SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002OR[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from                                    to                                    Commission file number          333-64679Harborside Healthcare CorporationDelaware(State or other jurisdiction of incorporation or organization)04-3307188(IRS employer identification no.) One Beacon Street, Boston, Massachusetts(Address of principal executive offices)02108(Zip Code)(617) 646-5400(Registrant's telephone number, including area code)Securities registered pursuant to Section 12 (b) of the Act:       NoneSecurities registered pursuant to Section 12 (g) of the Act:       None
* Harborside HealthcareCorporation is filing this report voluntarily in order to comply with Section4.02 of its Indenture dated May 10, 2001, among Harborside HealthcareCorporation and United States Trust Company of New York and is not required tofile this report pursuant to either Section 13 or 15(d) of the SecuritiesExchange Act of 1934 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes       No X     * (see explanatory note above)

Indicate by 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 statementsincorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ].  * (see explanatorynote above)

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes             NoX  * (see explanatory note above)

At March 30, 2003, theregistrant had 7,877,166 shares of all classes of Common Stock outstanding. 

Documents incorporated by reference:   None
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS                                           SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-K, including information setforth under the caption “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations”, constitute“Forward-Looking Statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995 (the “Reform Act”).Harborside Healthcare Corporation and its subsidiaries (the "Company") desiresto take advantage of certain “safe harbor” provisions of the ReformAct and is including this special note to enable the Company to do so.Forward-looking statements included in this Form 10-K, or hereafter included inother publicly available documents filed with the Securities and ExchangeCommission, reports to the Company's stockholders and other publicly availablestatements issued or released by the Company involve known and unknown risks,uncertainties, and other factors which could cause the Company’s actualresults, performance (financial or operating) or achievements to differmaterially from the future results, performance (financial or operating) orachievements expressed or implied by such forward-looking statements. TheCompany believes the following important factors could cause such a materialdifference to occur: 
1.   The occurrence of changes in the mix of payment sources utilized by the     Company's patients to pay for the Company's services.2.   The adoption of cost containment measures by private pay sources such as     commercial insurers and managed care organizations, as well as efforts by     governmental reimbursement sources to impose cost containment measures.3.   Changes in the United States healthcare system, including changes in     reimbursement levels and the method of reimbursement, under Medicaid and     Medicare, and other changes in applicable government regulations that might     affect the profitability of the Company.4.   The Company’s continued ability to operate in a heavily regulated     environment and to satisfy regulatory authorities, thereby avoiding a     number of potentially adverse consequences, such as the imposition of     fines, temporary suspension of admission of patients, restrictions on the     ability to acquire new facilities, suspension or decertification from     Medicaid or Medicare programs, and in extreme cases, revocation of a     facility’s license or the closure of a facility, including as a result     of unauthorized activities by employees.5.   The Company’s ability to secure the capital and the related cost of     such capital necessary to fund its future growth through acquisition and     development, as well as internal growth.6.   Changes in certificate of need laws that might increase competition in the     Company’s industry, including, particularly, in the states in which     the Company currently operates or anticipates operating in the future.7.   The Company’s ability to staff its facilities appropriately with     qualified healthcare personnel, including in times of shortages of such     personnel and to maintain a satisfactory relationship with labor unions.8.   The level of competition in the Company’s industry, including without     limitation, increased competition from acute care hospitals, providers of     assisted and independent living and providers of home healthcare and     changes in the regulatory system in the state in which the Company operates     that facilitate such competition.9.   The continued availability of insurance for the inherent risks of liability     in the healthcare industry.10.  Price increases in pharmaceuticals, durable medical equipment and other     items.11.  The Company’s reputation for delivering high-quality care and its     ability to attract and retain patients, including patients with relatively     high acuity levels.12.  Changes in general economic conditions, including changes that pressure     governmental reimbursement sources to reduce the amount and scope of     healthcare coverage.
The foregoing review ofsignificant factors should not be construed as exhaustive or as an admissionregarding the adequacy of disclosures previously made by the Company. 

Except as required by law,the Company undertakes no obligation to publicly update any forward lookingstatements, whether as a result of new information, future events or otherwise. 
                                       2TABLE OF CONTENTS                                                                                        PAGE                                                                                        -----                                     PART IITEM 1.  BUSINESS                                                                        4ITEM 2.  PROPERTIES                                                                      14ITEM 3.  LEGAL PROCEEDINGS                                                               15ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                             15                                     PART IIITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED         STOCKHOLDER MATTERS                                                             16ITEM 6.  SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA                              17ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL         CONDITION AND RESULTS OF OPERATIONS                                             19ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES         ABOUT MARKET RISK                                                               31ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                     31ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON         ACCOUNTING AND FINANCIAL DISCLOSURE                                             59                                    PART IIIITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                             59ITEM 11.  EXECUTIVE COMPENSATION                                                         61ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND           MANAGEMENT AND RELATED STOCKHOLDER MATTERS                                    64ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                 66ITEM 14.  CONTROLS AND PROCEDURES                                                        66                                     PART IVITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON           FORM 8-K                                                                      66SIGNATURES                                                                               73CERTIFICATIONS                                                                           74                                       3
**PART I**
**ITEM 1. BUSINESS**

**GENERAL OVERVIEW**
 Subsidiaries of Harborside Healthcare Corporation provide highquality long-term care, subacute care and other specialty medical services infour principal geographic regions: the Southeast (Florida), the Midwest (Ohioand Indiana), New England (Connecticut, Massachusetts, New Hampshire and RhodeIsland), and the Mid-Atlantic (New Jersey and Maryland). Within these regions,as of December 31, 2002, subsidiaries of Harborside Healthcare Corporationoperated 55 long-term care facilities (53 skilled nursing facilities, oneresidential care facility and one independent living facility). As of December31, 2002, these 55 facilities had licenses for 6,567 skilled nursing beds, 6assisted living beds, 115 residential care beds and 24 rest home beds, and alsooperated 49 independent living beds. One facility operated by a subsidiary ofHarborside Healthcare Corporation includes 115 of the licensed residential carebeds while another facility contains 49 independent living beds. Of the 55facilities operated by subsidiaries of Harborside Healthcare Corporation as ofDecember 31, 2002, 18 are owned, 36 are leased and one is managed. 

Subsidiaries of Harborside Healthcare Corporation (on aconsolidated basis, the “Company” or “Harborside”) providetraditional skilled nursing care, a wide range of subacute care programs (suchas orthopedic, CVA/stroke, cardiac, pulmonary and wound care), as well asprograms for the provision of care to Alzheimer's and hospice patients. As partof its subacute services, the Company provides physical, occupational and speechrehabilitation therapy services at Company-operated facilities. ThroughSeptember 1999, the Company also provided rehabilitation therapy services undercontracts with non-affiliated long-term care facilities through a wholly-ownedsubsidiary. During the third quarter of 1999, the Company terminated itscontracts with non-affiliated facilities and ceased providing therapy servicesto non-affiliated facilities. 

Harborside was formed inDelaware in March 1996, in anticipation of an initial public offering (the“IPO”), in order to combine under its control the operations ofvarious long-term care facilities and ancillary businesses (the“Predecessor Entities”) which had operated since 1988. The Companycompleted the IPO, on June 14, 1996 and issued 3,600,000 shares of common stockat $11.75 per share. Immediately prior to the IPO the owners of the PredecessorEntities contributed their interests in such Predecessor Entities to the Companyand received 4,400,000 shares of the Company’s common stock (the“Reorganization”). 

On April 15, 1998,Harborside entered into a Merger Agreement with HH Acquisition Corp.(“MergerCo”), an entity organized for the sole purpose of effecting amerger on behalf of Investcorp S.A., certain of its affiliates and certain otherinternational investors (the “New Investors”). On August 11, 1998,MergerCo merged with and into Harborside, with Harborside as the survivingcorporation. In the merger, each share not retained by existing shareholders wasconverted into $25 in cash, representing in the aggregate, cash payments ofapproximately $184 million. Holders of outstanding stock options of the Companyconverted the majority of their options into cash at $25 per underlying share(less applicable exercise price and withholding taxes) with aggregate paymentsof approximately $8 million. In connection with the transaction and prior to themerger, the New Investors made cash common equity contributions of $158.5million, net of issuance costs, to MergerCo, and MergerCo obtained grossproceeds of $99.5 million through the issuance of 11% Senior SubordinatedDiscount Notes (“Discount Notes”) due 2008 and $40 million through theissuance of 13.5% Exchangeable Preferred Stock (“Preferred Stock”)mandatorily redeemable in 2010. In the third quarter of 1998, Harborsiderecorded a charge to income from operations of $37 million for direct and othercosts related to the merger transaction. In connection with the merger and therelated refinancings, the Company exercised purchase options for sevenfacilities which had been financed through synthetic leases. As a result of thetransaction, and pursuant to the Merger Agreement, the New Investors acquiredapproximately 91% of the post-merger common stock of Harborside. The remaining9% of the common stock was retained by existing shareholders, includingmanagement. As a result of the merger, Harborside shares were de-listed from theNew York Stock Exchange. 

In March 2001, the Companyentered into an agreement (the “Restructuring Agreement”) withInvestcorp S.A. and the holders of more than a majority in interest of theCompany’s Discount Notes and Preferred Stock for purposes of implementing arestructuring of the Discount Notes and Preferred Stock. The RestructuringAgreement contemplated that the Company would offer to exchange for each $1,000amount at maturity of outstanding Discount Notes a combination of the following:(1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the“New Notes”) each having a principal amount at maturity equal to$1,000 and an original issue price of $685.67 (assuming that the New Notes wereissued on May 4, 2001), (2)  $88.2353 in cash and (3) common stockpurchase warrants for approximately 10.9 shares of its Class A CommonStock. The Company would also offer to exchange common stock purchase warrantsfor approximately 10.7 shares of its Class A Common Stock for each $1,000liquidation preference of Preferred Stock (based on the aggregate liquidationpreference to be outstanding on May 1, 2001) plus any dividends accrued on suchPreferred Stock after May 1, 2001. In conjunction with the restructuringproposal, the Company would solicit consents from holders of outstandingDiscount Notes and Preferred Stock to amendments to the Indenture governing theDiscount Notes and to the Certificate of Designation governing the PreferredStock that would eliminate or modify certain restrictive covenants and otherprovisions contained in the Indenture and the Certificate of Designation andwould substantially eliminate the preferences of the Preferred Stock, includingthe reduction of the liquidation preference from $1,000 to $0.01 per share andthe elimination of the right of holders to be paid dividends on shares ofPreferred Stock. Also, the Company would issue to Investcorp S.A. (or one ormore of its affiliates or designees) up to 15,000 shares of a new series of 13%convertible exchangeable preferred stock (the “New Preferred Stock”)and 1,854,422 common stock purchase warrants for a total purchase price of up to$15,000,000. 

On April 6, 2001 theCompany initiated the exchange offer and consent solicitation contemplated bythe Restructuring Agreement. On May 10, 2001, the Company completed the exchangeoffer and consent solicitation, thereby implementing each of the elements of theRestructuring Agreement. All of the outstanding Discount Notes and 99.96% of theshares of Preferred Stock were tendered and exchanged in the exchange offer. As
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a result of the exchange, (1) the Company had an aggregate principal amount atmaturity of $100,276,000 of New Notes outstanding and an aggregate liquidationpreference of $15,000,000 (as of May 10, 2001) of New Preferred Stockoutstanding, (2) warrants were issued to holders of Discount Notes, toholders of Preferred Stock, and to Investcorp S.A. representing the right topurchase an aggregate of approximately 15%, 5% and 15%, respectively, of thetotal number of shares of all classes of the Company’s common stock on afully diluted basis (excluding shares issuable upon conversion of the NewPreferred Stock, each share of which will initially be convertible into 150shares of Class A Common Stock), and (3) the Company paid $15,000,000in cash as partial consideration for the tendered Discount Notes. 

The reduction in theliquidation preference of the Preferred Stock was completed on May 10, 2001, ascontemplated by the Restructuring Agreement. The carrying amount of thePreferred Stock was reduced from $57,595,000 to $576, and the amount of thereduction, net of unamortized deferred financing costs related to the issuanceof the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directlytransferred to the Company’s Accumulated Deficit account. With the exchangeof the New Notes for the Discount Notes (the “Note Exchange”), thecarrying value of the accreted principal of the Discount Notes was reduced to$68,890,000, and the amount of the reduction, net of the aggregate cash paymentof $15,000,000, was directly transferred to the Company’s Long-term AccruedInterest account. Subsequent to their issuance, the carrying amount of the NewNotes increases as the result of accretion and results in a correspondingdecrease in the carrying amount of Long-term Accrued Interest. Interest expenseon the New Notes is recognized such that a constant effective interest rate isapplied to the aggregate carrying amount of the New Notes and Long-term AccruedInterest for all periods between the issuance date and the maturity date of theNew Notes. 

In connection with anamendment to the Company’s revolving credit facility (the “CreditFacility”) and the implementation of the Restructuring Agreement, theCompany incurred a non-recurring charge of $9,045,000. The charge resulted fromthe write-off of approximately $1,500,000 of unamortized deferred financingcosts incurred when the Credit Facility was obtained, the write-off ofapproximately $3,400,000 of unamortized deferred financing costs related to theissuance of the Discount Notes, and the recognition of various investmentadvisory, legal and other fees associated with these events of $4,145,000. 

The New Notes were issuedat a discount and interest on the New Notes accretes until August 1, 2004. Cashinterest payments will be paid semi-annually in arrears beginning on February 1,2005 based on the fully accreted value of the New Notes and a 12% cash interestpayment rate. The New Notes mature on August 1, 2007. The New Preferred Stock ismandatorily redeemable on February 1, 2008. The holders of the New PreferredStock are entitled to dividends quarterly in arrears beginning August 1, 2001and payable in additional shares of New Preferred Stock. Warrants to purchase atotal of 4,326,641 shares of common stock at $0.01 per share were issued on May10, 2001. 

PATIENT SERVICES

Basic Patient Services

Basic patient services arethose traditionally provided to elderly patients in long-term care facilities toassist with the activities of daily living and to provide general medical care.The Company provides 24-hour skilled nursing care by registered nurses, licensedpractical nurses and certified nursing aides in all of its skilled nursingfacilities. Each skilled nursing facility is managed by an on-site licensedadministrator who is responsible for the overall operation of the facility,including the quality of care provided. The medical needs of patients at theCompany’s licensed skilled nursing facilities are supervised by a medicaldirector, who is a licensed physician. Although treatment of patients is theresponsibility of their own attending physicians, who are not employed by theCompany, the medical director monitors all aspects of delivery of care. TheCompany also provides support services, including dietary services, therapeuticrecreational activities, social services, housekeeping and laundry services,pharmaceutical and medical supplies and routine rehabilitation therapy. 

Each skilled nursingfacility offers a number of individualized therapeutic activities designed toenhance the quality of life of its patients. These activities includeentertainment events, musical productions, trips, arts and crafts and volunteerand other programs that encourage community interaction. 

Specialty Medical Services

Specialty medical servicesare those provided to patients with medically complex needs, who generallyrequire more extensive treatment and a higher level of skilled nursing care.These services typically generate higher net patient service revenues perpatient day than basic patient services as a result of increased levels of careand the provision of ancillary services. 

Subacute Care. Subacutecare is goal-oriented, comprehensive care designed for an individual who has hadan acute illness, injury, or exacerbation of a disease process. Subacute care istypically rendered immediately after, or instead of, acute hospitalization inorder to treat one or more specific, active, complex medical conditions or inorder to administer one or more technically complex treatments. The Companyprovides subacute care services at all of its existing skilled nursingfacilities in such areas as complex medical, cardiac recovery, digestive,immuno-suppressed disease, post-surgical, wound, CVA/stroke care, hemodialysis,infusion therapy, and diabetes and pain management. 

In facilities that haveshown strong demand for subacute services, the Company has developed subacuteunits. Each unit contains 20 to 60 beds and is specially staffed and equippedfor the delivery of subacute care. Patients in these units typically requirehigh levels of nursing care and the services of physicians, therapists,dietitians, clinical pharmacists or psycho/social counselors. Certain patientsmay also require life support or monitoring equipment. Because patient goals aregenerally rehabilitation-oriented, lengths of stay in distinct subacute unitsare generally not expected to substantially exceed 30 days. 
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Alzheimer’s Care. TheCompany has also developed units that provide care for patients withAlzheimer’s disease. As of December 31, 2002, the Company operateddedicated Alzheimer’s units at eleven facilities. 

OPERATIONS

Facilities. Each of the Company's skilled nursingfacilities is supervised by a licensed facility administrator who is responsiblefor all aspects of the facility's operations. The facility administratoroversees (i) a director of nursing who supervises a staff of registered nurses,licensed practical nurses and certified nursing aides, (ii) a director ofadmissions who is responsible for developing local marketing strategies andprograms and (iii) various other departmental supervisors. The Company alsocontracts with one or more licensed physicians at each facility to serve asmedical directors for the purpose of supervising the medical management ofpatients. Facilities with subacute or specialty medical units or programs mayalso contract with physician specialists to serve as rehabilitation or specialtyprogram medical directors in areas such as physiatry (physical medicine),neurology or gero-psychology. Facilities may also employ or contract foradditional clinical staff such as nurse liaisons, case managers, therapists andprogram directors. Department supervisors at each of the Company's facilitiesoversee personnel who provide dietary, maintenance, laundry, housekeeping,therapy and social services. In addition, a business office staff at eachfacility routinely performs administrative functions, including billing, payrolland accounts payable processing. The Company's corporate and regional staffprovide support services such as quality assurance, management training,clinical consultation and support, management information systems, riskmanagement, human resource policies and procedures, operational support,accounting and reimbursement expertise.

Regions. The Company seeks to cluster its long-term carefacilities in selected geographic regions to establish a strong competitiveposition as well as to position the Company as a healthcare provider of choiceto managed care and private payors in these markets. The Company's facilitiescurrently serve four principal geographic regions: the Southeast (Florida), theMidwest (Ohio and Indiana), New England (Connecticut, Massachusetts, NewHampshire and Rhode Island), and the Mid-Atlantic (New Jersey and Maryland). TheCompany maintains regional operating offices in Palm Harbor, Florida; Beachwood,Ohio; Indianapolis, Indiana; Topsfield, Massachusetts; West Hartford,Connecticut; and Sharon, New Hampshire. Each region is supervised by a regionaldirector of operations who directs the efforts of a team of professional supportstaff in the areas of clinical services, marketing, bookkeeping, human resourcesand engineering. Other Company staff, who are principally based in the regions,provide support and assistance to all of the Company's facilities in the areasof subacute services, managed care contracting, reimbursement services, riskmanagement, data processing and training. Financial control is maintainedthrough financial and accounting policies established at the corporate level foruse at each facility. The Company has standardized operating policies andprocedures and continually monitors operating performance to assure consistencyand quality of operations.

Continuous QualityImprovement Program. The Company has developed a continuous quality improvementprogram which is designed to monitor, evaluate and improve the delivery ofpatient care. The program is supervised by the Company’s Senior VicePresident of Clinical Services and the Vice President of Quality Assurance andImprovement and consists of the standardization of policies and procedures,routine site visits and assessments and a quality control system for patientcare and physical plant compliance. Pursuant to its quality control system, theCompany routinely collects information from patients, family members, referralsources, employees and state survey agencies which is then compiled, analyzedand distributed throughout the Company in order to monitor the quality of careand services provided. 

The Company’scontinuous quality improvement program is modeled after guidelines for long-termcare and subacute facilities promulgated by the Joint Commission onAccreditation of Healthcare Organizations (“JCAHO”), a nationallyrecognized accreditation agency for hospitals and other healthcareorganizations. The Company believes that JCAHO accreditation is an importantfactor in gaining provider contracts from managed care and commercial insurancecompanies. As of December 31, 2002, 35 of the Company’s 53 skilled nursingfacilities had received accreditation. 

MARKETING

The Company’smarketing program is designed to attract patients who will have a favorableimpact on the Company’s profits and quality mix of revenues. The Companyestablishes monthly occupancy and revenue goals for each of its facilities andmaintains marketing objectives to be met by each facility. The Company’sVice President of Marketing and Managed Care is principally responsible for thedevelopment and implementation of the Company’s marketing program. Regionalmarketing directors provide routine support to the facility-based admissionsdirectors through the development of facility-based marketing strategies,competitive assessments and routine visits. 

The Company uses adecentralized marketing approach in order to capitalize on each facility’sstrengths and reputation in the community it serves. Admissions staff at eachfacility are primarily responsible for marketing basic medical services anddeveloping semi-annual marketing plans in consultation with the Company’sregional marketing and operations staff. Basic medical services are marketed toarea physicians, hospital discharge planning personnel, individual patients andtheir families and community referral sources. Facility personnel also marketthe Company’s specialty medical services to these sources. Corporate andregional personnel who specialize in subacute care, managed care andreimbursement also assist in the marketing of specialty medical services. 

SOURCES OF REVENUES

The Company derives itsrevenues primarily from private pay sources, the Federal Medicare program forcertain elderly and disabled patients and state Medicaid programs for indigentpatients. The Company’s revenues are influenced by a number of factors,including (i) the bed capacity of its facilities, (ii) the occupancy rates ofits facilities, (iii) the payor mix of its facilities and the rates ofreimbursement among payor categories (private and other, Medicare and Medicaid)
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and (iv) the extent to which subacute and other specialty medical and ancillaryservices are utilized by the patients and paid for by the respective paymentsources. The Company employs specialists to monitor reimbursement rules,policies and related developments in order to comply with all reportingrequirements and to assist the Company in receiving reimbursements. AlthoughMedicare and higher acuity patients generally produce the highest revenue perpatient day, costs associated with the higher acuity needs of these patientsalso tend to be higher. The Company believes that Medicaid patients generallyproduce the lowest profit margins. 

The following tableidentifies the Company’s percentage of net revenues attributable to each ofits payor sources for the periods indicated: 
                                       PERCENTAGE OF TOTAL NET REVENUES BY PAYOR (1)                                                 YEAR ENDED DECEMBER 31,                                                 ----------------------                                           2000            2001            2002                                         ------          ------          ------Private and other ..............           25.8%           22.6%           19.7%Medicare .......................           25.0            30.7            33.1Medicaid .......................           49.2            46.7            47.2                                         ------          ------          ------  Total ........................          100.0%          100.0%          100.0%                                         ======          ======          ======
 (1) Total net revenues exclude net revenues of the LarkinChase Center which is owned by the Bowie Center Limited Partnership (“BowieL.P.”). The Company owns a 75% partnership interest in Bowie L.P. butrecords its investment in Bowie L.P. using the equity method of accounting. SeeNote A to the Company's consolidated financial statements included elsewhere inthis report.

