment
agreement, or upon termination of his employment for any reason
after the term of his amended employment agreement. This
repurchase right by the Company will terminate immediately prior
to an IPO to the such right has not been exercised.

If the Company has repurchased any of the
executives vested Class B common shares and
additional shares held by the executive vests upon the
occurrence of a Trigger Event within nine months following the
termination of the executives employment for death or
disability or termination by the Company without cause, or
within nine months following the term of employment under his
amended employment agreement, the Company will pay the executive
to repurchase such additional shares for fair market value. The
Company may also purchase any unvested shares of Class B
common stock from the executive upon termination of his
employment for the lesser of $0.05 per share, the price he
initially paid for the shares, or the fair market value of the
shares at the time of repurchase.

We will not have the right to repurchase any
shares of Class B common stock that vest in connection with
a Trigger Event. However, if the terminal equity value of the
Company, as such term is defined in the agreements, is less than
$100 million upon the occurrence of a trigger event, the
Company will have the right to purchase all vested and unvested
shares of the Class B common stock from the executive for
the lesser of $0.05 per share, the price he initially paid for
the shares, or the fair market value of the shares at the time
of repurchase.

The restricted stock for which vesting is
contingent upon the occurrence of certain event or the achieving
of certain levels of financial performance by the Company will
require variable accounting. As required by Statement of
Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensationand FASB Interpretation
No. 44, Accounting for Certain Transactions involving
Stock Compensation, the Company will account for the
difference between the purchase price and the estimated fair
value of the Companys Class B common stock as
estimated by the Companys management for financial
reporting purposes as stock-based compensation charges over the
period prior to the selling or cancellation of the restricted
stock which are expected to eventually vest.

F-25



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##### Table of Contents



SCHEDULE II  VALUATION
ACCOUNTS

SKILLED HEALTHCARE GROUP, INC.

December 31, 2003


|                             |  |                        |        |            |  |               |        |                |  |   |         |   |  |   |        | 
|---------------------------- |  | ---------------------- | ------ | ---------- |  | ------------- | ------ | -------------- |  | - | ------- | - |  | - | ------ | 
|                             |  | Balance at             |        | Charged to |  |               |        |               
|                             |  | Beginning of           |        | Costs and  |  |               |        | Balance at End
|                             |  | Period                 |        | Expenses   |  | Deductions(1) |        | of Period     
|                             |  |                        |        |            |  |               |        |               
|                             |  |                       
|                             |  | (Dollars in thousands)
|Accounts receivable          |  |                        |        |            |  |               |        |                |  |   |         |   |  |   |        | 
|Year Ended December 31, 2003 |  | $                      | 17,315 |            |  | $             | 3,559  |                |  | $ | (10,841 | ) |  | $ | 10,033 | 
|Year Ended December 31, 2002 |  | $                      | 24,789 |            |  | $             | 3,960  |                |  | $ | (11,434 | ) |  | $ | 17,315 | 
|Year Ended December 31, 2001 |  | $                      | 9,961  |            |  | $             | 20,006 |                |  | $ | (5,178  | ) |  | $ | 24,789 | 
|Notes receivable             |  |                        |        |            |  |               |        |                |  |   |         |   |  |   |        | 
|Year Ended December 31, 2003 |  | $                      | 2,035  |            |  | $             | (188   | )              |  |   |        |   |  | $ | 1,847  | 
|Year Ended December 31, 2002 |  | $                      | 1,880  |            |  | $             | 155    |                |  |   |        |   |  | $ | 2,035  | 
|Year Ended December 31, 2001 |  | $                      | 697    |            |  | $             | 1,183  |                |  |   |        |   |  | $ | 1,880  | 



---



|    |                                                           
|--- | ----------------------------------------------------------
|(1) | Uncollectible accounts written off, net of
    recoveries.