Private and Other. Privateand other net revenues include payments from individuals who pay directly forservices without governmental assistance and payments from commercial insurers,HMOs, PPOs, Blue Cross organizations, workers’ compensation programs,hospice programs and other similar payment sources. The Company’s rates forprivate pay patients are typically higher than rates for patients eligible forassistance under state Medicaid programs. The Company’s private pay ratesvary from facility to facility and are influenced primarily by the rates chargedby other providers in the local market and by the Company’s ability todistinguish its services from those provided by its competitors. Private payrates are generally established on a facility-specific fee schedule, while inthe case of managed care, they are either negotiated on a case-by-case basiswith the payor or are fixed by contract. Rates charged to private pay patientsare not subject to regulatory control in any of the states in which the Companyoperates. 

Medicare. All but one of the Company's skilled nursingfacilities are certified Medicare providers. Medicare is a federally funded andadministered health insurance program primarily designed for individuals who areage 65 or over and are entitled to receive Social Security benefits. TheMedicare program consists of two parts. The first part, Part A, covers inpatienthospital services and certain services furnished by other institutionalhealthcare providers, such as skilled nursing facilities. The Medicare Part Aprogram provides reimbursement for skilled nursing services provided to Medicarebeneficiaries who are admitted to skilled nursing care facilities following aminimum three-day stay in an acute care hospital. Part A covered servicesinclude skilled nursing care, rehabilitative therapy treatment, social services,pharmaceuticals and medical supplies in addition to other services. Part Acoverage for services delivered in a skilled nursing facility requires athree-day stay in an acute care hospital and is limited to a specified term(generally 100 days per "spell of illness"), requires beneficiaries to sharesome of the cost of covered services through a co-insurance payment and requiresbeneficiaries to meet certain qualifying criteria. The second part of theMedicare program, Part B, covers the services of doctors, suppliers of medicalitems and services and various types of outpatient services. Part B servicesinclude physical, speech and occupational therapy and durable medical equipmentand other ancillary services of the type provided by long-term care or acutecare facilities. Part B services generally require beneficiaries to share thecost of covered services through an annual deductible amount and a co-insurancepayment. Prior to December 31, 1998 there were no limits on duration of coveragefor Part B services.

Through December 31, 1998, the Medicare Part A programreimbursed the Company for covered services under a cost-based reimbursementsystem for its allowable direct and indirect costs. During any given costreporting period through December 31, 1998, the Company’s facilities wouldeach be reimbursed by the Medicare program through an interim daily paymentrate, based on the most recent filed cost reports. At the end of the costreporting period, each facility would file a cost report for the cost reportingperiod. A settlement payment would occur to reconcile the filed cost reportamount to the total of interim payments made to the facility. Audits of thefiled cost report could result in additional payments being made to the Companyor in recoupments from the Company. To date, adjustments from Medicare auditshave not had a material adverse effect upon the Company. 

In August of 1997, theBalanced Budget Act of 1997 (the “BBA”) was enacted. The BBA provideda prospective payment system (“PPS”) for skilled nursing facilities tobe implemented for cost reporting years beginning on or after July 1, 1998. TheCompany’s facilities began to be reimbursed in accordance with the BBAbeginning January 1, 1999. During the first three years of PPS, the Part AMedicare per diem rates were based on a blend of facility-specific rates andfederal rates. Beginning on January 1, 2002, the per diem rates were basedsolely on federal rates. As a result of the implementation of PPS, theCompany’s Medicare Part A per diem rate declined from $397 in 1998 to $290in 1999. The Company’s average Medicare Part A rate during fiscal 2001 andfiscal 2002 was significantly affected by changes to the Medicare payment systemin those years. See “Government Regulation ” and“Management’s Discussion and Analysis of Financial Condition andResults of Operations.” The BBA also implemented a prospective paymentsystem for Part B services. Prior to January 1, 1999, the Company was reimbursedfor Part B services on a cost reimbursement basis. Beginning January 1, 1999,Medicare Part B services began being reimbursed on a fee screen basis. These feescreens are revised by the Centers for Medicare and Medicaid Services(“CMS”) on an annual basis. The BBA also imposed an annual limitationon Part B therapy charges of $1,500 per beneficiary. 
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Medicaid. All of the Company's skilled nursing facilitiesparticipate in the Medicaid programs of the states in which they are located.Medicaid is a state-administered reimbursement program for indigent patientsfinanced by state funds (and in certain states, county funds) and matchingfederal funds. Although administered under Federal regulations, states havesubstantial flexibility to design programs and determine reimbursement rates,and as a result, individuals programs and reimbursement rates vary significantlyfrom state to state. The Federal government retains the right to approve ordisapprove individual state plans.

Until the enactment of theBBA, a Federal Medicaid statute, generally referred to as the “BorenAmendment,” required Medicaid programs to provide reimbursement rates thatwere reasonable and adequate to cover the costs that would be incurred byefficiently and economically operated facilities while providing services inconformity with state and federal laws, regulations and quality and safetystandards. The BBA repealed the Boren Amendment effective October 1, 1997 andallowed the states to develop their own standards for determining Medicaidpayment rates. In the past, several states’ healthcare providerorganizations and providers have initiated litigation challenging the Medicaidreimbursement methodologies employed in such states, asserting thatreimbursement payments are not adequate to reimburse an efficiently operatedfacility for the costs of providing Medicaid covered services. The repeal of theBoren Amendment provides states with greater flexibility to amend individualstate programs and potentially reduce state Medicaid payments to skilled nursingfacilities. Medicaid covered services vary by state, but generally includenursing care, room and board, and social services. Additionally, some statesprovide reimbursement for pharmaceuticals, rehabilitative therapy treatment andother services. 

The Company has been in thepast and could be in the future, adversely affected by the continuing efforts ofgovernmental third-party payors to control health care expenditures. 

MANAGEMENT INFORMATION SYSTEMS

The Company’sinformation systems strategy is to provide its facilities with extensive andtimely information, which will allow them to operate efficiently underprospective payment reimbursement systems. A cornerstone of this strategy is toavoid the high costs and risks associated with the internal development ofsignificant transaction processing systems. Whenever possible, theCompany’s buys well-tested software and avoids the costs and risks inherentin customizing these systems. The Company also places high importance on theinterconnection of transactional and clinical data through its extensive datawarehouse capabilities. 

All of the Company’sfacilities are supported by a centralized, integrated financial reporting systemwhich processes financial transactions and which enables Company personnel tomonitor and respond on a timely basis to key operating and financial data andbudget variances. Using its data warehouse, the Company monitors its occupancylevels, payor mix and overall staffing and temporary labor utilization on adaily basis. The Company utilizes a payroll processing service company toprocess payroll transactions and maintain human resources files for employees atall of its facilities. The Company’s clinical system captures the datanecessary to obtain proper reimbursement from the Federal Part A Medicareprogram as well as certain state Medicaid programs. The Company’s clinicalsystem also provides data essential to the Company’s clinical services,continuous quality improvement program. 

GOVERNMENTAL REGULATION

The Federal government andall states in which the Company operates regulate various aspects of theCompany’s business. In addition to the regulation of payment rates bygovernmental payor sources, the development and operation of long-term carefacilities and the provision of long-term care services are subject to Federal,state and local licensure and certification laws which regulate with respect toa facility, among other matters, the number of beds, the services provided, thedistribution of pharmaceuticals, equipment, staffing requirements,patients’ rights, operating policies and procedures, fire preventionmeasures, environmental matters and compliance with building and safety codes.There can be no assurance that Federal, state or local governmental regulationswill not change or be subjected to new interpretations that impose additionalrestrictions which might adversely affect the Company’s business. 

All of the skilled nursingfacilities operated by the Company are licensed under applicable state laws andpossess the required Certificates of Need (“CON”) from responsiblestate authorities. All of the Company’s skilled nursing facilities arelicensed as providers under the Medicaid programs of the states in which theyoperate. All but one of the Company’s skilled nursing facilities arecertified as providers under the Medicare program. Both the initial andcontinuing qualification of a skilled nursing care facility to participate insuch programs depend upon many factors, including accommodations, equipment,services, non-discrimination policies against indigent patients, patient care,quality of life, patients’ rights, safety, personnel, physical environmentand adequacy of policies, procedures and controls. Licensing, certification andother applicable standards vary from jurisdiction to jurisdiction and arerevised periodically. State agencies survey or inspect all skilled nursing carefacilities on a regular basis to determine whether such facilities are incompliance with the requirements for participation in government-sponsoredthird-party payor programs. In some cases, or upon repeat violations, thereviewing agency has the authority to take various adverse actions against afacility, including the imposition of fines, temporary suspension of admissionof new patients to the facility, suspension or decertification fromparticipation in the state Medicaid program or the Medicare program, offset ofamounts due against future billings to the Medicare or Medicaid programs, denialof payments under the state Medicaid program for new admissions, reduction ofpayments, restrictions on the ability to acquire new facilities and, in extremecircumstances, revocation of a facility’s license or closure of a facility. 

The Company believes thatits facilities are in substantial compliance with all statutes, regulations,standards and requirements applicable to its business, including applicableMedicaid and Medicare regulatory requirements. However, in the ordinary courseof its business, the Company from time to time receives notices of deficienciesfor failure to comply with various regulatory requirements. In most cases, theCompany and the reviewing agency will agree upon corrective measures to be takento bring the facility into compliance. Although the Company has been subject to
                                       8
some fines, statements of deficiency and other corrective actions have not had amaterial adverse effect on the Company. 

The Company believes thatthe regulatory environment surrounding the long-term care industry hasintensified, particularly for multi-facility for-profit operators. The Federalgovernment has imposed intensive enforcement policies resulting in a significantincrease in the number of inspections, citations of regulatory deficiencies, andother regulatory sanctions including terminations from the Medicare and Medicaidprograms, bars on Medicare and Medicaid payments for new admissions and civilmonetary penalties. There can be no assurance that future agency inspections andthe actions taken by the reviewing agency based upon such inspections will nothave a material adverse effect on the Company’s results of operations, cashflows or its financial position. 

Certificates of Need. Allbut one of the states (Indiana) in which the Company operates have adopted CONor similar laws that generally require that a state agency determine that a needexists prior to the construction of new skilled nursing facilities, the additionor reduction of licensed beds or services, the implementation of other changes,the incurrence of certain capital expenditures, and, in certain states, theapproval of certain acquisitions and changes in ownership or the closure of askilled nursing facility. State CON approval is generally issued for a specificproject or number of beds, specifies a maximum expenditure, is sometimes subjectto an inflation adjustment, and requires implementation of the proposal within aspecified period of time. Failure to obtain the necessary state approval canresult in the inability of the facility to provide the service, operate thefacility or complete the acquisition, addition or other change and can alsoresult in adverse reimbursement action or the imposition of sanctions or otheradverse action on the facility’s license. 

Medicare. A substantial portion of the Company's revenues arederived from the Medicare program. See "Sources of Revenues." All but one of theCompany's skilled nursing facilities are certified Medicare providers. Medicareis a federally funded and administered health insurance program primarilydesigned for individuals who are age 65 or over and are entitled to receiveSocial Security benefits. The Medicare program consists of two parts. The firstpart, Part A, covers inpatient hospital services and certain services furnishedby other institutional healthcare providers, such as skilled nursing facilities.The Medicare Part A program provides reimbursement for skilled nursing servicesprovided to Medicare beneficiaries who are admitted to skilled nursingfacilities following a minimum three-day stay in an acute care hospital. Part Acovered services include skilled nursing care, rehabilitative therapy treatment,social services, pharmaceuticals and medical supplies in addition to otherservices. Part A coverage for services delivered in a skilled nursing carefacility requires a three-day stay in an acute care hospital, is limited to aspecified term (generally 100 days per "spell of illness"), requiresbeneficiaries to share some of the cost of covered services through aco-insurance payment and requires beneficiaries to meet certain qualifyingcriteria. The second part of the Medicare program, Part B, covers the servicesof doctors, suppliers of medical items and services and various types ofoutpatient services. Part B services include physical, speech and occupationaltherapy and durable medical equipment and other ancillary services of the typeprovided by skilled nursing or acute care facilities. Part B services generallyrequire beneficiaries to share the cost of covered services through a an annualdeductible amount and a co-insurance payment. Prior to December 31, 1998 therewere no limits on duration of coverage for Part B services.

Over the past severalyears, the Federal government has enacted three significant laws thatdramatically affected the payment methodology through which skilled nursingfacilities are reimbursed by the Medicare program. The first, the BBA, wasenacted in August 1997 and significantly amended the reimbursement methodologyof the Medicare program. In addition to offering new Medicare health planoptions and increasing the penalties related to healthcare fraud and abuse, theBBA provided for a prospective payment system for skilled nursing facilities tobe implemented for cost report periods beginning on or after July 1, 1998.Through December 31, 1998, the Medicare Part A program reimbursed the Companyfor covered services under a cost-based reimbursement system for its allowabledirect and indirect costs. 

Medicare PPS was beingphased in over a period of four years, beginning with skilled nursing facilitycost reporting periods ending on or after July 1, 1998. “Newfacilities,” which first received Medicare payment on or after October 1,1995, moved to the federal per diem rate effective with the cost report periodsbeginning on or before July 1, 1998 and did not have a transitional period. Allother facilities were “phased-in” by a formula effective with the costreport period beginning on or after July 1, 1998 and through which Medicare PPSblended together facility-specific rates and federal industry per diemsaccording to the following schedule: Year One -- 75% facility-specific, 25%federal per diem; Year Two -- 50% each; Year Three -- 25% facility-specific, 75%federal per diem; Year Four -- 100% federal per diem. As a result of MedicarePPS being effective for cost reports beginning on or after July 1, 1998,Medicare PPS did not directly impact the Company’s Medicare reimbursementuntil the fiscal year beginning January 1, 1999. With full implementation,effective January 1, 2002, Medicare PPS resulted in each Medicare certifiedskilled nursing facility being reimbursed on a per diem rate (the “Federalper diem rate”) basis with acuity-based per diem rates being established asapplicable to all Medicare Part A beneficiaries who are residents of the skillednursing facility. The acuity-based per diem rates are determined by classifyingeach patient into one of forty-four resource utilization groups(“RUG”) using the data captured by completing the minimum dataassessment (“MDS”) required by CMS. Each RUG classification isassigned its own Federal per diem rate by CMS. The Federal per diem rates areall-inclusive rates through which the skilled nursing facility is reimbursed forits routine, ancillary and capital costs. The Federal Medicare PPS rates weredeveloped by CMS based on a blend of allowable costs from hospital-based andfreestanding skilled nursing facility cost reports for reporting periodsbeginning in Federal Fiscal Year 1995 (i.e., October 1, 1994 -- September 30,1995). CMS updated costs to the first year of Medicare PPS using a skillednursing facility market basket inflation index standardized for facilitydifferences in case-mix and for geographic variations in wages. Providers thatreceived “new provider” exemptions from the routine cost limits wereexcluded from the database used to compute the federal payment rates. Inaddition, costs related to payments for exceptions to the routine cost limitswere excluded from the database used to compute the federal payment rates. Thefacility-specific portion was based on each facility’s Medicare cost reportfor cost reporting periods beginning in Federal Fiscal Year 1995, includingroutine cost limit exception and exemption payments up to 150% of the routinecost limit, the allowable costs to be updated under Medicare PPS for the skillednursing facility market basket minus 1% through 1999 and the full skillednursing facility market basket after 1999. A variety of other adjustments aremade in developing the Medicare PPS rates pursuant to the BBA and theregulations. 
                                       9
The BBA also requiredskilled nursing facilities to institute “consolidated billing” for avariety of services and supplies. Under consolidated billing, the skillednursing facility must submit all Medicare claims for all the Part A services andsupplies that its residents receive, with the exception of certain services,including those provided by physicians. Payments for these services and suppliesbilled on a consolidated basis are made directly to the skilled nursingfacility, whether or not the services were provided directly by the skillednursing facility or by others under a contractual arrangement. The skillednursing facility is responsible for paying the provider of the services or thesupplier. 

The BBA also implemented a prospective payment system for Part Bservices. Prior to January 1, 1999, the Company was reimbursed for Part Bservices on a cost reimbursement basis. Beginning January 1, 1999, Medicare PartB services began being reimbursed on a fee screen basis. These fee screens arerevised by the CMS on an annual basis. The BBA also imposed an annual limitationon Part B therapy charges of $1,500 per beneficiary, separately forphysical/speech therapy and occupational therapy, and imposed a futurerequirement to implement consolidated billing for Part B services. 

On November 29, 1999, thesecond major law, the “Balanced Budget Refinement Act” of 1999 (the“BBRA”) was signed into law. The BBRA was designed to mitigate some ofthe effects of the BBA. The BBRA allowed skilled nursing facilities to electtransition to the full Federal per diem rate at the beginning of their costreporting periods for cost periods beginning on or after January 1, 2000. Usingthe election allowed by the BBRA, the Company chose to move fourteen facilitiesto the full Federal per diem rate effective January 1, 2000. As a result, as ofDecember 31, 2000, the Company used the full Federal per diem rate to calculateMedicare revenue at twenty-three of its skilled nursing facilities.Additionally, the BBRA increased the Federal per diem rates by 20% for fifteenRUG categories (three rehabilitative therapy RUG categories, twelvenon-rehabilitative therapy RUG categories) beginning on April 1, 2000. Theseincreased rates were to stay in effect until the later of (a) October 1, 2000 or(b) the date CMS implements a revised PPS system that more accurately reimbursesthe costs of caring for medically complex patients. The BBRA also provided for afour percent temporary increase in the Federal per diem rates for all RUGcategories for a two-year period beginning October 1, 2000. The BBRA alsoexcluded certain supplies and services that were formerly required tobe reimbursed by a skilled nursing facility’s PPS rate. The BBRA alsoeliminated the annual provider limitations on Part B therapy charges perbeneficiary for calendar year 2000 and 2001. 

In December 2000, the thirdmajor law, the Medicare, Medicaid, and State Child Health Insurance ProgramBenefits Improvement and Protection Act of 2000 (“BIPA”) was enacted.BIPA temporarily increased the existing nursing rate component of the Federalper diem rate, for each RUG category, by 16.66% from April 1, 2001 throughSeptember 30, 2002. In addition, BIPA eliminated the 20% add-ons (provided bythe BBRA) for the three rehabilitative therapy RUG categories and substituted6.7% add-ons for all fourteen rehabilitative therapy RUG categories. The 6.7%add-ons are scheduled to stay in effect until CMS implements a revised PPSsystem as contemplated by the BBRA. BIPA also extended the moratorium on theannual limitation on Part B therapy charges of $1,500 per beneficiary throughcalendar year 2002 and repealed the BBA requirement to implement consolidatedbilling for Part B services. 

On September 30, 2002,certain increases in Medicare reimbursement for skilled nursing facilitiesprovided for under the BBRA and BIPA expired: (i) the four percent increase inthe Federal per diem Medicare Part A rates for all RUG categories granted by theBBRA, which had been in effect since October 1, 2000, and (ii) the 16.66%increase to the nursing rate component of the Federal per diem Medicare Part Arates for all RUG categories, which had been in effect since April 1, 2001. Inaddition to these reimbursement reductions, effective October 1, 2002, theCompany’s Medicare Part A rates also experienced an increase ofapproximately 2.6% reflecting the Medicare program’s annual inflationaryincrease. The Medicare program increases the Part A rates for skilled nursingfacilities annually on the first of October. Historically, these inflationaryincreases have not kept pace with the rate of inflation experienced by operatorsof skilled nursing facilities. 

The net effect of (i) thetwo reductions in Medicare Part A reimbursement effective September 30, 2002,and (ii) and the annual inflationary increase effective October 1, 2002, was tolower the Company’s Medicare Part A per diem rate from $358 during thethird quarter of fiscal 2002 to $331 during the fourth quarter of fiscal 2002.The Company’s reduction of $27 per Medicare Part A day had the effect ofreducing revenues by approximately $2,330,000 during the fourth quarter offiscal 2002. 

The effect of the tworeductions by themselves (excluding the effect of the inflationary increase) wasto lower the Company’s Medicare Part A per diem rate by approximately $37per Medicare Part A day from the third quarter of fiscal 2002 to the fourthquarter of fiscal 2002. Assuming that the average Medicare Part A daily censusexperienced by the Company during the fourth quarter of fiscal 2002 was heldconstant, the impact of the two reductions in Medicare Part A reimbursementeffective September 30, 2002 would be to reduce the Company’s annualizedrevenues by approximately $12,668,000. 

The two year moratorium on the annual limitation on Part Btherapy charges of $1,500 per day, separately for physical/speech therapy andoccupational therapy, expired on December 31, 2002; however, CMS has stated thatit will not begin enforcing the annual therapy limitations until July 1,2003.

Medicaid. All but one of the Company's skilled nursingfacilities participate in the Medicaid programs of the states in which they arelocated. Medicaid is a state-administered reimbursement program for indigentpatients financed by state funds (and in certain states, county funds) andmatching federal funds. Although administered under Federal regulations, stateshave substantial flexibility to design programs and determine reimbursementrates, and as a result, individuals programs and reimbursement rates varysignificantly from state to state. The Federal government retains the right toapprove or disapprove individual state plans.

Until the enactment of theBBA, a Federal Medicaid statute, generally referred to as the “BorenAmendment,” required Medicaid programs to provide reimbursement rates thatwere reasonable and adequate to cover the costs that would be incurred byefficiently and economically operated facilities while providing services inconformity with state and federal laws, regulations and quality and safetystandards. The BBA repealed the Boren Amendment effective October 1, 1997 andallowed the states to develop their own standards for determining Medicaidpayment rates. In the past, several states’ healthcare providerorganizations and providers have initiated litigation challenging the Medicaidreimbursement methodologies employed in such states, asserting thatreimbursement payments are not adequate to reimburse an efficiently operatedfacility for the costs of providing Medicaid covered services. The repeal of theBoren Amendment provides states with greater flexibility to amend individualstate programs and potentially reduce state Medicaid payments to skilled nursing
                                       10
facilities. Medicaid covered services vary by state, but generally includesnursing care, room and board, and social services. Additionally, some statesprovide reimbursement for pharmaceuticals, rehabilitative therapy treatment andother services. 