F-26



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##### Table of Contents



INDEX OF EXHIBITS

|        |       |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                     
|------- | ----- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 2.1   |             |  | Debtors Third Amended Joint Plan of
    Reorganization(1)                                                                                                                                                                                                                                                                                                                                                          
|        | 2.2   |             |  | Debtors Disclosure Statement(1)                                                                                                                                                                                                                                                                                                                                                                                    
|        | 3.1   |             |  | Restated Certificate of Incorporation                                                                                                                                                                                                                                                                                                                                                                               
|        | 3.2   |             |  | Bylaws(2)                                                                                                                                                                                                                                                                                                                                                                                                           
|        | 4.1   |             |  | Indenture dated as of August 19, 2003 among
    the Company, the Guarantors (as defined therein) and U.S. Bank
    National Association(3)                                                                                                                                                                                                                                                                          
|        | 4.2   |             |  | Amended and Restated Stockholders Agreement(3)                                                                                                                                                                                                                                                                                                                                                                      
|        | 4.3   |             |  | Amendment No. 1 to Amended and Restated
    Stockholders Agreement(3)                                                                                                                                                                                                                                                                                                                                               
|        | 4.4.1 |             |  | Form of New Common Stock Certificate(3)                                                                                                                                                                                                                                                                                                                                                                             
|        | 4.4.2 |             |  | Form of New Series A Preferred Stock
    Certificate(3)                                                                                                                                                                                                                                                                                                                                                             
|        | 4.5   |             |  | Form of Warrant to Purchase Common Stock(3)                                                                                                                                                                                                                                                                                                                                                                         
|        | 10.1  |             |  | Revolving Credit and Security Agreement among the
    Subsidiary Borrowers listed on Schedule 1 annexed thereto
    and the Company, as borrowers, and CapitalSource Finance LLC, as
    administrative agent and collateral agent(3)                                                                                                                                                                               
|        | 10.2  |             |  | $20,000,000 Revolving Note dated as of
    August 19, 2003 made by the Company and the companies
    listed on the signature page thereto in favor of CapitalSource
    Finance LLC, as administrative agent and collateral agent(3)                                                                                                                                                                                
|        | 10.3  |             |  | $1,000,000 Revolving Note dated as of
    August 19, 2003 ,made by the Company and the companies
    listed on the signature page thereto in favor of CapitalSource
    Finance LLC, as administrative agent and collateral agent(3)                                                                                                                                                                                
|        | 10.4  |             |  | Revolving Credit and Security Agreement among the
    Borrowers listed on Schedule 1 annexed thereto, as
    borrowers, and CapitalSource Finance LLC, as administrative
    agent and collateral agent for Lenders, and Lenders party
    thereto(3)                                                                                                                                                               
|        | 10.5  |             |  | $11,000,000 Revolving Note dated as of
    August 19, 2003 made by the companies listed on the
    signature page thereto in favor of CapitalSource Finance LLC, as
    administrative agent and collateral agent(3)                                                                                                                                                                                                
|        | 10.6  |             |  | Loan Agreement dated as of August 19, 2003
    between the entities listed on Schedule I annexed thereto,
    as Borrower, and Column Financial, Inc., as Lender(3)                                                                                                                                                                                                                                                 
|        | 10.7  |             |  | $85,000,000 Promissory Note A dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                          
|        | 10.8  |             |  | $5,000,000 Promissory Note B-1 dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                         
|        | 10.9  |             |  | $2,500,000 Promissory Note B-2 dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                         
|        | 10.10 |             |  | $2,500,000 Promissory Note B-3 dated
    August 19, 2003 made by each of the entities set forth on
    Schedule A annexed thereto in favor of Column Financial,
    Inc.(3)                                                                                                                                                                                                                                         
|        | 10.11 |             |  | Guaranty Agreement dated August 19, 2003 by
    the Company for the benefit of Column Financial, Inc.(3)                                                                                                                                                                                                                                                                                                            
|        | 10.12 |             |  | Mezzanine Loan Agreement dated as of
    August 19, 2003 between SHG Property Resources, LLC and SHG
    Investments, LLC, collectively, as Borrower, and CapitalSource
    Finance LLC, Fortress Credit Opportunities I, L.P. and
    Highbridge/Zwirn Special Opportunities Fund, L.P., collectively,
    as Lender, and CapitalSource Finance LLC, as administrative
    agent and collateral agent for Lender(3)
|        | 10.13 |             |  | $11,500,000 Promissory Note dated as of
    August 19, 2003 made by SHG Property Resources, LLC and SHG
    Investments, LLC in favor of CapitalSource Finance LLC(3)                                                                                                                                                                                                                                               
|        | 10.14 |             |  | $5,750,000 Promissory Note dated as of
    August 19, 2003 made by SHG Property Resources, LLC and SHG
    Investments, LLC in favor of Highbridge/Zwirn Special
    Opportunities Fund, L.P.(3)                                                                                                                                                                                                                    
|        | 10.15 |             |  | $5,750,000 Promissory Note dated as of
    August 19, 2003 made by SHG Property Resources, LLC and SHG
    Investments, LLC in favor of Fortress Credit
    Opportunities I, L.P.(3)                                                                                                                                                                                                                                