The Medicaid programs inthe states in which the Company operates pay a per diem rate for providingservices to Medicaid patients based on the facility’s reasonable allowablecosts incurred in providing services, subject to cost ceilings applicable topatient care, other operating costs and capital costs. Some state Medicaidprograms in which the Company currently operates currently include incentiveallowances for providers whose costs are less than certain ceilings. 

There are generally twotypes of Medicaid reimbursement rates: retrospective and prospective, althoughmany states have adopted plans that have both retrospective and prospectivefeatures. A retrospective rate is determined after completion of a cost reportby the service provider and is designed to reimburse expenses. Typically, aninterim rate, based upon historical cost factors and inflation is paid by thestate during the cost reporting period and a cost settlement is made followingan audit of the filed cost report. Such adjustments may result in additionalpayments being made to the Company or in recoupments from the Company, dependingon actual performance and the limitations within an individual state plan. 

The more prevalent type ofMedicaid reimbursement rate is the prospective rate. Under a prospective plan,the state sets its rate of payment for the period before services are rendered.Actual costs incurred by operators during a period are used by the state toestablish the prospective rate for subsequent periods. The provider must acceptthe prospective rate as payment in full for all services rendered. Subsequentaudits may provide a basis for the state program to retroactively recoup monies. 

To date, adjustments fromMedicaid audits have not had a material adverse effect on the Company. Althoughthere can be no assurance that future adjustments will not have a materialadverse effect on the Company, the Company believes that it has properly appliedthe various payment formulas and that it is not likely that audit adjustmentswould have a material adverse effect on the Company. 

Potential HealthcareReform. In addition to extensive existing governmental healthcare regulation,there are numerous legislative and executive initiatives at the federal andstate levels for comprehensive reforms affecting the payment for andavailability of healthcare services. It is not clear at this time whatproposals, if any, will be adopted or, if adopted, what effect such proposalswould have on the Company’s business. Aspects of certain of theseproposals, such as reductions in funding of Medicaid programs, or changes in theadministration of Medicaid at the state level, could materially adversely affectthe Company. Additionally, the BBA repealed the Boren Amendment effectiveOctober 1, 1997 and allows the states to develop their own standards fordetermining Medicaid payment rates. The BBA provides certain proceduralrestrictions on the states’ ability to amend state Medicaid programs byrequiring that the states use a public process to establish paymentmethodologies including a public comment and review process. The repeal of theBoren Amendment provides states with greater flexibility to amend individualstate programs and potentially reduce state Medicaid payments to skilled nursingfacilities. There can be no assurance that currently proposed or futurehealthcare legislation or other changes in the administration or interpretationof governmental healthcare programs will not have an adverse effect on theCompany. 

Fee Splitting andReferrals. The Company is also subject to federal and state laws that governfinancial and other arrangements between healthcare providers. Federal laws, aswell as the laws of certain states, prohibit direct or indirect payments or feesplitting arrangements between healthcare providers that are designed to induceor encourage the referral of patients to, or the recommendation of, a particularprovider for medical products and services. These laws include the federal“anti-kickback law” which prohibits, among other things, the offer,payment, solicitation or receipt of any form of remuneration in return for thereferral of Medicare and Medicaid patients. A wide array of relationships andarrangements, including ownership interests in a company by persons in aposition to refer patients and personal service agreements have, under certaincircumstances, been alleged to violate these provisions. Certain discountarrangements may also violate these laws. Because of the broad reach of theselaws, the federal government has published certain “safe harbors,”which set forth the requirements under which certain relationships will not beconsidered to violate such laws. A violation of the federal anti-kickback lawcould result in the loss of eligibility to participate in Medicare or Medicaid,or in criminal penalties. Violation of state anti-kickback laws could lead toloss of licensure, significant fines and other penalties. 

Various federal and statelaws regulate the relationship between healthcare providers and physicians,including employment or service contracts and investment relationships. Theselaws include the broadly worded fraud and abuse provisions of the Medicaid andMedicare statutes, which prohibit various transactions involving Medicaid orMedicare covered patients or services. In particular, the Omnibus BudgetReconciliation Act of 1993 (“OBRA 93”) contains provisions whichgreatly expand the federal prohibition on physician referrals to entities withwhich they have a financial relationship. Effective January 1, 1995, OBRA 93prohibits any physician with a financial relationship (defined as a direct orindirect ownership or investment interest or compensation arrangement) with anentity from making a referral for “designated health services” to thatentity and prohibits that entity from billing for such services.“Designated health services” do not include skilled nursing servicesbut do include many services which long-term care facilities provide to theirpatients, including physical therapy, occupational therapy, infusion therapy andenteral and parenteral nutrition. Various exceptions to the application of thislaw exist, including one which protects the payment of fair market compensationfor the provision of personal services, so long as various requirements are met.Violations of these provisions may result in civil or criminal penalties forindividuals or entities and/or exclusion from participation in the Medicaid andMedicare programs. Various state laws contain analogous provisions, exceptionsand penalties. The Company believes that in the past it has been, and in thefuture it will be, able to arrange its business relationships so as to complywith these provisions. 

Each of the Company’sskilled nursing care facilities has at least one medical director that is alicensed physician. The medical directors may from time to time refer theirpatients to the Company’s facilities in their independent professionaljudgment. The physician anti-referral restrictions and prohibitions could, among 
                                       11
other things, require the Company to modify its contractual arrangements withits medical directors or prohibit its medical directors from referring patientsto the Company. From time to time, the Company has sought guidance as to theinterpretation of these laws. However, there can be no assurance that such lawswill ultimately be interpreted in a manner consistent with the practices of theCompany. 

The Health Insurance Portability and Accountability Act of 1996(“HIPAA”) broadened the scope of fraud and abuse laws to include allhealth plans, whether or not they are reimbursed under Federal programs. HIPAAalso mandated the adoption of federal regulations designed to (a) standardizetransaction formats and billing codes for documenting health care services,determining eligibility and processing claims for payment; and (b) protect theprivacy and security of individually identifiable health information. FinalHIPAA regulations that standardize transactions and code sets were issued duringthe third quarter of 2000. The ultimate compliance date was subsequentlymodified by legislation to require health care providers and health plans toeither comply with the HIPAA transaction code set standards beginning in Octoberof 2002 or submit a written plan to the federal government by October of 2002describing specific plans for compliance by October of 2003. The regulations donot require healthcare providers to submit claims electronically, but do requirestandard formatting for those that do so. The Company currently submits mostclaims electronically and expects to continue to do so. The Company hassubmitted, on behalf of all owned, operated and affiliated entities and healthplans, an Electronic Transactions and Code Sets Compliance Extension Plan andcopies of all CMS approval/confirmation for each entity are maintained on fileat the Company’s corporate offices. The Company is currently evaluating theimpact of the Transactions and Code Sets provisions but does expect to fullycomply in accordance with each model compliance plan filed previously filed withthe Centers for Medicare and Medicaid services. On February 20, 2003, the U.S.Department of Health and Human Services published modifications to the finaltransaction standards; however, the October 2003 compliance date was notchanged. 

Final HIPAA privacyregulations were published during the fourth quarter of 2000. However, on March21, 2002, the U.S. Department of Health and Human Services released a proposedrule which if finally adopted would modify the regulations published during2000. In general, the regulations apply to “protected healthinformation”, which is defined as individually identifiable healthinformation transmitted or maintained in any form or medium, excluding certaineducation records and student medical records. The privacy regulations seek tolimit the use and disclosure of most paper and oral communications, as well asthose in electronic form, regarding an individual’s past, present or futurephysical or mental health or condition, or relating to the provision of healthcare to the individual or payment of that health care. The regulations furtherimpose requirements on health care providers to contractually obligate certainof their subcontractors who may receive protected health care information duringthe course of rendering services on behalf of such health care provider to abideby certain privacy requirements as well. In addition, the current HIPAAregulations provide that certain state privacy laws may not be preempted byHIPAA. Accordingly, the Company, in certain instances, will remain subject tovarious state privacy laws in jurisdictions in which it currently operatesfacilities. HIPAA provides for the imposition of civil and criminal penalties ifprotected health information is improperly disclosed. The Company must complywith applicable privacy regulations by April of 2003. The Company is continuingto evaluate the impact of the privacy regulations on its operations butanticipates that it will be able to comply with those HIPAA requirements thathave been adopted. 

HIPAA’s securityregulations have not been finalized. The proposed security regulations specifyadministrative procedures, physical safeguards, and technical services andmechanisms designed to ensure that protected health information remains secure.The proposed security rules contemplate a compliance date of 24 months after theeffective date of the final rule published in the Federal Register, although itis possible that such compliance date will differ and could align with thecompliance date for the privacy regulations depending on when the securityregulations are ultimately finalized. 

 Management continues to evaluate the likely effects of HIPAA onthe Company and its operations. At this time management believes that theCompany will be able to comply with the HIPAA requirements that have beenadopted to date, and that the costs of compliance will not have a materialadverse effect on the Company’s results of operations, cash flows or financialposition. 

COMPETITION

The long-term care industryis highly competitive. The Company competes with other providers of long-termcare on the basis of the scope and quality of services offered, the rate ofpositive medical outcomes, cost-effectiveness and the reputation and appearanceof its long-term care facilities. The Company also competes in recruitingqualified healthcare personnel, in acquiring and developing additionalfacilities and in obtaining CONs. The Company’s current and potentialcompetitors include national, regional and local long-term care providers, someof whom have substantially greater financial and other resources and may be moreestablished in their communities than the Company. The Company also facescompetition from assisted living facility operators as well as providers of homehealthcare. In addition, certain competitors are operated by not-for-profitorganizations and similar businesses which can finance capital expenditures andacquisitions on a tax-exempt basis or receive charitable contributionsunavailable to the Company. 

In general, consolidationin the long-term care industry has resulted in the Company being faced withlarger competitors, many of whom have significant financial and other resources.The Company expects that this continuing consolidation may increase thecompetition for the acquisition of long-term care facilities. 

The Company believes thatstate regulations which require a CON before a new long-term care facility canbe constructed or additional licensed beds can be added to existing facilitiesreduce the possibility of overbuilding and promote higher utilization ofexisting facilities. CON legislation is currently in place in all states inwhich the Company operates or expects to operate with the exception of Indianawhere the CON program expired as of June 30, 1998. Several of the states inwhich the Company operates have imposed moratoriums on the issuance of CONs fornew skilled nursing facility beds. A relaxation of CON requirements could leadto an increase in competition. In addition, as cost containment measures havereduced occupancy rates at acute care hospitals, a number of these hospitals
                                       12
have converted portions of their facilities into subacute units. In the statesin which the Company currently operates, these conversions are subject to stateCON regulations. The Company believes that the application of the new MedicarePPS rules have made such conversions less desirable. 

EMPLOYEES

As of December 31, 2002,the Company employed approximately 8,850 facility-based personnel on a full- andpart-time basis. The Company’s corporate and regional staff consisted of164 persons as of such date. Approximately 615 employees at ten of theCompany’s facilities are covered by collective bargaining agreements.Although the Company believes that it maintains good relationships with itsemployees and the unions that represent certain of its employees, it cannotpredict the impact of continued or increased union representation ororganizational activities on its future operations. 

The Company believes thatthe attraction and retention of dedicated, skilled and experienced nursing andother professional staff has been and will continue to be a critical factor inthe successful growth of the Company. The Company believes that its wage ratesand benefit packages for nursing and other professional staff are commensuratewith market rates and practices. 

The Company competes withother healthcare providers in attracting and retaining qualified or skilledpersonnel. The long-term care industry has, at times, experienced shortages ofqualified personnel. A continued shortage of nurses or other trained personnelor general economic inflationary pressures may require the Company to enhanceits wage and benefits package in order to compete with other employers. Therecan be no assurance that the Company’s labor costs will not increase or, ifthey do, that they can be matched by corresponding increases in private-payorrevenues or governmental reimbursement. Failure by the Company to attract andretain qualified employees, to control its labor costs or to match increases inits labor expenses with corresponding increases in revenues could have amaterial adverse effect on the Company. 

INSURANCE

During the year endedDecember 31, 1998, the Company implemented a general and professional liabilityinsurance program that, for the period from September 1, 1998 to August 31,2001, limited the Company’s self-retention risk for this program to amaximum of $25,000 per year. The long-term care industry has seen the cost ofmaintaining traditional professional liability insurance increase significantlyover the past several years, especially in the State of Florida. Most insurancecompanies are unwilling to underwrite new professional liability policies in theState of Florida. In May 2001, tort reform legislation was enacted in Florida.This legislation provided caps on punitive damages, limits to add-on legal fees,stricter rules of evidence and a shorter statute of limitations period. Giventhe tremendous increase in professional liability premiums and the tort reformlegislation that was enacted in the State of Florida in May 2001, the Companyconcluded that it would be more cost effective to assume a higher level ofretained risk for professional liability claims. As a result, the Companyimplemented a new general and professional liability program, effectiveSeptember 1, 2001, which resulted in the Company maintaining an unaggregatedself-insured retention of $2,000,000 per occurrence for locations outside ofFlorida and completely retaining risk at the Florida facilities. As of December1, 2002, the Company’s unaggregated self-insured retention increased to$10,000,000 per occurrence for locations outside of Florida. The Company maintainsan accrual for estimated unpaid losses including unreported claims.  The amount of theaccrual is determined through an estimation process that uses information fromboth the Company’s records as well as industry data. The Company uses anindependent actuary to help estimate the required general and professionalliability accrual. Factors reviewed include the frequency of expected claims,the average cost per claim, emerging industry trends, changes in regulatoryenvironment (such as the recently enacted Florida tort reform legislation) andthe expected effect of various operational and risk management initiatives. TheCompany will continue to evaluate its insurance accrual requirements on aquarterly basis. Required adjustments to the Company’s general andprofessional liability accrual will be recorded in the accounting period inwhich the change in estimate occurs. There can be no assurances that the recentFlorida tort reform legislation will have a positive impact on claims activity,that the coverage limits of the Company’s insurance program will beadequate or that insurance will continue to be available to the Company in thefuture. (See Note M to the Company’s consolidated financial statementsincluded elsewhere in this report.) 
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**ITEM 2. PROPERTIES
The following tablesummarizes certain information regarding the Company’s facilities as ofDecember 31, 2002: 
SUMMARY OF FACILITIES                                                  YEAR             OWNED/FACILITY                       LOCATION         ACQUIRED       LEASED/MANAGED        BEDS--------                       --------        -----------    ---------------       -----SOUTHEAST REGIONFloridaHuntington Place               Rockledge           1994              Leased           100   (2)Sunset Point                   Clearwater          1990              Owned            120   (2)Orchard Ridge                  New Port Richey     1990              Owned            120   (2)Lakeside Pavilion              Naples              1989              Leased           120   (2)Oakhurst                       Ocala               1990              Owned            180   (2)Bay Tree                       Palm Harbor         1990              Owned            120   (2)Pinebrook Rehabilitation       Venice              1989              Leased           120   (2)Springwood                     Sarasota            1990              Leased           120   (2)Westbay                        Oldsmar             1990              Owned            120   (2)                                                                                   ------                                                                                    1,120MIDWEST REGIONOhio  Defiance                     Defiance            1993              Leased           100   (2)  Northwestern Ohio            Bryan               1993              Leased           189   (2)  Swanton                      Swanton             1995              Leased           100   (2)  Perrysburg                   Perrysburg          1990              Owned            100   (2)  Troy                         Troy                1989              Leased           195   (2)  Beachwood                    Beachwood           1996              Leased           274   (2)  Broadview                    Broadview Heights   1996              Leased           159   (2)  Westlake I                   Westlake            1996              Leased           153   (2)  Westlake II                  Westlake            1996              Leased           106   (2)  Dayton                       Dayton              1997              Owned            100   (2)  Laurelwood                   Dayton              1997              Owned            115   (3)  New Lebanon                  New Lebanon         1997              Owned            126   (2)  Point Place                  Toledo              1998              Owned             98   (4)  Sylvania                     Sylvania            1998              Owned            150   (2)  Marietta                     Marietta            2001              Leased           150   (2)Indiana  Decatur                      Indianapolis        1988              Owned             88   (2)  Indianapolis                 Indianapolis        1988              Leased           104   (2)  New Haven                    New Haven           1990              Leased           120   (2)  Terre Haute                  Terre Haute         1990              Owned            120   (2)                                                                                   ------                                                                                    2,547NEW ENGLAND REGIONConnecticut  Arden House                  Hamden              1997              Leased           360   (2)  Governor's House             Simsbury            1997              Leased            73   (2)  Madison House                Madison             1997              Leased            90   (2)  The Reservoir                West Hartford       1997              Leased            75   (2)  Willows                      Woodbridge          1997              Leased            90   (2)  Glen Hill                    Danbury             1998              Owned            100   (2)  Glen Crest                   Danbury             1998              Owned             49   (5)Massachusetts  Maplewood                    Amesbury            1997              Leased           120   (2)  Cedar Glen                   Danvers             1997              Leased           100   (2)  Danvers-Twin Oaks            Danvers             1997              Leased           101   (2)  Northshore                   Saugus              1997              Leased            80   (2)  The Stone Institute          Newton Upper Falls  1997              Managed          106   (6)  Falmouth                     Falmouth            2002              Leased           120   (2)  Mashpee                      Mashpee             2002              Leased           120   (2)  Wakefield                    Wakefield           2002              Leased           149   (2)  Westfield                    Westfield           2002              Leased            98   (2)                                       14New Hampshire  Applewood                    Winchester          1996              Leased            70   (2)  Crestwood                    Milford             1996              Leased            82   (2)  Milford                      Milford             1996              Leased            52   (2)  Northwood                    Bedford             1996              Leased           147   (2)  Pheasant Wood                Peterborough        1996              Leased            99   (2)  Westwood                     Keene               1996              Leased            87   (2)Rhode Island  Greenwood                    Warwick             1998              Owned            136   (2)  Pawtuxet Village             Warwick             1998              Owned            131   (2)                                                                                   ------                                                                                    2,635MID-ATLANTIC REGIONMarylandHarford Gardens                Baltimore           1997              Leased           163   (2)Larkin Chase Center            Bowie               1994              Owned (1)        120   (2)New JerseyWoods Edge                     Bridgewater         1988              Leased           176   (2)                                                                                   ------                                                                                      459                               Total                                                6,761   (7)                                                                                    =====(1)  Owned by Bowie L.P. The Company's interest in Bowie L.P. is pledged to the     facility's mortgage lender. The Company has guaranteed the indebtedness of     Bowie L.P.(2)  Indicated number of beds is comprised entirely of licensed skilled nursing     facility beds.(3)  Indicated number of beds is comprised entirely of licensed residential care     beds.(4)  Indicated number of beds consists of 92 licensed skilled nursing facility     beds and 6 licensed assisted living facility beds.(5)  Indicated number of beds is comprised entirely of independent living beds.(6)  Indicated number of beds consists of 82 licensed skilled nursing facility     beds and 24 licensed rest home beds.(7)  As of December 31, 2002, the Company had licenses for 6,567 skilled nursing     facility beds, 6 assisted living facility beds, 115 residential care beds     and 24 rest home beds and also operated 49 independent living beds.
The Company maintains its Corporateoffices in Boston as well as regional offices in Palm Harbor, Florida;Beachwood, Ohio, Indianapolis, Indiana; Topsfield, Massachusetts; West Hartford,Connecticut; and Sharon, New Hampshire. The Company considers its properties tobe in good operating condition and suitable for the purposes for which they arebeing used. 

**ITEM 3. LEGAL PROCEEDINGS
The Company is a party toclaims and legal actions arising in the ordinary course of business. Managementdoes not believe that unfavorable outcomes in any such matters, individually orin the aggregate, would have a material adverse effect on the Company’sfinancial condition, results of operations or liquidity. 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submittedto a vote of the Company’s stockholders during the last quarter of theCompany’s fiscal year ended December 31, 2002. 
                                       15
**PART II**

**ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS' MATTERS**

No market information is available because no currentestablished trading market exists for the Company's securities. 

The Company has notdeclared or paid any cash dividends on its common stock since its formation in1996. The Company does not anticipate paying cash dividends on its common stockfor the foreseeable future and intends to retain all of its earnings forreinvestment in the operations and activities of the Company. Any futuredecision as to the payment of dividends will be at the discretion of theCompany’s Board of Directors. The Company’s ability to pay dividendsis also limited by the terms of current (and possibly future) lease andfinancing arrangements that restrict, among other things, the ability of theCompany’s subsidiaries to distribute funds to the Company. 

Information concerningsecurities authorized for issuance under equity compensation plans appears inPart III, Item 12, “Security Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters.” 
                                       16
**ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table setsforth selected consolidated financial data for the Company. The selectedhistorical consolidated financial data for each of the years in the five yearperiod ended December 31, 2002 have been derived from the Company’sconsolidated financial statements, which have been audited byPricewaterhouseCoopers LLP, our independent accountants. The financial data setforth below should be read in conjunction with the Consolidated FinancialStatements and the Notes thereto, and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” includedelsewhere in this report. 
                                          SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA                                           (dollars in thousands, except per share amounts)                                                          YEAR ENDED DECEMBER 31,                                                          -----------------------                                                   1998           1999           2000           2001           2002                                            -----------    -----------    -----------    -----------    -----------Statement of operations data: Total net revenues .....................   $   311,044    $   300,615    $   322,672    $   346,738    $   400,224                                            -----------    -----------    -----------    -----------    -----------Expenses: Facility operating .....................       246,000        248,795        259,780        282,194        332,049 General and administrative .............        15,422         17,808         17,993         19,043         20,220 Service charges paid to former affiliate         1,291          1,173          1,083            979            759 Amortization of prepaid management fee .           500          1,200          1,200          1,200          1,200 Depreciation and amortization ..........         6,350         10,249         10,210          9,355          9,889 Facility rent ..........................        22,412         22,394         24,275         28,889         30,611 Merger costs ...........................        37,172           --             --             --             -- Financial restructuring costs ..........          --             --             --            9,045           -- Facility reorganization costs ..........          --             --             --            1,080           -- Restructuring costs ....................          --            5,745           --             --             -- Financing costs ........................          --             --             --             --            2,835 Loss on termination of capital lease ...          --             --            8,914           --             --                                             ----------    -----------    -----------    -----------    -----------Total expenses ..........................       329,147        307,364        323,455        351,785        397,563                                             ----------    -----------    -----------    -----------    ----------- Income (loss) from operations ..........       (18,103)        (6,749)          (783)        (5,047)         2,661Other: Interest expense, net ..................        11,271         20,895         21,675         11,945          8,056 Other expense (income) .................          (167)           261            (74)          (315)            24                                             ----------    -----------    -----------    -----------    -----------Loss before income taxes ................       (29,207)       (27,905)       (22,384)       (16,677)        (5,419)Income tax expense (benefit) ............        (5,020)       (10,304)        14,322            225            240                                             -----------   -----------    -----------    -----------    -----------Net loss ................................       (24,187)       (17,601)       (36,706)       (16,902)        (5,659)Preferred stock dividends ...............        (2,296)        (6,004)        (6,853)        (3,774)        (2,223)                                             -----------   -----------    -----------    -----------    -----------     Loss applicable to common shares ...    $  (26,483)      $(23,605)   $   (43,559)   $   (20,676)   $    (7,882)                                             ===========   ===========    ===========    ===========    ===========Loss per common share:     Basic and Diluted ..................    $    (3.42)   $     (3.25)   $     (6.00)   $     (2.82)   $     (1.05)                                             ===========    ===========    ===========    ===========    ===========Weighted average number of common shares used in per share computations:    Basic and Diluted ...................     7,742,000      7,261,000      7,261,000      7,335,000      7,541,000                                       17SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued)                                                        (DOLLARS IN THOUSANDS)                                                      YEAR ENDED DECEMBER 31,                                                      -----------------------                                                   1998           1999              2000            2001            2002                                            -----------    -----------       -----------     -----------     -----------Operational data (as of end of year) (1): Facilities .............................            50             50                50              51              55 Licensed beds ..........................         6,120          6,124             6,124           6,274           6,761Average occupancy rate (2) ..............          92.3%          90.9%             90.1%           88.9%           87.8%Patient days (3):Private and other .......................       503,234        489,074           455,491         415,861         391,607Medicare ................................       196,222        219,924           238,574         293,257         352,326Medicaid ................................     1,169,258      1,240,228         1,246,735       1,207,004       1,311,654                                            -----------    -----------       -----------     -----------     -----------Total ...................................     1,868,714      1,949,226         1,940,800       1,916,122       2,055,587                                            ===========    ===========       ===========     ===========     ===========Sources of total net revenues:Private and other (4) ...................          30.2%          28.9%             25.8%           22.6%           19.7%Medicare ................................          27.7%          21.8%             25.0%           30.7%           33.1%Medicaid ................................          42.1%          49.3%             49.2%           46.7%           47.2%Balance sheet data:Working capital .........................   $    36,403    $    36,536       $    33,280     $    22,076     $    32,462Total assets ............................       264,536        283,233           203,097         193,369         221,343Total debt ..............................       134,680        171,245           179,116         116,654         143,318Capital lease obligation ................        55,531         54,700              --              --              --Stockholders' equity (deficit) (5) (6) ..            83        (23,522)          (67,074)        (31,167)        (39,290)(1)  Includes one managed facility with 106 licensed beds.(2)  "Average occupancy rate" is computed by dividing the number of billed bed     days by the total number of available licensed bed days during each of the     periods indicated. This calculation includes all facilities operated by the     Company excluding managed facilities.(3)  "Patient Days" includes billed bed days for the facilities operated by the     Company excluding billed bed days of managed facilities and the one     facility accounted for using the equity method.(4)  Consists primarily of revenues derived from private pay individuals,     managed care organizations, HMO's, hospice programs, commercial insurers,     management fees from managed facilities, and through September 1999,     rehabilitation therapy revenues from non-affiliated facilities.(5)  In accordance with Securities and Exchange Commission requirements, the     carrying amount of the Company's 13.5% Exchangeable Preferred Stock is     excluded from total stockholders' equity (deficit). As of December 31,     1998, 1999 and 2000, the carrying amount of the Company's 13.5%     Exchangeable Preferred Stock was $42,293,000, $48,277,000 and $55,112,000,     respectively.(6)  In accordance with Securities and Exchange Commission requirements, the     carrying amount of the Company's 13% Convertible Exchangeable Preferred     Stock is excluded from total stockholders' equity (deficit). As of December     31, 2001 and 2002, the carrying amount of the Company's 13% Convertible     Exchangeable Preferred Stock was $16,286,000 and $18,509,000, respectively.                                       18
**ITEM 7.MANAGEMENT'S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONSOVERVIEW
Subsidiaries of Harborside Healthcare Corporation, providehigh-quality long-term care, subacute care and specialty medical services in theeastern United States. Harborside Healthcare Corporation has focused onestablishing strong local market positions with high-quality facilities in fourprincipal geographic regions: the Southeast (Florida), the Midwest (Ohio andIndiana), New England (Connecticut, Massachusetts, New Hampshire and RhodeIsland) and the Mid-Atlantic (New Jersey and Maryland). As of December 31, 2002,subsidiaries of Harborside Healthcare Corporation operated 55 facilities (18owned, 36 leased and one managed) with a total of 6,761 licensed beds. Asdescribed in Note A to the audited consolidated financial statements ofHarborside Healthcare Corporation included elsewhere in this report, HarborsideHealthcare Corporation accounts for its investment in one of its ownedfacilities using the equity method of accounting. Subsidiaries of HarborsideHealthcare Corporation (on a consolidated basis, the “Company” or“Harborside”) provide a broad continuum of medical services including:(i) traditional skilled nursing care and (ii) specialty medical services,including a variety of subacute care programs such as orthopedic rehabilitation,CVA/stroke care, cardiac recovery, pulmonary rehabilitation and wound care, aswell as distinct programs for the provision of care to Alzheimer's and hospicepatients. As part of its subacute services, the Company provides physical,occupational and speech rehabilitation therapy services at Company-operatedfacilities. Through September 1999, the Company also provided rehabilitationtherapy services under contracts with non-affiliated long-term care facilitiesthrough a wholly-owned subsidiary. During the third quarter of 1999, the Companyterminated its contracts with non-affiliated facilities and ceased providingtherapy services to non-affiliated facilities. 

The Company was formed inDelaware in March 1996, in anticipation of an initial public offering (the“IPO”), in order to combine under its control the operations ofvarious long-term care facilities and ancillary businesses (the“Predecessor Entities”) which had operated since 1988. The Companycompleted the IPO on June 14, 1996 and issued 3,600,000 shares of common stockat $11.75 per share. The owners of the Predecessor Entities contributed theirinterests in such Predecessor Entities to the Company and received 4,400,000shares of the Company’s common stock. 

On April 15, 1998,Harborside entered into a Merger Agreement with HH Acquisition Corp.(“MergerCo”), an entity organized for the sole purpose of effecting amerger on behalf of Investcorp S.A., certain of its affiliates and certain otherinternational investors (the “New Investors”). On August 11, 1998,MergerCo merged with and into Harborside, with Harborside Healthcare Corporationas the surviving corporation. As a result of the transaction, and pursuant tothe Merger Agreement, the New Investors acquired approximately 91% of thepost-merger common stock of Harborside. The remaining 9% of the common stock wasretained by existing shareholders, including management. As a result of themerger, Harborside shares were de-listed from the New York Stock Exchange. 

The merger was approved bya majority of the Company’s shareholders at a special meeting held onAugust 11, 1998. Each share not retained by existing shareholders was convertedinto $25 in cash, representing in the aggregate, cash payments of approximately$184 million. Holders of outstanding stock options of the Company converted themajority of their options into cash at $25 per underlying share (less applicableexercise price and withholding taxes) with aggregate payments of approximately$8 million. 

In connection with thetransaction and prior to the merger, the New Investors made cash common equitycontributions of $158.5 million, net of issuance costs, to MergerCo, andMergerCo obtained gross proceeds of $99.5 million through the issuance of 11%Senior Subordinated Discount Notes (“Discount Notes”) due 2008 and $40million through the issuance of 13.5% Exchangeable Preferred Stock(“Preferred Stock”) mandatorily redeemable in 2010. In connection withthe merger, Harborside also entered into a new $250 million collateralizedcredit facility. In the third quarter of 1998, Harborside recorded a charge toincome from operations of approximately $37 million for direct and other costsrelated to the Merger transaction. In connection with the merger and the relatedrefinancings, the Company exercised purchase options for seven facilities whichhad been financed through synthetic leases. 

In March 2001, the Companyentered into an agreement (the “Restructuring Agreement”) withInvestcorp S.A. and the holders of more than a majority in interest of theCompany’s Discount Notes and Preferred Stock for purposes of implementing arestructuring of the Discount Notes and Preferred Stock. The RestructuringAgreement contemplated that the Company would offer to exchange for each $1,000amount at maturity of outstanding Discount Notes a combination of the following:(1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the“New Notes”) each having a principal amount at maturity equal to$1,000 and an original issue price of $685.67 (assuming that the New Notes wereissued on May 4, 2001), (2)  $88.2353 in cash and (3) common stockpurchase warrants for approximately 10.9 shares of its Class A CommonStock. The Company would also offer to exchange common stock purchase warrantsfor approximately 10.7 shares of its Class A Common Stock for each $1,000liquidation preference of Preferred Stock (based on the aggregate liquidationpreference to be outstanding on May 1, 2001) plus any dividends accrued on suchPreferred Stock after May 1, 2001. In conjunction with the restructuringproposal, the Company would solicit consents from holders of outstandingDiscount Notes and Preferred Stock to amendments to the Indenture governing theDiscount Notes and to the Certificate of Designation governing the PreferredStock that would eliminate or modify certain restrictive covenants and otherprovisions contained in the Indenture and the Certificate of Designation andwould substantially eliminate the preferences of the Preferred Stock, includingthe reduction of the liquidation preference from $1,000 to $0.01 per share andthe elimination of the right of holders to be paid dividends on shares ofPreferred Stock. Also, the Company would issue to Investcorp S.A. (or one ormore of its affiliates or designees) up to 15,000 shares of a new series of 13%convertible exchangeable preferred stock (the “New Preferred Stock”)and 1,854,422 common stock purchase warrants for a total purchase price of up to$15,000,000. 
                                       19
On April 6, 2001 theCompany initiated the exchange offer and consent solicitation contemplated bythe Restructuring Agreement. On May 10, 2001, the Company completed the exchangeoffer and consent solicitation, thereby implementing each of the elements of theRestructuring Agreement. All of the outstanding Discount Notes and 99.96% of theshares of Preferred Stock were tendered and exchanged in the exchange offer. Asa result of the exchange, (1) the Company had an aggregate principal amount atmaturity of $100,276,000 of New Notes outstanding and an aggregate liquidationpreference of $15,000,000 (as of May 10, 2001) of New Preferred Stockoutstanding, (2) warrants were issued to holders of Discount Notes, toholders of Preferred Stock, and to Investcorp S.A. representing the right topurchase an aggregate of approximately 15%, 5% and 15%, respectively, of thetotal number of shares of all classes of the Company’s common stock on afully diluted basis (excluding shares issuable upon conversion of the NewPreferred Stock, each share of which will initially be convertible into 150shares of Class A Common Stock), and (3) the Company paid $15,000,000in cash as partial consideration for the tendered Discount Notes. 

The reduction in theliquidation preference of the Preferred Stock was completed on May 10, 2001, ascontemplated by the Restructuring Agreement. The carrying amount of thePreferred Stock was reduced from $57,595,000 to $576, and the amount of thereduction, net of unamortized deferred financing costs related to the issuanceof the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directlytransferred to the Company’s Accumulated Deficit account. With the exchangeof the New Notes for the Discount Notes (the “Note Exchange”), thecarrying value of the accreted principal of the Discount Notes was reduced to$68,890,000, and the amount of the reduction, net of the aggregate cash paymentof $15,000,000, was directly transferred to the Company’s Long-term AccruedInterest account. Subsequent to their issuance, the carrying amount of the NewNotes increases as the result of accretion and results in a correspondingdecrease in the carrying amount of Long-term Accrued Interest. Interest expenseon the New Notes is recognized such that a constant effective interest rate isapplied to the aggregate carrying amount of the New Notes and Long-term AccruedInterest for all periods between the issuance date and the maturity date of theNew Notes. 

In connection with anamendment to the Company’s revolving credit facility (the “CreditFacility”) and the implementation of the Restructuring Agreement, theCompany incurred a non-recurring charge of $9,045,000. The charge resulted fromthe write-off of approximately $1,500,000 of unamortized deferred financingcosts incurred when the Credit Facility was obtained, the write-off ofapproximately $3,400,000 of unamortized deferred financing costs related to theissuance of the Discount Notes, and the recognition of various investmentadvisory, legal and other fees associated with these events of $4,145,000. 

The New Notes were issuedat a discount and interest on the New Notes accretes until August 1, 2004. Cashinterest payments will be paid semi-annually in arrears beginning on February 1,2005 based on the fully accreted value of the New Notes and a 12% cash interestpayment rate. The New Notes mature on August 1, 2007. The New Preferred Stock ismandatorily redeemable on February 1, 2008. The holders of the New PreferredStock are entitled to dividends quarterly in arrears beginning August 1, 2001and payable in additional shares of New Preferred Stock. Warrants to purchase atotal of 4,326,641 shares of common stock at $0.01 per share were issued on May10, 2001. 

**REVENUES**

The Company’s totalnet revenues include net patient service revenues, and beginning in 1995,rehabilitation therapy service revenues from contracts with non-affiliatedlong-term care facilities until the third quarter of 1999 when these contractswere terminated. The Company derives its net patient service revenues primarilyfrom private pay sources, the federal Medicare program for certain elderly anddisabled patients and state Medicaid programs for indigent patients. TheCompany’s total net revenues are influenced by a number of factors,including: (i) the licensed bed capacity of its facilities; (ii) the occupancyrates of its facilities; (iii) the payor mix of its facilities and the rates ofreimbursement among payor categories (private and other, Medicare and Medicaid);and (iv) the extent to which subacute and other specialty medical and ancillaryservices are utilized by the patients and paid for by the respective paymentsources. Private net patient service revenues are recorded at established perdiem billing rates. Net patient service revenues to be reimbursed undercontracts with third-party payors, primarily the Medicare and Medicaid programs,are recorded at amounts estimated to be realized under these contractualarrangements. The Company employs specialists to monitor reimbursement rules,policies and related developments in order to comply with all reportingrequirements and to assist the Company in receiving reimbursements. 

The table set forth belowidentifies the percentage of the Company’s total net revenues attributableto each of its payor sources for each of the periods indicated. The increase inMedicare revenues as a percentage of total revenues during fiscal 2001 andfiscal 2002 is significantly affected by changes in the Company’s averageMedicare Part A per diem rate in those years resulting from changes to theMedicare payment system. The Federal government implemented the MedicareProspective Payment System (“PPS”) effective January 1, 1999.Implementation of PPS was effective for all of the Company’s facilitiesbeginning January 1, 1999 and caused the Company’s average Medicare Part Aper diem rate to decrease from $397 per day in 1998 to $290 per day in 1999. OnNovember 29, 1999, the Balanced Budget Refinement Act of 1999 (the“BBRA”) was enacted. The BBRA allowed skilled nursing facilities toelect transition to the full Federal per diem rate at the beginning of theircost reporting periods for periods beginning on or after January 1, 2000. Usingthis election the Company chose to move fourteen facilities to the full Federalper diem rate effective January 1, 2000. Additionally, the BBRA increased theFederal per diem rates by 20% for fifteen RUG categories (three rehabilitativetherapy RUG categories, twelve non-rehabilitative therapy RUG categories)beginning April 1, 2000. The BBRA also provided a temporary four percentincrease in the Federal per diem rates for all RUG categories for a two-yearperiod beginning October 1, 2000. In December 2000, the Medicare, Medicaid, andState Child Health Insurance Program Benefits Improvement and Protection Act of2000 (“BIPA”) was enacted. BIPA temporarily increased the existingnursing rate component of the Federal per diem rate, for each RUG category, by16.66% effective April 1, 2001 through September 30, 2002. In addition, BIPAeliminated the 20% add-ons (provided by the BBRA) for the three rehabilitativetherapy RUG categories and substituted 6.7% add-ons for all fourteenrehabilitative therapy RUG categories. The 6.7% add-ons are scheduled to stay ineffect until CMS implements a revised PPS system as contemplated by the BBRA. OnOctober 1, 2002, certain increases in Medicare reimbursement for skilled nursingfacilities provided for under the BBRA and BIPA expired. The four percent
                                       20
increase in the Federal per diem Medicare Part A rates for allRUG categories granted by the BBRA, which had been in effect since October 1,2000 expired on September 30, 2002. The 16.66% increase to the nursing ratecomponent of the Federal per diem Medicare Part A rates for all RUG categories,which had been in effect since April 1, 2001, expired on September 30, 2002. Inaddition to these reimbursement reductions, effective October 1, 2002, theCompany’s Medicare Part A rates also experienced an increase ofapproximately 2.6% reflecting the Medicare program’s annual inflationaryincrease. The Medicare program increases the Part A rates for skilled nursingfacilities annually on the first of October. Historically, these inflationaryincreases have not kept pace with the rate of inflation experienced by operatorsof skilled nursing facilities. 

The net effect of (i) thetwo reductions in Medicare Part A reimbursement, effective September 30, 2002,and (ii) and the annual inflationary increase effective October 1, 2002, was tolower the Company’s Medicare Part A per diem rate from $358 during thethird quarter of fiscal 2002 to $331 during the fourth quarter of fiscal 2002.The Company’s reduction of $27 per Medicare Part A day had the effect ofreducing revenues by approximately $2,330,000 during the fourth quarter offiscal 2002. The effect of the two reductions by themselves (excluding theeffect of the inflationary increase) was to lower the Company’s MedicarePart A per diem rate by approximately $37 per Medicare Part A day from the thirdquarter of fiscal 2002 to the fourth quarter of fiscal 2002. Assuming that theaverage Medicare Part A daily census experienced by the Company during thefourth quarter of fiscal 2002 was held constant, the impact of the tworeductions in Medicare Part A reimbursement effective September 30, 2002 wouldbe to reduce the Company’s annualized revenues by approximately$12,668,000. 

Primarily as the result ofthe effects of the BBRA, the Company’s average Medicare Part A payment rateincreased from $290 per Medicare patient day during fiscal 1999 to $322 perMedicare patient day during fiscal 2000. Primarily as the result of the effectsof BIPA, the Company’s average Medicare Part A payment rate increased from$322 per Medicare patient day during fiscal 2000 to $340 per Medicare patientday during fiscal 2001 and to $346 per Medicare patient day during 2002. Theincrease in Medicare revenues as a percentage of total net revenues from fiscal2000 to fiscal 2001 was primarily the result of the rate increases noted above.The increase in Medicare revenues as a percentage of total net revenues fromfiscal 2001 to fiscal 2002 was primarily the result of an increase in Medicarepatient days. 
                          TOTAL NET REVENUES (1)                            2000     2001      2002                          ------    ------    ------Private and other.......    25.8%     22.6%     19.7%Medicare ...............    25.0      30.7      33.1Medicaid ...............    49.2      46.7      47.2                          ------    ------    ------  Total ................   100.0%    100.0%    100.0%                          ======    ======    ======(1)  Total net revenues exclude net revenues of the Larkin Chase Center which is     owned by Bowie Center Limited Partnership ("Bowie L.P."). The Company owns     a 75% partnership interest in Bowie L.P. but records its investment in     Bowie L.P. using the equity method of accounting. See Note A to the     Company's consolidated financial statements included elsewhere in this     report.
**OPERATING EXPENSES**

The Company’s facilityoperating expenses consist primarily of payroll and employee benefits related tonursing, rehabilitation therapy services, housekeeping and dietary servicesprovided to patients, as well as maintenance and administration of thefacilities. Other significant facility operating expenses include the cost ofmedical and pharmacy supplies, food, utilities, insurance and taxes. TheCompany’s general and administrative expenses include costs associated withits regional and corporate operations. 

**CRITICAL ACCOUNTING POLICIES**

Our discussion and analysisof the financial condition and results of operations of the Company are based onthe Company’s consolidated financial statements, included elsewhere withinthis report, which have been prepared in accordance with accounting principlesgenerally accepted in the United States of America. The preparation of thesefinancial statements requires the use of estimates and judgments that affect thereported amounts and related disclosures of commitments and contingencies. Werely on historical experience and on various other assumptions that we believeto be reasonable under the circumstances to make judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources. Actual results may differ materially from these estimates. 

**REVENUE RECOGNITION**

Net patient servicerevenues to be reimbursed by contracts with third-party payors, primarily theMedicare and Medicaid programs, are recorded at the amount estimated to berealized under these contractual arrangements. The Company separately estimatesrevenues due from each third-party with which it has a contractual arrangementand records anticipated settlements with these parties in the contractual periodduring which services were rendered. The amounts actually reimbursable underMedicare and Medicaid are determined by filing cost reports, which are thenaudited and generally retroactively adjusted by the payor. Legislative changesto state or Federal reimbursement systems may also retroactively affect recordedrevenues. Changes in estimated revenues due in connection with Medicare andMedicaid may be recorded by the Company subsequent to the year of originationand prior to final settlement based on improved estimates. Such adjustments andfinal settlements with third-party payors, which could materially and adverselyaffect the Company, are reflected in operations at the time of the adjustment orsettlement. 
                                       21
**PROVISION FOR DOUBTFUL ACCOUNTS**

Accounts receivable consistprimarily of amounts due from third party payors (the Medicare and Medicaidprograms, other governmental programs, managed care companies and commercialinsurance companies) as well as amounts due from private individuals. Estimatedprovisions for doubtful accounts are recorded to the extent that it is probablethat a portion or all of a particular account receivable will not be collected.We estimate the provision for doubtful accounts based on a number of factorsincluding payor type, historical collection patterns and the age of thereceivable. Changes in estimates for particular accounts receivable are recordedin the period in which the change occurs. 