---



##### Table of Contents



|        |       |             |  |                                                                                                                                                                                                                                                                                                                                            
|------- | ----- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|Number  |       | Description
|        |       |            
|        | 10.16 |             |  | Pledge and Security Agreement dated
    August 19, 2003 by and among SHG Property Resources, LLC
    and SHG Investments, LLC, as Borrowers, Summit Care Corporation,
    Summit Care Texas, L.P., Summit Care Texas Management, LLC and
    Skilled Healthcare, LLC, as Pledgor Guarantors, and
    CapitalSource Finance LLC, as Agent(3)
|        | 10.17 |             |  | Environmental Indemnity Agreement dated
    August 19, 2003 by SHG Property Resources, LLC and SHG
    Investments, LLC, as Borrowers in favor of CapitalSource Finance
    LLC, as Agent(3)                                                                                                                                               
|        | 10.18 |             |  | Guaranty of Payment dated August 19, 2003 by
    the Company in favor of CapitalSource Finance LLC, as Agent(3)                                                                                                                                                                                                                            
|        | 10.19 |             |  | Guaranty of Payment (Pledgor) dated
    August 19, 2003 by Summit Care Corporation, Summit Care
    Texas, L.P., Summit Care Texas Management, LLC and Skilled
    Healthcare, LLC, as Pledgor Guarantors in favor of CapitalSource
    Finance LLC, as Agent(3)                                                                           
|        | 10.20 |             |  | Security Agreement dated August 19, 2003
    among the Company, those subsidiaries a party thereto and
    CapitalSource Finance LLC, as Agent(3)                                                                                                                                                                                          
|        | 10.21 |             |  | B Note Guaranty dated August 19, 2003 by the
    Company in favor of Column Financial, Inc.(3)                                                                                                                                                                                                                                             
|        | 10.22 |             |  | Amendment No. 1 to Revolving Credit and
    Security Agreement dated October 30, 2003 among the
    Subsidiary Borrowers signatory thereto, Skilled Healthcare
    Group, Inc. and CapitalSource Finance LLC, as administrative
    agent for Lenders, and Lenders party thereto(3)                                                        
|        | 10.23 |             |  | Amendment No. 1 to Revolving Credit and
    Security Agreement dated October 30, 2003 among the
    Borrowers signatory thereto and CapitalSource Finance LLC, as
    administrative agent and Agent for Lenders, and Lenders party
    thereto(3)                                                                                         
|        | 10.24 |             |  | Commercial Lease dated August 25, 2003
    between Matmel Enterprises, Inc. and the Company(3)                                                                                                                                                                                                                                             
|        | 10.25 |             |  | Skilled Healthcare Group, Inc. 2004 Equity
    Incentive Plan*                                                                                                                                                                                                                                                                             
|        | 31.1  |             |  | Certification of Chief Executive Officer of
    Skilled Healthcare Group, Inc., Pursuant to Section 302 of
    the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                             
|        | 31.2  |             |  | Certification of Chief Financial Officer of
    Skilled Healthcare Group, Inc., Pursuant to Section 302 of
    the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                             
|        | 32.1  |             |  | Certification of Chief Executive Officer and
    Chief Financial Officer of Skilled Healthcare Group, Inc.,
    Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                              



---



|    |                                                                                                                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Each of these exhibits is incorporated herein by
    reference to the Companys Form T-3 filed with the
    Securities and Exchange Commission on July 16, 2003.                                                   
|   
|(2) | Each of these exhibits is incorporated by
    reference to the Companys Registration Statement on
    Form S-4 (No. 333-57279) filed with the Securities and
    Exchange Commission on June 19, 1998, as amended.
|   
|(3) | Each of these exhibits is incorporated by
    reference to the Companys Report on Form 10-Q for the
    Quarter ended September 30, 2003.                                                                         



| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| | * | Management contract or compensatory plan,
    contract or arrangement required to be filed as an exhibit
    pursuant to Item 14(c) of Form 10-K.