**IMPAIRMENT OF PROPERTY AND EQUIPMENT AND INTANGIBLE ASSETS**

The Company reviews thecarrying value of its property and equipment and intangible assets on aquarterly basis. The Company’s review is undertaken to determine if currentfacts and circumstances suggest that the assets have been impaired or that thelives of the assets need to be changed. As part of its review, the Companyconsiders a number of factors including local market developments, changes inthe regulatory environment, historical financial performance, recent operatingresults and projected future cash flows. Any impairment would be recognized inoperating results if a diminution in value considered to be other than temporarywere to occur. During the years ended December 31, 2000, 2001 and 2002, theCompany recognized adjustments to the carrying value of its deferred financingcosts in connection with amendments to the Company’s Credit Facility andthe early termination of a capital lease. (See Notes H and I to theCompany’s consolidated financial statements included elsewhere in thisreport.) During the year ended December 31, 2002, the Company was obligated topurchase two facilities (the “Synthetic Lease Properties”) at apre-determined price ($13,700,000) in connection with the termination andrefinancing of the Company’s Credit Facility. The carrying value of theSynthetic Lease Properties was recorded at the purchase price ($13,700,000),less a charge of $1,700,000 to reflect uncertainties related to the value ofthese properties in connection with the expiration of a significant portion ofMedicare reimbursement effective October 1, 2002. This charge is included as acomponent of the non-recurring Financing Costs totaling $2,835,000 incurredduring the year ended December 31, 2002 in connection with the refinancing ofthe Company’s Credit Facility. 

**INSURANCE RESERVES**

The Company retains a significant amount of self-insurance riskfor its employee health benefits and workers compensation programs, andbeginning on September 1, 2001, its general liability and professional liabilityrisks. The Company maintains stop-loss insurance such that the Company’sliability for health insurance and workers’ compensation losses is limited.At the end of each accounting period, the Company records an accrued expense for(a) estimated health benefit claims including claims incurred but not reportedand (b) estimated workers’ compensation claims including claims incurredbut not reported. The Company estimates these accruals based on a number offactors including historical experience, industry trends, recent claims history,programs implemented to control claims, and actuarial reports. These accrualsare by necessity based on estimates and are subject to ongoing revision asconditions change and as new data presents itself. Adjustments to estimatedliabilities are recorded in the accounting period in which the change inestimate occurs.

During the year ended December 31, 1998, the Company implementeda general and professional liability insurance program which, for the periodfrom September 1, 1998 to August 31, 2001, limited the Company’sself-retention risk for this program to a maximum of $25,000 per year. Thelong-term care industry has seen the cost of maintaining traditionalprofessional liability insurance increase significantly over the past severalyears, especially in the State of Florida. Most insurance companies areunwilling to underwrite new professional liability policies in the State ofFlorida. In May 2001, tort reform legislation was enacted in Florida. Thislegislation provides caps on punitive damages, limits to add-on legal fees,stricter rules of evidence and a shorter statute of limitations period. Giventhe tremendous increase in professional liability premiums and the tort reformlegislation that was enacted in the State of Florida in May 2001, the Companyconcluded that it would be more cost effective to assume a higher level ofretained risk for professional liability claims. As a result, the Companyimplemented a new general and professional liability program, effectiveSeptember 1, 2001, which resulted in the Company maintaining an unaggregatedself-insured retention of $2,000,000 per occurrence for locations outside ofFlorida and completely retaining risk at the Florida facilities. As of December1, 2002, the Company’s unaggregated self-insured retention increased to$10,000,000 per occurrence outside of Florida. The Company maintains an accrualfor estimated unpaid losses including unreported claims.The amount of theaccrual is determined through an estimation process that uses information fromboth the Company’s records as well as industry data. The Company uses anindependent actuary to help estimate the required general and professionalliability accrual. Factors reviewed include the frequency of expected claims,the average cost per claim, emerging industry trends, changes in regulatoryenvironment (such as the recently enacted Florida tort reform legislation) andthe expected effect of various operational and risk management initiatives. TheCompany will continue to evaluate its insurance accrual requirements on aquarterly basis. Required adjustments to the Company’s general andprofessional liability accrual will be recorded in the accounting period inwhich the change in estimate occurs. (See Note M to the Company’sconsolidated financial statements included elsewhere in this report.)

**NEW ACCOUNTING PRONOUNCEMENTS**

In July 2001, the FinancialAccounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 143, “Accounting for AssetRetirement Obligations” (“SFAS 143”). Companies are required toadopt SFAS 143 in their fiscal year beginning after June 15, 2002. SFAS 143requires that obligations associated with the retirement of a tangiblelong-lived asset be recorded as a liability when these obligations are incurred,with the amount of the liability initially measured at fair value. Uponrecognizing a liability, an entity must capitalize the cost by recognizing anincrease in the carrying amount of the related long-lived asset, accrete theliability over time to its present value each period, and depreciate thecapitalized cost over the useful life of the related asset. Upon settlement of
                                       22
the liability, the obligation is either settled for its recorded amount or again or loss is recognized. The Company does not believe that the adoption ofSFAS 143 will have a material impact on its financial position, results ofoperations, or cash flows. 

In July 2002, the FASBissued SFAS No. 146 “Accounting for Costs Associated with Exit or DisposalActivities” (“SFAS 146”). SFAS 146 replaces Emerging Issues TaskForce Issue No. 94-3 “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity”. SFAS 146requires the recognition of costs associated with exit or disposal activitieswhen they are incurred rather than at the date of a commitment to an exit ordisposal plan. SFAS 146 is to be applied prospectively to exit or disposalactivities initiated after December 31, 2002. The Company does not believe thatthe adoption of SFAS 146 will have a material impact on its financial position,results of operations, or cash flows. 

On November 25, 2002, the FASB issued FASB Interpretation No. 45(“FIN 45”), “Guarantor’s Accounting and Disclosure for Guarantees,Including Indirect Guarantees of Indebtedness of Others, an interpretation ofFASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No.34.”  FIN 45 clarifies the requirements of FASB Statement No. 5,“Accounting for Contingencies” (“SFAS 5”), relating to theguarantor’s accounting for, and disclosure of, the issuance of certaintypes of guarantees.  FIN 45 requires that, upon issuance of a guarantee,the guarantor must recognize a liability for the fair value of the obligation. FIN 45 is applicable to guarantees that encompass guarantees based onchanges in an underlying asset, liability or equity security, guarantees thatare made on behalf of another entity’s performance, certain indemnificationagreements and indirect guarantees of the indebtedness of others. Therecognition and measurement provisions of FIN 45 are effective prospectively forguarantees issued or modified after December 31, 2002.  The disclosurerequirements are effective for reporting periods ending after December 15, 2002. The Company has made the required disclosures in the consolidatedfinancial statements as of December 31, 2002 and is in the process of assessingthe impact of FIN 45 recognition and measurement provisions on its consolidatedfinancial statements.  The Company does not believe that the adoption ofFIN 45 will have a significant impact on its financial statements. 

In December 2002, the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure.” SFAS No.148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” toprovide alternative methods of transition for a voluntary change to the fairvalue method of accounting for stock-based employee compensation. In addition,this Statement amends the disclosure requirements of SFAS No. 123 to requireprominent disclosures about the method of accounting for stock-based employeecompensation and the effect of the method used on reported financial results.SFAS No. 148 amends Accounting Principles Board (“APB”) Opinion No.28, “Interim Financial Reporting,” to require these disclosures ininterim financial information. The Company continues to account for theirstock-based employee compensation under APB Opinion 25, but has adopted the newdisclosure requirements of the SFAS No. 148 for the year ended December 31,2002. Additional information related to the Company’s stock option plans isdetailed in Note E of the Notes to the Consolidated Financial Statements.

In January 2003, the FASB issued Interpretation No. 46(“FIN 46”), “Consolidation of Variable Interest Entities, aninterpretation of Accounting Research Bulletin (“ARB”) No. 51(“ARB 51”).“ The primary objectives of FIN 46 are to provideguidance on the identification of, and financial reporting for, entities forwhich control is achieved through means other than through voting rights; suchentities are known as variable-interest entities (“VIEs”). FIN 46 providesguidance that determines (1) whether consolidation is required under the“controlling financial interest” model of ARB 51, “ConsolidatedFinancial Statements,” or (b) other existing authoritative guidance, oralternatively, (2) whether the variable-interest model under FIN 46 should beused to account for existing and new entities. In addition, FIN 46 requires thatboth the primary beneficiary and all other enterprises with a significantvariable interest in a VIE make additional disclosures. FIN 46 is effective forVIEs which are created after January 31, 2003 and for all VIEs for the firstfiscal year or interim period beginning after June 15, 2003. The Company hasevaluated the provisions of FIN 46 and determined that this Interpretation willhave no material effect currently on its consolidated financial statements.

***Year Ended December 31, 2002 Compared to Year Ended December 31, 2001***

*Total Net Revenues*.Total net revenues increased by $53,486,000 or 15.4%, from $346,738,000 in 2001to $400,224,000 in 2002. The increase in total revenues, from 2001 to 2002, wasprimarily due to the operation of five additional facilities. The Company beganoperating a leased skilled nursing facility in Marietta, Ohio on November 1,2001, and four leased skilled nursing facilities in Massachusetts on March 1,2002. Approximately, $28,125,000, or 52.6%, of the increase in revenues from2001 to 2002 resulted from the operation of these five new facilities. Theremainder of the revenue increase was attributable to higher average revenuesper patient day at the Company’s “same store” facilities. Theaverage occupancy rate at the Company’s “same store” facilitiesdecreased from 88.9% for the year ended December 31, 2001 to 88.3% for the yearended December 31, 2002. Average net patient service revenues (includingancillary services) per patient day at the Company’s “same store”facilities increased from $179 for the year ended December 31, 2001 to $194 forthe year ended December 31, 2002. The Company’s “same store”average Medicare Part A per diem rate increased from $340 per Medicare patientday for the year ended December 31, 2001 to $346 per Medicare patient day forthe year ended December 31, 2002, while the Company’s “samestore” average per diem Medicaid rate increased from $134 for the yearended December 31, 2001 to $145 for the year ended December 31, 2002. 

The Balanced BudgetRefinement Act of 1999 (“BBRA”) temporarily increased the Federal perdiem Medicare Part A rates by 20% for fifteen resource utilization groups(“RUG”) categories (three rehabilitative therapy RUG categories,twelve non-rehabilitative RUG categories) beginning on April 1, 2000. Theseincreased rates were to stay in effect until the date on which the Centers forMedicare and Medicaid Services (“CMS”) implements a revisedprospective payment system (“PPS”) that more accurately reimburses thecosts of caring for medically complex patients. The BBRA also provided for afour percent temporary increase in the Federal per diem Medicare Part A ratesfor all RUG categories for a two-year period beginning October 1, 2000. InDecember 2000, the Medicare, Medicaid, and State Child Health Insurance ProgramBenefits Improvement and Protection Act of 2000 (“BIPA”) was enacted.BIPA temporarily increased the existing nursing rate component of the Federalper diem Medicare Part A rate, for each RUG category, by 16.66% effective April
                                       23
1, 2001 through September 30, 2002. In addition, BIPA eliminated the 20% add-ons(provided by the BBRA) for the three rehabilitative therapy RUG categories andsubstituted 6.7% add-ons for all fourteen rehabilitative therapy RUG categories.The 6.7% add-ons are scheduled to stay in effect until CMS implements a revisedPPS system as contemplated by the BBRA 

On September 30, 2002,certain increases in Medicare reimbursement for skilled nursing facilitiesprovided for under the BBRA and BIPA expired: (i) the four percent increase inthe Federal per diem Medicare Part A rates for all RUG categories granted by theBBRA, which had been in effect since October 1, 2000, and (ii) the 16.66%increase to the nursing rate component of the Federal per diem Medicare Part Arates for all RUG categories, which had been in effect since April 1, 2001. Inaddition to these reimbursement reductions, effective October 1, 2002, theCompany’s Medicare Part A rates also experienced an increase ofapproximately 2.6% reflecting the Medicare program’s annual inflationaryincrease. The Medicare program increases the Part A rates for skilled nursingfacilities annually on the first of October. Historically, these inflationaryincreases have not kept pace with the rate of inflation experienced by operatorsof skilled nursing facilities. 

The net effect of (i) thetwo reductions in Medicare Part A reimbursement effective September 30, 2002,(ii) and the annual inflationary increase effective October 1, 2002, was tolower the Company’s Medicare Part A per diem rate from $358 during thethird quarter of fiscal 2002 to $331 during the fourth quarter of fiscal 2002.The Company’s reduction of $27 per Medicare Part A day had the effect ofreducing revenues by approximately $2,330,000 during the fourth quarter offiscal 2002. 

The effect of the tworeductions by themselves (excluding the effect of the inflationary increase) wasto lower the Company’s Medicare Part A per diem rate by approximately $37per Medicare Part A day from the third quarter of fiscal 2002 to the fourthquarter of fiscal 2002. Assuming that the average Medicare Part A daily censusexperienced by the Company during the fourth quarter of fiscal 2002 was heldconstant, the impact of the two reductions in Medicare Part A reimbursementeffective September 30, 2002 would be to reduce the Company’s annualizedrevenues by approximately $12,668,000. 

The Company’s qualitymix of private, Medicare and insurance revenues was 53.3% for the year endedDecember 31, 2001 as compared to 52.8% for the year ended December 31, 2002. 

*Facility OperatingExpenses*. Facility operating expenses increased by $49,855,000, or 17.7%,from $282,194,000 in 2001 to $332,049,000 in 2002. Approximately $25,671,000, or51.5%, of this increase resulted from the operation of the five additionalfacilities. The remainder of the increase in operating expenses in 2002 wasprimarily the result of higher expenditures for employee wages, benefit costsand insurance expense at “same store” facilities. 

*General andAdministrative; Service Charges Paid to Former Affiliate*. General andadministrative expenses increased by $1,177,000 or 6.2%, from $19,043,000 in2001 to $20,220,000 in 2002. The Company reimburses a former affiliate for dataprocessing services provided to the Company. During 2001, such reimbursementstotaled $979,000 compared to $759,000 in 2002. 

*Amortization of PrepaidManagement Fees.*Amortization of prepaid management fees was $1,200,000 in2001 and 2002. (See Note O to the Company’s consolidated financialstatements included elsewhere in this report.) 

*Depreciation and Amortization.*Depreciation andamortization increased from $9,355,000 in 2001 to $9,889,000 in 2002.

*Facility Rent.* Facility rent expense increased by $1,722,000from $28,889,000 in 2001 to $30,611,000 in 2002. Most of the increase in rentexpense was associated with the leasing of the new Ohio facility and the fournew Massachusetts facilities. 

*Financial RestructuringCosts*.In connection with an amendment to the Company’s bankcredit facility and the financial restructuring completed during the year endedDecember 31, 2001, the Company recorded non-recurring charges totaling$9,045,000. The charges resulted from the write-off of unamortized deferredfinancing costs related to obtaining the Company’s bank credit facility andissuing its Discount Notes, and the recognition of various investment advisory,legal and other fees associated with completing the amendment to the bank creditfacility and the financial restructuring. (See Note H to the Company’sconsolidated financial statements included elsewhere in this report.) 

*Facility ReorganizationCosts*. During the year ended December 31, 2001, the Company incurred anon-recurring charge of $1,080,000 in connection with its decision to revise themarketing approach for facilities operated through subsidiaries in Florida. TheCompany determined that a local community-based marketing approach would betterserve the needs of these facilities. The marketing approach stresses ties to thelocal community and required renaming these facilities in order to emphasizethis approach. In connection with this effort, the Company also restructuredcertain of its subsidiaries effective October 1, 2001. In order to implementthis strategy, the Company incurred non-recurring marketing, legal and otherexpenses. 

*Financing Costs.*OnSeptember 13, 2002, the Company entered into a new three-year collateralizedcredit facility (the “Secured Credit Facility”) that provides accessto a maximum of $100 million. Borrowings under the Secured Credit Facility wereused to repay all amounts owed in connection with the termination of theCompany’s previous Credit Facility (including amounts outstanding inconnection with a $13,700,000 synthetic lease obligation) as well as relatedclosing costs and expenses. In connection with entering into the Secured CreditFacility, the Company incurred non-recurring Financing Costs totalingapproximately $2,835,000. This non-recurring charge includes a charge of$1,700,000 recorded in connection with the termination of a synthetic lease fortwo of the Company’s facilities made through the Company’s priorCredit Facility. The significant terms of the Secured Credit Facility and thecomponents of the non-recurring Financing Costs are described in Note H to theconsolidated financial statements included elsewhere in this report. 
                                       24
*Interest Expense,net*. Interest expense, net, decreased from $11,945,000 in 2001 to $8,056,000in 2002. This decrease is primarily the result of the restructuring of theCompany’s Discount Notes which was completed in May 2001. The restructuringof the Discount Notes reduced both the carrying amount of the debt and itseffective interest rate. (See Note H to the Company’s consolidatedfinancial statements included elsewhere in this report.) 

*Income Tax Expense.*For the year ended December 31, 2001, income tax expense was $225,000, allof which related to state income taxes. For the year ended December 31, 2002,income tax expense was $240,000, all of which related to state income taxes.(See Note K to the Company’s consolidated financial statements includedelsewhere in this report.) 

*Net Loss. The Company's net loss decreased from$16,902,000 in 2001 to $5,659,000 in 2002.
***Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
*Total Net Revenues*.Total net revenues increased by $24,066,000 or 7.5%, from $322,672,000 in 2000to $346,738,000 in 2001. The Company began operating a leased facility inMarietta, Ohio on November 1, 2001. This facility generated approximately$1,250,000 of revenues during the year ended December 31, 2001. Most of theremaining increase in total revenues was the result of higher average revenuesper patient day. The average occupancy rate at all of the Company’sfacilities decreased from 90.1% for the year ended December 31, 2000 to 88.9%for the year ended December 31, 2001. Average net patient service revenues(including ancillary services) per patient day at the Company’s facilitiesincreased from $164 for the year ended December 31, 2000 to $179 for the yearended December 31, 2001. The Company’s average Medicare Part A per diemrate increased from $322 per Medicare patient day for the year ended December31, 2000 to $340 per Medicare patient day for the year ended December 31, 2001,while the Company’s average per diem Medicaid rate increased from $127 forthe year ended December 31, 2000 to $134 for the year ended December 31, 2001.The Balanced Budget Refinement Act of 1999 (“BBRA”) temporarilyincreased the Federal per diem Medicare Part A rates by 20% for fifteen RUGcategories (three rehabilitative therapy RUG categories, twelvenon-rehabilitative RUG categories) beginning on April 1, 2000. These increasedrates will stay in effect until the date on which the Centers for Medicare andMedicaid Services (“CMS”), previously known as the Health CareFinancing Administration, implements a revised PPS system that more accuratelyreimburses the costs of caring for medically complex patients. The Companybelieves that it is unlikely that a new PPS system will be implemented prior toOctober 1, 2002. The BBRA also provided for a four percent temporary increase inthe Federal per diem Medicare Part A rates for all RUG categories for a two-yearperiod beginning October 1, 2000. In December 2000, the Medicare, Medicaid, andState Child Health Insurance Program Benefits Improvement and Protection Act of2000 (“BIPA”) was enacted. BIPA temporarily increased the existingnursing rate component of the Federal per diem Medicare Part A rate, for eachRUG category, by 16.66% effective April 1, 2001 through September 30, 2002. Inaddition, BIPA eliminated the 20% add-ons (provided by the BBRA) for the threerehabilitative therapy RUG categories and substituted 6.7% add-ons for allfourteen rehabilitative therapy RUG categories. 

Primarily as the result ofthe Medicare rate increases implemented on April 1, 2000 and 2001, theCompany’s average Medicare Part A payment rate increased from $322 perMedicare patient day for the year ended December 31, 2000 to $340 per Medicarepatient day for the year ended December 31, 2001. The Company’s quality mixof private, Medicare and insurance revenues was 50.8% for the year endedDecember 31, 2000 as compared to 53.3% for the year ended December 31, 2001. 

*Facility OperatingExpenses*. Facility operating expenses increased by $22,414,000, or 8.6%,from $259,780,000 in 2000 to $282,194,000 in 2001. Approximately $1,000,000 ofthis expense increase resulted from the operation of the Company’sMarietta, Ohio facility commencing on November 1, 2001. Most of the remainingincrease in operating expenses in 2001 was the result of higher expenditures foremployee benefit costs and temporary nursing personnel. The increase in employeebenefits costs are driven primarily by higher costs associated with maintainingthe Company’s health insurance plan. The Company’s health insuranceplan expense increased by $2,060,000 from 2000 to 2001. Consistent with otherlong-term care providers, the Company continues to find it difficult to recruitand retain employees, most notably nursing personnel. As a result of thesedifficulties, the Company has been forced to rely more heavily on temporarynursing personnel. The expense associated with temporary nursing personnelincreased by $3,108,000, or 29.6%, from 2000 to 2001. 

*General andAdministrative; Service Charges Paid to Former Affiliate*. General andadministrative expenses increased by $1,050,000 or 5.8%, from $17,993,000 in2000 to $19,043,000 in 2001. The Company reimburses a former affiliate for dataprocessing services provided to the Company. During 2000, such reimbursementstotaled $1,083,000 compared to $979,000 in 2001. 

*Amortization of PrepaidManagement Fees.*Amortization of prepaid management fees was $1,200,000 in2000 and 2001. (See Note N to the Company’s consolidated financialstatements included elsewhere in this report.) 

*Depreciation andAmortization*. Depreciation and amortization decreased from $10,210,000 in2000 to $9,355,000 in 2001. Depreciation expense decreased primarily as theresult of the refinancing of the Company’s four Cleveland-area facilities.On September 27, 2000, the Company terminated its capital leases for theseproperties and entered into new operating leases for each of the Clevelandfacilities. (See Note I to the Company’s consolidated financial statementsincluded elsewhere in this report.) As a result of this transaction, theCompany’s annual depreciation and interest expense decreased byapproximately $1,400,000 and $4,100,000, respectively, while the Company’sannual rent expense increased by approximately $5,900,000. The Company’samortization expense decreased in 2001 primarily as a result of the write-off ofdeferred financing costs in September 2000 and the first half of 2001. Thewrite-off of deferred financing costs in the first half of 2001 were made inconnection with amendments to the Company’s bank credit facility and thefinancial restructuring completed in the second quarter of 2001. 
                                       25
*Facility Rent*.Facility rent expense increased by $4,614,000 from $24,275,000 in 2000 to$28,889,000 in 2001. Most of the increase in rent expense occurred as a resultof the Company terminating capital leases for four facilities in the Clevelandarea in September 2000 and entering into four new operating leases for thesefacilities. 

*Financial RestructuringCosts*.****In connection with an amendment to the Company’s bankcredit facility and the financial restructuring completed during the year endedDecember 31, 2001, the Company recorded non-recurring charges totaling$9,045,000. The charges resulted from the write-off of unamortized deferredfinancing costs related to obtaining the Company’s bank credit facility andissuing its Discount Notes, and the recognition of various investment advisory,legal and other fees associated with completing the amendment to the bank creditfacility and the financial restructuring. (See Note H to the Company’sconsolidated financial statements included elsewhere in this report.) 

*Facility ReorganizationCosts*. During the year ended December 31, 2001, the Company incurred anon-recurring charge of $1,080,000 in connection with its decision to revise themarketing approach for facilities operated through subsidiaries in Florida. TheCompany determined that a local community-based marketing approach would betterserve the needs of these facilities. The marketing approach stresses ties to thelocal community and required renaming these facilities in order to emphasizethis approach. In connection with this effort, the Company also restructuredcertain of its subsidiaries effective October 1, 2001. In order to implementthis strategy, the Company incurred non-recurring marketing, legal and otherexpenses. 

*Interest Expense,net*. Interest expense, net, decreased from $21,675,000 in 2000 to$11,945,000 in 2001. This decrease is the result of the refinancing of theCleveland-area facilities in September 2000 and the restructuring of theCompany’s Discount Notes completed in May 2001. The termination of theCleveland-area capital leases reduced the Company’s interest expense byapproximately $4,100,000 on an annual basis. The restructuring of the DiscountNotes reduced both the carrying amount of the debt and its effective interestrate. (See Note H to the Company’s consolidated financial statementsincluded elsewhere in this report.) 

*Income Tax Expense.*During the year ended December 31, 2000, the Company’s deferred incometax assets were eliminated (through an adjustment to the related valuationallowance) due to uncertainty regarding future realization of these assets,resulting in income tax expense of $14,322,000 for that year. For the year endedDecember 31, 2001, income tax expense (all related to state income taxes) was$225,000. (See Note K to the Company’s consolidated financial statementsincluded elsewhere in this report.) 

*Net Loss. The Company's net loss decreased from$36,706,000 in 2000 to $16,902,000 in 2001.
**LIQUIDITY AND CAPITAL RESOURCES**

The Company’s primarycash needs are for acquisitions, capital expenditures, working capital, debtservice and general corporate purposes. The Company has historically financedthese requirements primarily through a combination of internally generated cashflow, mortgage financing and operating leases, in addition to funds borrowedunder a credit facility. The Company’s existing leased facilities areleased from either the owner of the facilities, or from an investment entitythat has purchased the facilities from the owner. The Company’s existingfacility leases generally require it to make monthly lease payments and pay allproperty operating costs. The Company generally negotiates leases which providefor extensions beyond the initial lease term and an option to purchase theleased facility. In some cases, the option to purchase the leased facility is ata price based on the fair market value of the facility at the time the option isexercised. In other cases, the lease for the facility sets forth a fixedpurchase option price which the Company believes is equal to the fair marketvalue of the facility at the inception date of such lease, thus allowing theCompany to realize the value appreciation of the facility while maintainingfinancial flexibility. 

In connection with theleveraged recapitalization completed on August 11, 1998, the Company obtainedgross proceeds of $99.5 million through the issuance of 11% Senior SubordinatedDiscount Notes (the “Discount Notes”) due 2008 and $40 million throughthe issuance of 13.5% Exchangeable Preferred Stock (the “PreferredStock”) mandatorily redeemable in 2010. Interest on the Discount Notes wasto accrete at 11% per annum until August 1, 2003 and then become payable incash, semi-annually in arrears, beginning on February 1, 2004. Dividends on thePreferred Stock were payable, at the option of the Company, in additional sharesof the Preferred Stock until August 1, 2003. After that date dividends wererequired to be paid in cash. In August 1998, the Company also entered into a$250 million collateralized credit facility (the “Credit Facility”).The terms of the Credit Facility originally provided up to $75 million on arevolving credit basis plus an additional $175 million initially funded on arevolving basis that would convert to a term loan on an annual basis on eachanniversary of the closing. During the first four years of the Credit Facility,any or all of the full $250 million of availability under the Credit Facilitycould be used for synthetic lease financings. Interest was based on either LIBORor prime rates of interest (plus applicable margins determined by theCompany’s leverage ratio) at the election of the Company. The CreditFacility contained various financial and other restrictive covenants and limitedaggregate borrowings under the Credit Facility to a predetermined multiple ofearnings before interest, taxes, depreciation and amortization(“EBITDA”). 

During the first quarter of1999, the Company determined that its anticipated financial results for thatquarter would cause the Company to be out of compliance with certain financialcovenants of the Credit Facility. The Company’s reduced level of EBITDAduring the first quarter of 1999 was attributable to transitional difficultiesassociated with the implementation of the new Medicare prospective paymentsystem which became effective at all of the Company’s facilities on January1, 1999. Such transitional difficulties resulted in lower than expectedrevenues, primarily due to fewer than expected Medicare patient days, lowerMedicare Part A rates, reduced revenues from therapy services provided tonon-affiliated long-term care centers and a reduction in revenues from theprovision of Medicare Part B services at the Company’s own facilities. Inresponse, during the first quarter of 1999, the Company initiated additionalfacility-based training directed towards the documentation requirements of therevised Medicare reimbursement system. The Company also continued to refine its
                                       26
admission and assessment protocols in order to increase patient admissions andintroduced a series of targeted initiatives to lower operating expenses. Suchinitiatives included wage and staffing reductions (primarily related to thedelivery of rehabilitative therapy services and indirect nursing support) andrenegotiation of vendor contracts. All of the staffing reductions wereimplemented, on or prior to, April 1, 1999. Effective March 30, 1999, theCompany obtained an amendment (the “First Amendment”) to the CreditFacility which limited borrowings under the Credit Facility to an aggregate of$58,500,000 (exclusive of undrawn letters of credit outstanding as of March 30,1999) and which modified certain financial covenants. Beginning with the firstquarter of 1999, the First Amendment replaced the original financial covenantswith one new financial covenant, a minimum cumulative amount of EBITDA. Theoriginal financial covenants provided maximum ratios of total indebtedness toEBITDA and senior indebtedness to EBITDA, and a minimum debt service coverageratio. The First Amendment required minimum amounts of EBITDA, measuredquarterly, but calculated on a rolling twelve-month basis, through December 31,2000. As long as the Company met or exceeded the required minimum cumulativeamounts of EBITDA, the Company could access the Credit Facility for generalcorporate purposes, subject to the reduced amount of availability. 

Until September 27, 2000,the Company, through a wholly owned limited partnership, leased and operatedfour facilities in Ohio (the “Cleveland Facilities”) which it acquiredin 1996 through capital leases. Each of the four leases contained an option topurchase the facility beginning July 1, 2001 and each lease was guaranteed bythe Company. The guaranty provided that failure by the Company to have aspecified minimum consolidated net worth at the end of any two consecutivequarters would be an event of default under the guaranty, which in turn would bean event of default under each lease. During the third quarter of 1999, theCompany recorded a $5.7 million restructuring charge to terminate its contractsto provide rehabilitation therapy services to non-affiliated long-term carefacilities. As a result of this restructuring charge, the Company’sconsolidated net worth as of September 30, 1999 (as calculated for purposes ofthis requirement) had fallen below the required level. The Company anticipatedthat its net worth would continue to be below the required level at December 31,1999, which would have resulted in an event of default under each of theseleases with the Company potentially facing the loss of these operations. Suchdefault could also have triggered cross-defaults under the Company’s otherlease and debt obligations. In December 1999, the Company paid $5 million to itslandlord and obtained an option (the “New Option”) to acquire theCleveland Facilities. The Company borrowed $5 million from an affiliate ofInvestcorp S.A. to fund this payment. The New Option allowed the Company toexercise its right to purchase the Cleveland Facilities beginning as of the dateof the New Option, required the Company to complete the acquisition prior toDecember 31, 2000 and provided a waiver of the net worth covenant through thatdate. The Company exercised the New Option on June 30, 2000 and on September 27,2000, the Company terminated the Cleveland Facilities capital leases andassigned its purchase rights for these facilities to an investment entity(organized by Investcorp S.A.) for $5.0 million, which acquired the ClevelandFacilities on September 27, 2000. On that date, the Company entered into newoperating leases for each of the Cleveland Facilities with combined annual rentexpense of approximately $5.9 million. The Company also repaid the $5.0 millionloan from an affiliate of Investcorp S.A. As a result of the capital leasetermination, the Company recorded a non-recurring charge of $8.9 million. (SeeNote I to the Company’s consolidated financial statements includedelsewhere in this report.) The principal components of this charge included thewrite-off of capital leased assets in excess of the related capital leaseobligation ($5.7 million) and the write-off of deferred financing costs ($1.8million) originally incurred in obtaining the Company’s Credit Facility. Inorder to complete the Cleveland Facility leasing transaction, the Company wasrequired to obtain the release of certain collateral held by the bank group thatprovided the Credit Facility. The Company obtained the release of the collateralas part of an amendment (the “Second Amendment”) to the CreditFacility, which also resulted in a permanent reduction of the Company’smaximum borrowings under the Credit Facility from $250 million to $150 millionand an increase in the Company’s borrowing rate. As a result of thepermanent reduction in funds available through the Credit Facility, the Companywas required to write off a proportionate amount of the deferred financing costsincurred when the credit facility was originally obtained. 

On March 28, 2001, theCompany obtained an additional amendment (the “Third Amendment”) tothe Credit Facility in order to be able to complete the financial restructuringof the Company’s Discount Notes and Preferred Stock discussed below. TheThird Amendment resulted in a permanent reduction of the Company’s maximumborrowings under the Credit Facility from $150 million to $60 million, revisedcertain financial covenants, changed the maturity date of the Credit Facility toMarch 31, 2004 and increased the Company’s borrowing rate. The ThirdAmendment also required the Company to repay, on an annual basis, the greater of$5.0 million or 50% of the Company’s excess cash flow (as defined). As aresult of the permanent reduction in funds available through the CreditFacility, the Company was required to write off approximately $2.6 million ofdeferred financing costs incurred when the Credit Facility was obtained. (SeeNote H to the Company’s consolidated financial statements includedelsewhere in this report.) 

In March 2001, the Companyentered into an agreement (the “Restructuring Agreement”) withInvestcorp S.A. and the holders of more than a majority in interest of theCompany’s Discount Notes and Preferred Stock for purposes of implementing arestructuring of the Discount Notes and Preferred Stock. The RestructuringAgreement contemplated that the Company would offer to exchange for each $1,000amount at maturity of outstanding Discount Notes a combination of the following:(1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the“New Notes”) each having a principal amount at maturity equal to$1,000 and an original issue price of $685.67 (assuming that the New Notes wereissued on May 4, 2001), (2)  $88.2353 in cash and (3) common stockpurchase warrants for approximately 10.9 shares of its Class A CommonStock. The Company would also offer to exchange common stock purchase warrantsfor approximately 10.7 shares of its Class A Common Stock for each $1,000liquidation preference of Preferred Stock (based on the aggregate liquidationpreference to be outstanding on May 1, 2001) plus any dividends accrued on suchPreferred Stock after May 1, 2001. In conjunction with the restructuringproposal, the Company would solicit consents from holders of outstandingDiscount Notes and Preferred Stock to amendments to the Indenture governing theDiscount Notes and to the Certificate of Designation governing the PreferredStock that would eliminate or modify certain restrictive covenants and otherprovisions contained in the Indenture and the Certificate of Designation andwould substantially eliminate the preferences of the Preferred Stock, includingthe reduction of the liquidation preference from $1,000 to $0.01 per share andthe elimination of the right of holders to be paid dividends on shares ofPreferred Stock. Also, the Company would issue to Investcorp S.A. (or one ormore of its affiliates or designees) up to 15,000 shares of a new series of 13%convertible exchangeable preferred stock (the “New Preferred Stock”)and 1,854,422 common stock purchase warrants for a total purchase price of up to$15,000,000. 

On April 6, 2001 theCompany initiated the exchange offer and consent solicitation contemplated bythe Restructuring Agreement. On May 10, 2001, the Company completed the exchangeoffer and consent solicitation, thereby implementing each of the elements of the
                                       27
Restructuring Agreement. All of the outstanding Discount Notes and 99.96% of theshares of Preferred Stock were tendered and exchanged in the exchange offer. Asa result of the exchange, (1) the Company had an aggregate principal amount atmaturity of $100,276,000 of New Notes outstanding and an aggregate liquidationpreference of $15,000,000 (as of May 10, 2001) of New Preferred Stockoutstanding, (2) warrants were issued to holders of Discount Notes, toholders of Preferred Stock, and to Investcorp S.A. representing the right topurchase an aggregate of approximately 15%, 5% and 15%, respectively, of thetotal number of shares of all classes of the Company’s common stock on afully diluted basis (excluding shares issuable upon conversion of the NewPreferred Stock, each share of which will initially be convertible into 150shares of Class A Common Stock, and (3) the Company paid $15,000,000in cash as partial consideration for the tendered Discount Notes. 

The reduction in theliquidation preference of the Preferred Stock was completed on May 10, 2001, ascontemplated by the Restructuring Agreement, the carrying amount of thePreferred Stock was reduced from $57,595,000 to $576 and the amount of thereduction, net of unamortized deferred financing costs related to the issuanceof the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directlytransferred to the Company’s Accumulated Deficit account. With the exchangeof the New Notes for the Discount Notes (the “Note Exchange”), thecarrying value of the accreted principal of the Discount Notes was reduced to$68,890,000, and the amount of the reduction, net of the aggregate cash paymentof $15,000,000, was directly transferred to the Company’s Long-term AccruedInterest account. Subsequent to their issuance, the carrying amount of the NewNotes increases as the result of accretion and results in a correspondingdecrease in the carrying amount of Long-term Accrued Interest. Interest expenseon the New Notes is recognized such that a constant effective interest rate isapplied to the aggregate carrying amount of the New Notes and Long-term AccruedInterest for all periods between the issuance date and the maturity date of theNew Notes. 

In connection with theThird Amendment to the Credit Facility and the implementation of theRestructuring Agreement, the Company incurred a non-recurring charge of$9,045,000. The charge resulted from the write-off of approximately $1,500,000of unamortized deferred financing costs incurred when the Credit Facility wasobtained, the write-off of approximately $3,400,000 of unamortized deferredfinancing costs related to the issuance of the Discount Notes, and therecognition of various investment advisory, legal and other fees associated withthese events approximating $4,145,000. 

The New Notes were issuedat a discount and interest on the New Notes accretes until August 1, 2004. Cashinterest payments will be paid semi-annually in arrears beginning on February 1,2005 based on the fully accreted value of the New Notes and a 12% cash interestpayment rate. The New Notes mature on August 1, 2007. The New Preferred Stock ismandatorily redeemable on February 1, 2008. The holders of the New PreferredStock are entitled to dividends quarterly in arrears beginning August 1, 2001and payable in additional shares of New Preferred Stock. Warrants to purchase atotal of 4,326,641 shares of common stock at $0.01 per share were issued on May10, 2001. 

On September 13, 2002, theCompany entered into a new credit facility (the “Secured CreditFacility”). Borrowings under the Secured Credit Facility were used to repayall amounts owed in connection with the Credit Facility (including the$13,700,000 purchase obligation associated with a synthetic lease made throughthe Credit Facility) and the Credit Facility was terminated. As a result of thetermination of the Credit Facility, the Company wrote off approximately $666,000of unamortized deferred financing costs incurred when the Credit facility wasobtained, recognized a $1,700,000 charge in connection with the termination ofthe synthetic lease and $469,000 of other costs related to the termination ofthe Credit Facility. 

As of December 31, 2002,total borrowings under the Secured Credit Facility were approximately$60,420,000 and consisted of borrowings under the term loan of approximately$43,015,000 and $17,405,000 of undrawn letters of credit. As of December 31,2002, the Company had approximately $24,580,000 of funding available under theSecured Credit Facility. 

The Company’soperating activities in 2001 provided net cash of $19,235,000 as compared toproviding net cash of $17,116,000 in 2002. 

Net cash used by investingactivities was $13,061,000 during 2001 as compared to $23,687,000 used in 2002.The primary use of cash for investing purposes during 2001 was to fund additionsof property and equipment associated with the maintenance of the Company’slong-term care facilities. The primary use of cash for investing purposes during2002 was to fund additions to property and equipment. During the year endedDecember 31, 2002, $13,700,000 of cash was used to fund the termination of asynthetic lease for two of the Company’s properties. During the period thesynthetic lease was in effect, the operating results of these facilities wereincluded with the operating results of the Company; however, in accordance withaccounting for synthetic leases, the fixed assets of these properties and therelated debt of $13,700,000, were not included in the Company’sconsolidated balance sheet. Rather than recognizing interest on the $13,700,000purchase commitment then outstanding, as well as depreciation on the fixedassets of the two facilities, the Company recognized as rent expense thepayments made in connection with the synthetic lease. The Company’s“Additions to Property and Equipment” for the year ended December 31,2002 include approximately $9,609,000 with respect to the termination of thesynthetic lease and acquisition of the two properties. Most of the remainder ofthe cash used during 2002 to fund additions of property and equipment wasassociated with the maintenance of the Company’s long-term care facilities.The Company used approximately $6,219,000 to fund additions to deferredfinancing and other intangibles. Of this amount, approximately $2,391,000reflected the recording of goodwill in connection with the acquisition of twoproperties that the Company had previously leased by means of a synthetic lease.Additionally, the Company incurred approximately $3,821,000 of deferredfinancing costs in connection with obtaining the Secured Credit Facility. 

Net cash used by financingactivities was $7,649,000 in 2001 as compared to net cash provided by financingactivities of $17,490,000 in 2002. The financing activities during the yearended December 31, 2001 included the issuance of $15,000,000 of New PreferredStock, a payment of $15,000,000 to the holders of the Discount Notes and arepayment of $7,500,000 of borrowings outstanding under the Credit Facility. Thefinancing activities during the year ended December 31, 2002 included$43,015,000 of borrowings under the Secured Credit Facility and the repaymentof all amounts ($25,250,000, including $23,250,000 paid attermination) due under the Credit Facility, excluding the $13,700,000purchase obligation associated with a synthetic lease. 
                                       28
As of December 31, 2002, inaddition to borrowings outstanding under the Secured Credit Facility and theDiscount Notes (which had an accreted balance of $83,399,000), the Company hadtwo mortgage loans outstanding totaling $16,904,000. One mortgage loan had anoutstanding principal balance of $15,422,000 of which $14,880,000 is due atmaturity in 2004. This loan bears interest at an annual rate of 10.65% plusadditional interest equal to 0.3% of the difference between the operatingrevenues of the four mortgaged facilities in each applicable year and operatingrevenues during the twelve-month base period. The Company’s other mortgageloan, which encumbers a single facility, had an outstanding principal balance of$1,482,000 at December 31, 2002, of which $1,338,000 is due in 2010. 

Harborside expects that itscapital expenditures for 2003, excluding acquisitions of new long-term carefacilities, will aggregate approximately $6,000,000. Harborside’s expectedcapital expenditures will relate to maintenance capital expenditures, systemsenhancements, special construction projects and other capital improvements.Harborside expects that its future facility acquisitions will be financedprimarily through operating leases or assumed debt. Harborside may be requiredto obtain additional equity financing to finance any significant acquisitions inthe future, to refinance the New Notes when they mature on August 1, 2007 or torefinance the New Preferred Stock when it becomes mandatorily redeemable onFebruary 1, 2008. 

The Company owns a 75%interest in a partnership that owns one facility. The Company accounts for itsinvestment in this partnership using the equity method. The Company hasguaranteed a loan of approximately $5,600,000 made to this partnership torefinance a loan that funded the construction of the facility and providedworking capital. The loan is also collateralized by additional collateralpledged by the non-affiliated partner. The loan was to mature on May 31, 2002,but was extended by the lender. The loan currently matures on March 31,2003, butthe Partnership is currently negotiating replacement financing with the lenderon terms substantially similar to the existing financing. The partnershipagreement states that each partner will contribute an amount in respect of anyliability incurred by a partner in connection with a guarantee of thepartnership’s debt, so that partners each bear their proportionate share ofany liability based on their percentage ownership of the partnership. 

The Company is highlyleveraged, which makes it vulnerable to changes in general economic conditions.The Company’s ability to repay or refinance its debt will depend on, amongother things, financial, business, market, competitive and other conditions,many of which are beyond the control of the Company. The Company believes that,taken together, its current cash balances, internally generated cash flow andavailability under its credit facilities should result in the Company havingadequate cash resources to meet its debt service and other financial obligationsfor at least the next twelve months. 

**CONTRACTUAL OBLIGATIONS**

The following tableprovides information about the Company’s contractual obligations as ofDecember 31, 2002, excluding current liabilities except for the current portionof long-term debt. 
                                 Payments due by Years                                   Total           2003      2004 and 2005  2006 and 2007    After 2007                                ------------   ------------   ------------   ------------   ------------Long-term debt ................ $143,318,000   $    303,000   $ 58,196,000   $ 83,440,000   $  1,379,000Preferred Stock ...............   35,469,000           --             --             --       35,469,000Operating leases ..............  209,567,000     29,885,000     60,098,000     40,366,000     79,218,000                                ------------   ------------   ------------   ------------   ------------Total contractual and cashobligations ................... $388,354,000   $ 30,188,000   $118,294,000   $123,806,000   $116,066,000                                ============   ============   ============   ============   ============
The Company issued$15,000,000 of New Preferred Stock on May 10, 2001. As long as theCompany’s New Notes remain outstanding, the New Preferred Stock is entitledto dividends at a rate of 13% per annum compounded quarterly and payable inadditional shares of New Preferred Stock. The New Preferred Stock is mandatorilyredeemable on February 1, 2008. 

During the year endedDecember 31, 1998, the Company implemented a general and professional liabilityinsurance program that, for the period from September 1, 1998 to August 31,2001, limited the Company’s self-retention risk for this program to amaximum of $25,000 per year. The long-term care industry has seen the cost ofmaintaining traditional professional liability insurance increase significantlyover the past several years, especially in the State of Florida. Most insurancecompanies are unwilling to underwrite new professional liability policies in theState of Florida. In May 2001, tort reform legislation was enacted in Florida.This legislation provides caps on punitive damages, limits to add-on legal fees,stricter rules of evidence and a shorter statute of limitations period. Giventhe tremendous increase in professional liability premiums and the tort reformlegislation that was enacted in the State of Florida in May 2001, the Companyconcluded that it would be more cost effective to assume a higher level ofretained risk for professional liability claims. As a result, the Companyimplemented a new general and professional liability program, effectiveSeptember 1, 2001, which resulted in the Company maintaining an unaggregatedself-insured retention of $2,000,000 per occurrence for locations outside ofFlorida and completely retaining risk at the Florida facilities. As of December1, 2002, the Company’s unaggregated self-insured retention increased to$10,000,000 per occurrence outside of Florida. As of December 31, 2002, theCompany maintained a Claims Reserve in the amount of $8,721,000 for incurred butnot reported claims. The amount of the reserve was determined through anestimation process that used information from both the Company’s records aswell as industry data. The Company uses an independent actuary to help estimatethe required general and professional liability reserve. Factors reviewedinclude the frequency of expected claims, the average cost per claim, emergingindustry trends, changes in regulatory environment (such as the recently enacted
                                       29
Florida tort reform legislation) and the expected effect of various operationaland risk management initiatives. The Company will continue to evaluate itsinsurance reserve requirements on a quarterly basis. Required adjustments to theCompany’s general and professional liability reserve will be recorded inthe accounting period in which the change in estimate occurs. There can be noassurances the recent Florida tort reform legislation will have a positiveimpact on claims activity, that the coverage limits of the Company’sinsurance program will be adequate or that insurance will continue to beavailable to the Company in the future. (See Note M to the Company’sconsolidated financial statements included elsewhere in this report.) 

The Health InsurancePortability and Accountability Act of 1996 (“HIPAA”) broadened thescope of fraud and abuse laws to include all health plans, whether or not theyare reimbursed under Federal programs. HIPAA also mandated the adoption offederal regulations designed to (a) standardize transaction formats and billingcodes for documenting health care services, determining eligibility andprocessing claims for payment; and (b) protect the privacy and security ofindividually identifiable health information. Final HIPAA regulations thatstandardize transactions and code sets were issued during the third quarter of2000. The ultimate compliance date was subsequently modified by legislation torequire health care providers and health plans to either comply with the HIPAAtransaction code set standards beginning in October of 2002 or submit a writtenplan to the federal government by October of 2002 describing specific plans forcompliance by October of 2003. The regulations do not require healthcareproviders to submit claims electronically, but do require standard formattingfor those that do so. The Company currently submits most claims electronicallyand expects to continue to do so. The Company is currently evaluating its plansfor compliance by October of 2002 or submitting the required plan describing itsplans for compliance by October of 2003. 

Final HIPAA privacyregulations were published during the fourth quarter of 2000. However, on March27, 2002, the U.S. Department of Health and Human Services published in theFederal Register a proposed rule which if finally adopted would modify theregulations published during 2000. In general, the regulations apply to“protected health information”, which is defined as individuallyidentifiable health information transmitted or maintained in any form or medium,excluding certain education records and student medical records. The privacyregulations seek to limit the use and disclosure of most paper and oralcommunications, as well as those in electronic form, regarding anindividual’s past, present or future physical or mental health orcondition, or relating to the provision of health care to the individual orpayment of that health care. The regulations further impose requirements onhealth care providers to contractually obligate certain of their contractors whomay receive protected health care information during the course of renderingservices on behalf of such health care provider to abide by certain privacyrequirements as well. In addition, the current HIPAA regulations provide thatcertain state privacy laws may not be preempted by HIPAA. Accordingly, theCompany, in certain instances, will remain subject to various state privacy lawsin jurisdictions in which it currently operates facilities. HIPAA provides forthe imposition of civil and criminal penalties if protected health informationis improperly disclosed. The Company must comply with the privacy regulations byApril of 2003. Given the issuance of the recent proposed rulemaking, it isuncertain the extent to which the regulations that were published in 2000 willchange. The Company is continuing to evaluate the impact of the privacyregulations on its operations. 

HIPAA’s securityregulations have not been finalized. The proposed security regulations specifyadministrative procedures, physical safeguards, and technical services andmechanisms designed to ensure that protected health information remains secure.The proposed security rules contemplate a compliance date of 24 months after theeffective date of the final rule published in the Federal Register, although itis possible that such compliance date will differ and could align with thecompliance date for the privacy regulations depending on when the securityregulations are ultimately finalized. 

The Company is currentlyworking in conjunction with its software vendors to evaluate the impact of HIPAAregulations on the Company’s systems and operating procedures. The Companyhas not yet completed its analysis or its estimate of the expected costs ofcompliance with the HIPAA regulations. There can be no assurances thatcompliance with HIPAA regulations will not have an adverse effect on theCompany’s results of operations, cash flows or its financial position. 

**SEASONALITY**

Harborside’s earningsgenerally fluctuate from quarter to quarter. This seasonality is related to acombination of factors which include, among other things, the timing of Medicaidand Medicare rate increases, seasonal census cycles and the number of calendardays in a given quarter. 

**INFLATION**

The healthcare industry islabor intensive. Wages and other labor related costs are especially sensitive toinflation. Shortages in the labor market or general inflationary pressure couldhave a significant effect on the Company. In addition, suppliers attempt to passalong rising costs to the Company in the form of higher prices. When faced withincreases in operating costs, the Company has generally increased its chargesfor services. The Company’s operations could be adversely affected if it isunable to recover future cost increases or if it experiences significant delaysin Medicare and Medicaid revenue sources increasing their rates ofreimbursement. 
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**ITEM 7A.**

**QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

Most of the Company’sdebt obligations bear interest at fixed rates and are not affected by changes inmarket interest rates; however, borrowings under the Company’s SecuredCredit Facility are sensitive to changes in interest rates. Under the Secured

Credit Facility, interest is based on either LIBOR or prime rates of interest,at the Company’s election, plus applicable margins, and, for the term loan,subject to a floor of 7%. As the prime and LIBOR rates of interest increase,interest expense associated with the Company’s borrowings under the SecuredCredit Facility would also increase, subject to existing floors and the impactof any hedging activities. An increase of 1% in the applicable rate wouldincrease the Company’s annual interest cost by approximately $430,000. 

The Company did notexperience significant changes in interest rates during the year ended December31, 2002. As part of the Company’s risk management program, the Companycontinuously reviews its overall exposure to interest rate risk and evaluatesthe benefits of interest rate hedging through the use of derivative instruments,such as interest rate swaps or caps. By entering into an interest rate swap orcaps, the Company can effectively transform variable rate debt into fixed ratedebt. The Company did not have any interest rate swap arrangements outstandingduring the year ended December 31, 2001. As described in Note H to theconsolidated financial statements of the Company included elsewhere in thisreport, the Company purchased a $40,000,000 interest rate cap effectiveSeptember 1, 2002. 

**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
**INDEX TO FINANCIAL STATEMENTS**
HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES:Report of Independent Accountants.........................................................32Consolidated Balance Sheets as of December 31, 2001 and 2002..............................33Consolidated Statements of Operations for the years ended December 31, 2000, 2001 and 2002......................................................................34Consolidated Statements of Changes in Stockholders' Deficit for the years ended December 31, 2000, 2001 and 2002.........................................................35Consolidated Statements of Cash Flows for the years ended December 31,2000, 2001 and 2002.......................................................................36Notes to Consolidated Financial Statements................................................37                                       31                                                   REPORT OF INDEPENDENT ACCOUNTANTSTo the Stockholders and Board of Directors ofHarborside Healthcare CorporationIn our opinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations, changes in stockholders’ deficit,and cash flows present fairly, in all material respects, the financial positionof Harborside Healthcare Corporation and its subsidiaries (the“Company”) at December 31, 2002 and 2001, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2002 in conformity with accounting principles generally accepted inthe United States of America. These financial statements are the responsibilityof the Company’s management; our responsibility is to express an opinion onthese financial statements based on our audits. We conducted our audits of thesestatements in accordance with auditing standards generally accepted in theUnited States of America, which require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion./s/ PricewaterhouseCoopers LLPBoston, MassachusettsMarch 28, 2003                                       32                                         HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                                      CONSOLIDATED BALANCE SHEETS                                      (dollars in thousands, except share and per share amounts)                                                               AS OF DECEMBER 31,                                                                                2001         2002                                                                           ---------    ---------        ASSETSCurrent assets:  Cash and cash equivalents ............................................   $   9,249    $  20,168  Accounts receivable, net of allowances for doubtful     accounts of $3,979 and $6,555 respectively ........................      45,502       46,978  Prepaid expenses and other ...........................................      11,628       15,153                                                                           ---------    ---------      Total current assets .............................................      66,379       82,299Restricted cash (Note C) ...............................................       5,898        6,611Property and equipment, net (Note D) ...................................     108,989      116,705Deferred financing and other intangibles, net (Note E) .................       3,916        8,153Other assets, net (Notes O and H) ......................................         700           88Note receivable (Note F) ...............................................       7,487        7,487                                                                           ---------    ---------    Total assets .......................................................   $ 193,369    $ 221,343                                                                           =========    =========        LIABILITIESCurrent liabilities:  Current maturities of long-term debt (Note H) ........................   $   2,776    $     303  Accounts payable .....................................................      14,711       14,648  Employee compensation and benefits ...................................      19,270       26,039  Other accrued liabilities ............................................       6,878        5,960  Accrued interest .....................................................         147          482  Current portion of deferred income ...................................         521          395                                                                           ---------    ---------    Total current liabilities ..........................................      44,303       47,827Claims reserve (Note M) ................................................       1,467        8,721Long-term portion of deferred income (Note G) ..........................       1,487          894Long-term debt (Note H) ................................................     113,878      143,015Long-term accrued interest (Note H) ....................................      47,115       41,667                                                                           ---------    ---------    Total liabilities ..................................................     208,250      242,124                                                                           ---------    ---------Commitments and contingencies (Notes G and M)13% Convertible exchangeable preferred stock, redeemable, $.01 par value with a liquidation value of $1,000 per share; 100,000 shares authorized;  16,286 and 18,509 shares issued and outstanding, respectively (Note L)      16,286       18,509        STOCKHOLDERS' DEFICIT (Note L)Common stock, $.01 par value, 40,700,000 shares authorized and 15,275,664 shares issued ...............................         153          153Additional paid-in capital .............................................     187,976      185,753Common stock in treasury, at cost, 7,379,165 and7,398,498 shares, respectively .........................................    (183,746)    (183,746)Accumulated other comprehensive loss ...................................        --           (241)Accumulated deficit ....................................................     (35,550)     (41,209)                                                                           ---------    ---------    Total stockholders' deficit ........................................     (31,167)     (39,290)                                                                           ---------    --------- Total liabilities and stockholders' deficit ...........................   $ 193,369    $ 221,343                                                                           =========    =========
The accompanying notes arean integral part of the consolidated financial statements. 
                                       33                                          HARBORSIDE HEATHCARE CORPORATION AND SUBSIDIARIES                                                 CONSOLIDATED STATEMENTS OF OPERATIONS                                           (dollars in thousands, except per share amounts)                                                   FOR THE YEARS ENDED DECEMBER 31,                                                         2000         2001       2002                                                      ---------    ---------    -------Total net revenues ................................   $ 322,672    $ 346,738    $ 400,224                                                      ---------    ---------    ---------Expenses:  Facility operating ..............................     259,780      282,194      332,049  General and administrative ......................      17,993       19,043       20,220  Service charges paid to former affiliate (Note O)       1,083          979          759  Amortization of prepaid management fee (Note O) .       1,200        1,200        1,200  Depreciation and amortization ...................      10,210        9,355        9,889  Facility rent ...................................      24,275       28,889       30,611  Loss on termination of capital lease (Note I) ...       8,914         --           --  Financial restructuring cost (Note H) ...........        --          9,045         --  Facility reorganization costs (Note P) ..........        --          1,080         --  Financing costs (Note H) ........................        --           --          2,835                                                      ---------    ---------    ---------   Total expenses .................................     323,455      351,785      397,563                                                      ---------    ---------    --------- Income (loss) from operations ....................        (783)      (5,047)       2,661Other:Interest expense, net .............................      21,675       11,945        8,056  Other (income) expense ..........................         (74)        (315)          24                                                      ---------    ---------    ---------Loss before income taxes ..........................     (22,384)     (16,677)      (5,419)Income tax expense (Note K) .......................      14,322          225          240                                                      ---------    ---------    ---------Net loss ..........................................     (36,706)     (16,902)      (5,659)Preferred stock dividends .........................      (6,853)      (3,774)      (2,223)                                                      ----------    ---------   ---------Loss applicable to common shares ..................   $ (43,559)    $(20,676)   $  (7,882)                                                      ==========    ========    =========Loss per common share (Note L):         Basic and Diluted ........................   $   (6.00)    $  (2.82)   $   (1.05)                                                      =========     ========    =========
The accompanying notes arean integral part of the consolidated financial statements. 
                                       34                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                      CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT                                                        (dollars in thousands)                                         FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 and 2002                                                                                        Accumulated                                                                 Additional                Other                                                      Common      Paid-in     Treasury  Comprehensive  Accumulated                                                      Stock       Capital       Stock       Loss         Deficit      Total                                                    ---------   ---------    ---------    ---------    ---------    ---------Stockholders' deficit, December 31, 1999 ........         146     198,603     (183,746)        --        (38,525)     (23,522)   Preferred stock dividends ....................        --        (6,853)        --           --           --         (6,853)   Issuance of restricted shares (664,500 shares)           7        --           --           --           --              7   Net loss .....................................        --          --           --           --        (36,706)     (36,706)                                                    ---------   ---------    ---------    ---------    ---------    ---------Stockholders' deficit, December 31, 2000 ........         153     191,750     (183,746)        --        (75,231)     (67,074)   Preferred stock dividends ....................        --        (3,774)        --           --           --         (3,774)   Reduction of liquidation preference and    exchange of 131/2% exchangeable    preferred stock (Note L) ....................        --          --           --           --         56,583       56,583   Net loss .....................................        --          --           --           --        (16,902)     (16,902)                                                    ---------   ---------    ---------    ---------    ---------    ---------Stockholders' deficit, December 31, 2001 ........         153     187,976     (183,746)        --        (35,550)     (31,167)                                                    ---------   ---------    ---------    ---------    ---------    ---------  Preferred stock dividends .....................        --        (2,223)        --           --           --         (2,223)  Comprehensive loss:   Net loss .....................................        --          --           --           --         (5,659)      (5,659)   Unrealized loss on derivative instrument .....        --          --           --           (241)        --           (241)                                                    ---------   ---------    ---------    ---------    ---------    ---------     Total comprehensive loss ...................        --          --           --           (241)      (5,659)      (5,900)                                                    ---------   ---------    ---------    ---------    ---------    ---------Stockholders' deficit, December 31, 2002 ........   $     153   $ 185,753    $(183,746)   $    (241)   $ (41,209)   $ (39,290)                                                    =========   =========    =========    =========    =========    =========
The accompanying notes are anintegral part of the consolidated financial statements. 
                                       35                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                                 CONSOLIDATED STATEMENTS OF CASH FLOWS                                                        (dollars in thousands)                                                   FOR THE YEARS ENDED DECEMBER 31,                                                           2000        2001        2002                                                       --------    --------    --------Operating activities:Net loss ...........................................   $(36,706)   $(16,902)   $ (5,659)Adjustments to reconcile net loss to net  cash provided (used) by operating activities:Depreciation of property and equipment .............      7,776       7,682       8,710Amortization of deferred financing and other non-current assets ................................      2,434       1,673       1,179             Amortization of prepaid management fee       1,200       1,200       1,200Amortization of deferred income ....................       (680)       (518)       (489)Accretion of senior subordinated discount notes ....     13,095      10,400       9,174Amortization of long-term accrued interest .........       --        (3,002)     (5,448)Amortization of loan costs  and fees (included in rental and interest expense)        143         143         137Accretion of interest on capital lease obligation ..      2,753        --          --Noncash lease termination costs ....................      7,542        --          --Noncash issuance of restricted shares ..............          7        --          --Noncash financial restructuring charge .............       --         4,896        --Noncash charges related to refinancing .............       --          --           436                                                       --------    --------    --------                                                         (2,436)      5,572       9,240Changes in operating assets and liabilities: (Increase) decrease in accounts receivable ........      1,509       3,157      (1,476) (Increase) decrease in prepaid expenses and other .      6,343       1,552      (4,025) Decrease in deferred income taxes .................     14,252        --          -- Increase (decrease) in accounts payable ...........      1,555       3,828         (63) Increase in employee compensation and benefits ....      1,844       3,405       6,769 Increase (decrease) in accrued interest ...........       (102)       (323)        335 Increase (decrease) in other accrued liabilities ..        793         577        (918) Increase in income taxes payable ..................      2,608        --          -- Increase in claims reserve accrual ................       --         1,467       7,254                                                       --------    --------    --------  Net cash provided by operating activities ........     26,366      19,235      17,116                                                       --------    --------    --------Investing activities: Additions to property and equipment ...............     (6,199)    (11,582)    (16,426) Additions to deferred financing and other  non-current assets ...............................       (118)       (386)     (6,219) Transfers to restricted cash, net .................     (2,385)     (1,093)       (713) Purchase of interest rate cap .....................       --          --          (329)                                                       --------    --------    -------- Net cash used by investing activities .............     (8,702)    (13,061)    (23,687)                                                       --------    --------    --------Financing activities: Issuance of New Preferred Stock ...................       --        15,000        -- Payment to holders of Discount Notes ..............       --       (15,000)       -- Receipt of cash in connection with lease ..........       --           102        -- Repayment of revolving line of credit .............       --        (7,500)    (25,250) Borrowings under secured credit facility ..........       --          --        43,015 Payment of note payable to affiliate ..............     (5,000)       --          -- Payment of long-term debt .........................       (224)       (245)       (275) Principal payments of capital lease obligation ....     (3,084)       --          -- Dividends paid on exchangeable preferred stock ....        (18)         (6)       --                                                       --------    --------    --------   Net cash provided (used) by financing activities      (8,326)     (7,649)     17,490                                                       --------    --------    --------Net increase (decrease) in cash and cash equivalents      9,338      (1,475)     10,919Cash and cash equivalents, beginning of year .......      1,386      10,724       9,249                                                       --------    --------    --------Cash and cash equivalents, end of year .............   $ 10,724    $  9,249    $ 20,168                                                       ========    ========    ========Supplemental Disclosure:  Interest paid ....................................   $  7,129    $  6,163    $  4,877  Income taxes paid ................................   $    130    $    257    $    226  Accretion of preferred dividends .................   $  6,835    $  3,768    $  2,223
The accompanying notes arean integral part of the consolidated financial statements. 
                                       36HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSA. NATURE OF BUSINESS
 Subsidiaries of Harborside Healthcare Corporation, on aconsolidated basis, (the "Company" or "Harborside"), operate long-term carefacilities and, until September 1999, provided rehabilitation therapy servicesto non-affiliated long-term care facilities. As of December 31, 2002, theCompany owned eighteen facilities, operated thirty-six additional facilitiesunder various leases and managed one facility. The Company accounts for itsinvestment in one 75% owned facility using the equity method of accounting.
B. BASIS OF PRESENTATION
The Company wasincorporated in Delaware on March 19, 1996 and was formed as a holding companyin anticipation of an initial public offering (the “IPO”), to combineunder the control of a single corporation the operations of various businessentities which were all under the majority control of several relatedstockholders. 

On April 15, 1998, theCompany entered into a Merger Agreement (the “Merger”) with HHAcquisition Corp. (“MergerCo”), an entity organized for the solepurpose of effecting a merger on behalf of Investcorp S.A., certain of itsaffiliates and certain other international investors (the “NewInvestors”). The New Investors made common equity cash contributionstotaling $165 million ($158.5 million, net of issuance costs). On August 11,1998, MergerCo merged with and into the Company, with Harborside HealthcareCorporation as the surviving corporation. As a result of the transaction, andpursuant to the Merger, the New Investors acquired approximately 91% of thepost-merger common stock of the Company. The remaining 9% of the common stockwas retained by existing shareholders, including management. As a result of theMerger, the Company’s shares were de-listed from the New York StockExchange. 

The Merger was approved bya majority of the Company’s shareholders at a special meeting held onAugust 11, 1998. Each share not retained by existing shareholders was convertedinto $25 in cash, representing in the aggregate, cash payments of approximately$184 million. The converted shares (7,349,832 shares) were recorded at cost astreasury stock and represent a deduction from the Company’sstockholders’ deficit. Holders of outstanding stock options of the Companyconverted the majority of their options into cash at $25 per underlying share(less applicable exercise price and withholding taxes) with aggregate paymentsof approximately $8 million. 

In connection with thetransaction and prior to the Merger, the New Investors made cash common equitycontributions of $158.5 million, net of issuance costs, to MergerCo, andMergerCo obtained gross proceeds of $99.5 million through the issuance of 11%Senior Subordinated Discount Notes (“Discount Notes”) due 2008 and $40million through the issuance of 13.5% Exchangeable Preferred Stock(“Preferred Stock”) mandatorily redeemable in 2010. In the thirdquarter of 1998, Harborside recorded a charge to income from operations of $37million for direct and other costs related to the Merger transaction. Inconnection with the Merger and the related refinancings, the Company exercisedpurchase options for seven facilities which had been previously financed throughsynthetic leases. 
C. SIGNIFICANT ACCOUNTING POLICIES
The Company uses thefollowing accounting policies for financial reporting purposes: 

Principles of Consolidation

The consolidated financialstatements include the accounts of the Company and its subsidiaries. Allsignificant intercompany transactions and balances have been eliminated inconsolidation. 

Total Net Revenues

Total net revenues includenet patient service revenues, management fees from managed facilities and thefacility accounted for using the equity method, and, through September 1999,rehabilitation therapy service revenues from contracts to provide rehabilitationtherapy services to non-affiliated long-term care facilities. 

Net patient service revenues payable by patients at theCompany's facilities are recorded at established billing rates. Net patientservice revenues to be reimbursed by contracts with third-party payors,primarily the Medicare and Medicaid programs, are recorded at the amountestimated to be realized under these contractual arrangements. Revenues from theMedicare program prior to January 1, 1999 and from Medicaid programs aregenerally based on reimbursement of the reasonable direct and indirect costs ofproviding services to program participants or a prospective payment system. TheCompany separately estimates revenues due from each third-party with which ithas a contractual arrangement and records anticipated settlements with theseparties in the contractual period during which services were rendered. Theamounts actually reimbursable under Medicare prior to January 1, 1999 andMedicaid are determined by filing cost reports which are then audited andgenerally retroactively adjusted by the payor. Legislative changes to state orFederal reimbursement systems may also retroactively affect recorded revenues.Changes in estimated revenues due in connection with Medicare and Medicaid maybe recorded by the Company subsequent to the year of origination and prior tofinal settlement based on improved estimates. Such adjustments and finalsettlements with third-party payors, which could materially and adversely affectthe Company, are reflected in operations at the time of the adjustment orsettlement. Accounts receivable, net, at
                                       37
December 31, 2001 and 2002, include $8,467,000 and $7,691,000,respectively, of estimated settlements due from third-party payors and$2,401,000 and $1,336,000, respectively, of estimated settlements due tothird-party payors. 

Concentrations

A significant portion ofthe Company’s revenues are derived from the Medicare and Medicaid programs.There have been, and the Company expects that there will continue to be, anumber of proposals to limit reimbursement allowable to long-term carefacilities under these programs. Approximately 74%, 77%, and 80% of theCompany’s net revenues in the years ended December 31, 2000, 2001 and 2002,respectively, are from the Company’s participation in the Medicare andMedicaid programs. As of December 31, 2001 and 2002, $25,862,000 and$26,995,000, respectively, of net accounts receivable were due from the Medicareand Medicaid programs. 

Facility Operating Expenses

Facility operating expensesinclude expenses associated with the normal operations of a long-term carefacility. The majority of these costs consist of payroll and employee benefitsrelated to nursing, rehabilitation therapy services, housekeeping and dietaryservices provided to patients, as well as maintenance and administration of thefacilities. Other significant facility operating expenses include: the cost ofmedical and pharmacy supplies, food and utilities. Through September 1999,facility operating expenses included expenses associated with rehabilitationtherapy services rendered by the Company under contracts to providerehabilitation therapy services to non-affiliated long-term care facilities. 

Provision for Doubtful Accounts

Provisions foruncollectible accounts receivable of $3,610,000, $3,998,000 and $5,043,000 areincluded in facility operating expenses for the years ended December 31, 2000,2001 and 2002, respectively. Individual patient accounts deemed to beuncollectible are written off against the allowance for doubtful accounts. 

Use of Estimates

The preparation offinancial statements in conformity with accounting principles generally acceptedin the United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financialstatements and revenues and expenses during the period reported. Actual resultscould differ from those estimates. Estimates are used when accounting for thecollectibility of receivables, depreciation and amortization, health benefit,workers’ compensation and general and professional liability claims, taxesand contingencies. 

Property and Equipment

Property and equipment arestated at cost less accumulated depreciation. Expenditures that extend the livesof affected assets are capitalized, while maintenance and repairs are charged toexpense as incurred. Upon the retirement or sale of an asset, the cost of theasset and any related accumulated depreciation are removed from the balancesheet, and any resulting gain or loss is included in net loss. 

Depreciation expense isestimated using the straight-line method. Depreciation is calculated using thefollowing estimated useful lives: 
     Buildings and improvements       31.5 to 40 years (limited to the life of lease, for leased facilies)     Furniture and equipment          3 to 10 years     Land improvements                8 to 40 years
Deferred Financing and Other Non-Current Assets

Deferred financing costsconsist of costs incurred in obtaining financing (primarily loans and facilityleases). These costs are amortized using the straight-line method (whichapproximates the interest method) over the term of the related financialobligation (See Notes E and H). 
                                       38
In connection with each ofits acquisitions, the Company reviewed the assets of the acquired facilities andassessed their relative fair value in comparison to the purchase price.Covenants not-to-compete are being amortized using the straight-line method overthe period during which competition is restricted. Goodwill resulted from theacquisition of certain assets for which the negotiated purchase prices exceededthe allocations of the fair market value of identifiable assets. TheCompany’s policy is to evaluate each acquisition separately and identify anappropriate amortization period for goodwill based on the acquiredproperty’s characteristics. Through December 31, 2001, goodwill wasamortized using the straight-line method over a 15 to 40 year period. In July2001, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 142,“Goodwill and Other Intangible Assets” (“SFAS 142”), whichwas effective January 1, 2002. SFAS 142 requires, among other things, thediscontinuance of goodwill amortization. In addition, the standard includesprovisions for the reclassification of certain existing recognized intangiblesas goodwill, reassessment of the useful lives of existing recognizedintangibles, reclassification of certain intangibles out of previously reportedgoodwill and the identification of reporting units for purposes of assessingimpairments of goodwill. As of December 31, 2001, the Company’s intangibleassets included no assets that were classified as goodwill. As of December 31,2002, the Company’s intangible assets included $2,391,000 of assets thatare classified as goodwill. The recognition of this goodwill related to theacquisition of two facilities in September 2002 that had previously beenoperated by the Company through synthetic leases. (See Notes G and H.)*Assessment of Long-Lived Assets*

The Company reviews, on aquarterly basis, the carrying value of its long-lived assets (primarily propertyand equipment and deferred financing and other non-current assets) to assess therecoverability of these assets; any impairments would be recognized in operatingresults if a diminution in value considered to be other than temporary were tooccur. As part of this assessment, the Company reviews the expected future netoperating cash flows from its facilities, as well as the values included inappraisals of its facilities, which have periodically been obtained inconnection with various financial arrangements. (See Notes H and I). 

Cash and Cash Equivalents

Cash and cash equivalentsconsist of highly liquid investments with maturities of three months or less atthe date of their acquisition by the Company. 

Restricted Cash

Restricted cash consists ofcash in escrow accounts as required by several of the Company’s leases andother financing arrangements. 

Income Taxes

The Company determinesdeferred taxes in accordance with Statement of Financial Accounting Standards(“SFAS”) 109, Accounting for Income Taxes, which requires thatdeferred tax assets and liabilities be computed based on the difference betweenthe financial statement and income tax basis of assets and liabilities usingenacted marginal tax rates. Deferred income tax expenses or credits are based onthe changes in the assets or liabilities from period to period. A valuationallowance reduces deferred tax assets when it is more likely than not that someportion or all of the deferred tax assets will not be recognized (See Note K). 

New Accounting Pronouncements
In July 2001, the FinancialAccounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 143, “Accounting for AssetRetirement Obligations” (“SFAS 143”). Companies are required toadopt SFAS 143 in their fiscal year beginning after June 15, 2002. SFAS 143requires that obligations associated with the retirement of a tangiblelong-lived asset be recorded as a liability when these obligations are incurred,with the amount of the liability initially measured at fair value. Uponrecognizing a liability, an entity must capitalize the cost by recognizing anincrease in the carrying amount of the related long-lived asset, accrete theliability over time to its present value each period, and depreciate thecapitalized cost over the useful life of the related asset. Upon settlement ofthe liability, the obligation is either settled for its recorded amount or again or loss is recognized. The Company does not believe that the adoption ofSFAS 143 will have a material impact on its financial position, results ofoperations, or cash flows. 

In July 2002, the FASBissued SFAS No. 146 “Accounting for Costs Associated with Exit or DisposalActivities” (“SFAS 146”). SFAS 146 replaces Emerging Issues TaskForce Issue No. 94-3 “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity”. SFAS 146requires the recognition of costs associated with exit or disposal activitieswhen they are incurred rather than at the date of a commitment to an exit ordisposal plan. SFAS 146 is to be applied prospectively to exit or disposalactivities initiated after December 31, 2002. The Company does not believe thatthe adoption of SFAS 146 will have a material impact on its financial position,results of operations, or cash flows. 

On November 25, 2002, the FASB issued FASB Interpretation No. 45(“FIN 45”), “Guarantor’s Accounting and Disclosure for Guarantees,Including Indirect Guarantees of Indebtedness of Others, an interpretation ofFASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No.34.”  FIN 45 clarifies the requirements of FASB Statement No. 5,“Accounting for Contingencies” (“SFAS 5”), relating to theguarantor’s accounting for, and disclosure of, the issuance of certaintypes of guarantees.  FIN 45 requires that, upon issuance of a guarantee,the guarantor must recognize a liability for the fair value of the obligation. FIN 45 is applicable to guarantees that encompass guarantees based onchanges in an underlying asset, liability or equity security, guarantees thatare made on behalf of another entity’s performance, certain indemnificationagreements and indirect guarantees of the indebtedness of others. Therecognition and measurement provisions of FIN 45 are effective prospectively forguarantees issued or modified after December 31, 2002.  The disclosurerequirements are effective for reporting periods ending after December 15, 2002. The Company has made the required disclosures in the consolidatedfinancial statements as of December 31, 2002 and is in the process of assessingthe impact of FIN 45 recognition and measurement provisions on its consolidatedfinancial statements.  The Company does not believe that the adoption ofFIN 45 will have a significant impact on its financial statements. 

In December 2002, the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure.” SFAS No.148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” toprovide alternative methods of transition for a voluntary change to the fairvalue method of accounting for stock-based employee compensation. In addition,this Statement amends the disclosure requirements of SFAS No. 123 to requireprominent disclosures about the method of accounting for stock-based employeecompensation and the effect of the method used on reported financial results.SFAS No. 148 amends Accounting Principles Board (“APB”) Opinion No.28, “Interim Financial Reporting,” to require these disclosures ininterim financial information. The Company continues to account for theirstock-based employee compensation under APB Opinion 25, but has adopted the newdisclosure requirements of the SFAS 148 for the year ended December 31, 2002.Additional information related to the Company’s stock option plans isdetailed in Note L of the Notes to the Consolidated Financial Statements.
                                       39
In January 2003, the FASB issued Interpretation No. 46(“FIN 46”), “Consolidation of Variable Interest Entities, aninterpretation of Accounting Research Bulletin (“ARB”) No. 51(“ARB 51”).“ The primary objectives of FIN 46 are to provideguidance on the identification of, and financial reporting for, entities forwhich control is achieved through means other than through voting rights; suchentities are known as variable-interest entities (“VIEs”). FIN 46 providesguidance that determines (1) whether consolidation is required under the“controlling financial interest” model of ARB 51, “ConsolidatedFinancial Statements,” or (b) other existing authoritative guidance, oralternatively, (2) whether the variable-interest model under FIN 46 should beused to account for existing and new entities. In addition, FIN 46 requires thatboth the primary beneficiary and all other enterprises with a significantvariable interest in a VIE make additional disclosures. FIN 46 is effective forVIEs which are created after January 31, 2003 and for all VIEs for the firstfiscal year or interim period beginning after June 15, 2003. The Company hasevaluated the provisions of FIN 46 and determined that this Interpretation willhave no material effect currently on its consolidated financial statements.
D. PROPERTY AND EQUIPMENT
The Company’s propertyand equipment are stated at cost less accumulated depreciation and consist ofthe following as of December 31: 
                                           2001           2002                                      ------------   ------------Land ..............................   $  7,238,000   $  8,522,000Land improvements .................      3,943,000      4,087,000Buildings and improvements ........    100,626,000    111,658,000Equipment, furnishings and fixtures     35,364,000     34,916,000                                      ------------   ------------                                       147,171,000    159,183,000Less accumulated depreciation .....     38,182,000     42,478,000                                      ------------   ------------                                      $108,989,000   $116,705,000                                      ============   ============E. DEFERRED FINANCING AND OTHER INTANGIBLES
Deferred financing andother non-current assets are stated at cost less accumulated amortization andconsist of the following as of December 31: 
                                          2001          2002                                     -----------   -----------Deferred financing costs ..........   $ 7,991,000   $ 9,408,000Goodwill ..........................          --       2,391,000Covenant not-to-compete ...........     1,200,000     1,200,000                                      -----------   -----------                                        9,191,000    12,999,000Less accumulated amortization......     5,275,000     4,846,000                                      -----------   -----------                                      $ 3,916,000   $ 8,153,000                                      ===========   ===========F. NOTE RECEIVABLE
On December 1, 1997, theCompany acquired five long-term care facilities in Connecticut. The Companyfinanced this acquisition through an operating lease with the seller. Inconnection with this acquisition, the Company received a note receivable fromthe owners in the amount of $7,487,000. Interest is earned at the rate of 9% perannum, and payments are due monthly, in arrears, commencing January 1, 1998 andcontinuing until November 30, 2010, at which time the entire principal balanceis due. The proceeds of the note were used by the owner to repay certainindebtedness. The note is collateralized by various mortgage interests and othercollateral. 
G. OPERATING LEASES
The Company leases certainlong-term care facilities and equipment under operating leases. TheCompany’s existing leased facilities are leased either from the owner ofthe facilities or from a real estate investment trust or other real estateentity that has purchased the facilities from the owner. The Company’sexisting facility leases generally require it to make monthly lease payments andpay all property operating costs. The Company generally negotiates leases thatprovide for extensions beyond the initial lease term and an option to purchasethe leased facility. In some cases, the option to purchase the leased facilityis at a price based on the fair market value of the facility at the time theoption is to be exercised. In other cases, the lease sets forth a fixed purchaseoption price. 
                                       40
Future minimum rentcommitments under the Company’s non-cancelable operating leases as ofDecember 31, 2002 are as follows: 
                   Real Estate      Equipment          Total                  ------------   ------------   ------------      2003        $ 29,638,000   $    247,000   $ 29,885,000      2004          29,995,000         13,000     30,008,000      2005          30,090,000           --       30,090,000      2006          21,498,000           --       21,498,000      2007          18,868,000           --       18,868,000Thereafter          79,218,000           --       79,218,000                  ------------   ------------   ------------                  $209,307,000   $    260,000   $209,567,000                  ============   ============   ============H. LONG-TERM DEBT
The Company has a mortgagepayable (the “Mortgage”) in the amount of $15,422,000 at December 31,2002. The Mortgage is cross-collateralized by the assets of four of theCompany’s facilities (the “Four Facilities”). The Mortgage bearsinterest at the annual rate of 10.65%. Additional interest payments are alsorequired in an amount equal to 0.3% of the difference between the operatingrevenues of the Four Facilities in each applicable year and the operatingrevenues of the Four Facilities during a twelve-month base period whichcommenced October 1, 1995. The Mortgage places certain restrictions on the FourFacilities; among them, the agreement restricts their ability to incuradditional debt or to make significant dispositions of assets. The FourFacilities are also required to maintain a debt service coverage ratio of atleast 1.2 to 1.0 (as defined in the loan agreement) and a current ratio of atleast 1.0 to 1.0. The Mortgage contains a prepayment penalty calculated inaccordance with a formula. 

A subsidiary of the Companyassumed a first mortgage note (the “Note”) with a remaining balance of$1,482,000 as part of the acquisition of a long-term care facility in 1988. TheNote requires the annual retirement of principal in the amount of $20,000. TheCompany pays interest monthly at the rate of 14% per annum on the outstandingprincipal amount until maturity in October 2010, when the remaining unpaidprincipal balance of $1,338,000 is due. The Note is collateralized by theproperty and equipment of the facility. 

On August 11, 1998, inconnection with the Merger, the Company entered into a six-year $250,000,000collateralized credit facility (the “Credit Facility”). During thefirst four years of the Credit Facility, up to $250,000,000 could be used inconnection with synthetic lease financing. Proceeds of the loans could be usedfor working capital, capital expenditures, acquisitions and general corporatepurposes. Interest was based on either LIBOR or prime rates of interest (plusapplicable margins), at the election of the Company. The Credit Facilityrequired that the Company maintain an interest/rent coverage ratio which variedby year, and limited aggregate borrowings under the Credit Facility to apredetermined multiple of EBITDA. 

During the first quarter of1999, the Company determined that its anticipated financial results for thatquarter would cause the Company to be out of compliance with certain financialcovenants of the Credit Facility. Accordingly, the Company obtained an amendment(the “First Amendment”) to the Credit Facility effective March 30,1999 which temporarily limited borrowings under the Credit Facility to anaggregate of $58,500,000 (exclusive of undrawn letters of credit outstanding asof March 30, 1999) and which modified certain financial covenants. In order tocomplete the Cleveland Facility leasing transaction (See Note I), the Companywas required to obtain the release of certain collateral held by the bank groupwhich provided the Credit Facility. The Company obtained the release of thecollateral as part of an amendment (the “Second Amendment”) to theCredit Facility, which also resulted in a permanent reduction of theCompany’s maximum borrowings under the Credit Facility from $250 million to$150 million and an increase in the Company’s borrowing rate. As a resultof the permanent reduction in funds available through the Credit Facility, theCompany was required to write off a proportionate amount of the deferredfinancing costs incurred when the Credit Facility was obtained. 

On March 28, 2001, theCompany obtained an additional amendment (the “Third Amendment”) tothe Credit Facility in order to be able to implement the financial restructuringof the Company’s Discount Notes and Preferred Stock discussed below. TheThird Amendment resulted in a permanent reduction of the Company’s maximumborrowings under the Credit Facility from $150 million to $60 million, revisedcertain financial covenants, changed the maturity date of the Credit Facility toMarch 31, 2004 and increased the Company’s borrowing rate. The ThirdAmendment also required the Company to repay, on an annual basis, the greater of$5,000,000 or 50% of the Company’s excess cash flow (as defined). As aresult of the permanent reduction in funds available through the CreditFacility, the Company was required to write off a proportionate amount of thedeferred financing costs incurred when the Credit Facility was obtained. 

On September 13, 2002, theCompany entered into a new three-year collateralized credit facility (the“Secured Credit Facility”) that provides access to a maximum of $100million. Borrowings under the Secured Credit Facility were used to repay allamounts owed in connection with the termination of the Company’s previousCredit Facility (including amounts outstanding in connection with a $13,700,000synthetic lease obligation) as well as related closing costs and expenses. Theterms of the Secured Credit Facility provide a maximum of $25 Million on arevolving credit basis and a maximum of $75 Million in the form of a term loan.Proceeds from the Secured Credit Facility can be used for the acquisition ofadditional healthcare facilities (including required working capital), jointventure investments, letters of credit, and general corporate purposes. TheSecured Credit Facility is collateralized by substantially all of theCompany’s patient accounts receivable, certain real estate and a first orsecond priority interest in the capital stock of certain of the Company’ssubsidiaries. Interest on the revolving credit facility is payable monthly inarrears at a rate of LIBOR plus 4.25% (or Prime plus 1.25%) at the election ofthe Company. The terms of the Secured Credit Facility initially limitavailability through the term loan to $60 million, but this amount may beincreased to $75 Million at the election of the Company after the occurrence ofcertain events. Interest on the term loan is payable monthly in arrears at therate of LIBOR plus 4.1% with a minimum interest rate of 7%. The Secured CreditFacility contains a number of restrictive covenants that, among other things,
                                       41
restrict the Company’s ability to dispose of certain assets, limits theCompany’s ability to declare and pay certain dividends, and requires theCompany to maintain a minimum occupancy, as well as predetermined levels offixed charge coverage and debt service coverage as defined in the loanagreement. As of December 31, 2002, total borrowings under the Secured CreditFacility were approximately $60,420,000 and consisted of borrowings under theterm loan of approximately $43,015,000 and $17,405,000 of undrawn letters ofcredit. As of December 31, 2002, the Company had approximately $24,580,000 offunding available under the Secured Credit Facility. As of December 2002, theinterest rate on the term loan outstanding under the Secured Credit Facility was7.0%. 

In connection with enteringinto the Secured Credit Facility, the Company incurred non-recurring FinancingCosts totaling $2,835,000. This non-recurring charge includes $1,700,000recorded in connection with the termination of a synthetic lease for two of theCompany’s facilities (the “Synthetic Lease Properties”) madethrough the Company’s prior Credit Facility. The Company was obligated topurchase the Synthetic Lease Properties at a pre-determined price ($13,700,000)upon the occurrence of certain events including a termination of the priorCredit Facility. The carrying value of the Synthetic Lease Properties wasrecorded at the purchase price ($13,700,000), less a charge of $1,700,000 toreflect uncertainties related to the value of these properties in connectionwith the expiration of a significant portion of Medicare reimbursement effectiveOctober 1, 2002. (See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Liquidity and CapitalResources”.) Additionally, the Company wrote off un-amortized deferredfinancing costs associated with the prior Credit Facility ($666,000), recognizedbonus payments to executive officers for securing the replacement financing(totaling $350,000) and incurred certain other professional and recording costs. 

In connection withobtaining the Secured Credit Facility, the Company purchased an interest ratecap on $40 million notional principal amount that matures on September 1, 2005.This interest rate cap is intended to provide the Company partial protectionfrom exposure to the floating interest rate associated with $40 million of termloan borrowings. The entire amount of this interest rate cap has been designatedan effective cash flow hedge to limit possible increases in interest payments onits term loan. The interest rate cap limits the Company’s exposure to anincrease in the underlying LIBOR rate to (a) 5.23% if LIBOR is less than 6.23%or (b) 6.23% if LIBOR increases above 6.23%. 

Changes in the fair marketvalue of a derivative that is highly effective and is designated and qualifiesas a cash flow hedge, are reported as “Accumulated Other ComprehensiveIncome or Loss” (“AOCIL”) in the“Stockholders’ Deficit” section of the Company’sconsolidated balance sheet. On December 31, 2002, the fair market value of theinterest rate cap was $88,000 which amount was included in “Other Assets,net”. A loss of $241,000 was charged to AOCIL for the year ended December31, 2002. None of the losses in AOCIL related to the interest rate cap areexpected to be reclassified into interest expense as a yield adjustment of thehedged debt obligation during the next twelve months. 

In connection with theMerger on August 11, 1998, the Company issued $170,000,000 principal amount atmaturity (approximately $99,500,000 gross proceeds) of Discount Notes. EachDiscount Note was issued with a principal amount at maturity of $1,000 and anoriginal issue price of $585.25. Interest on the Discount Notes accreted inaccordance with a predetermined formula on a semi-annual basis on February 1,and August 1, of each year. Cash interest was not to accrue on the DiscountNotes until August 1, 2003. In March 2001, the Company entered into an agreement(the “Restructuring Agreement”) with Investcorp S.A. and the holdersof more than a majority in interest of the Company’s Discount Notes andPreferred Stock for purposes of implementing a restructuring of the DiscountNotes and Preferred Stock. The Restructuring Agreement contemplated that theCompany would offer to exchange for each $1,000 amount at maturity ofoutstanding Discount Notes a combination of the following: (1) 0.5899118 ofa new 12% Senior Subordinated Discount Note due 2007 (the “New Notes”)each having a principal amount at maturity equal to $1,000 and an original issueprice of $685.67 (assuming that the New Notes were issued on May 4, 2001),(2)  $88.2353 in cash and (3) common stock purchase warrants forapproximately 10.9 shares of its Class A Common Stock. The Company wouldalso offer to exchange common stock purchase warrants for approximately 10.7shares of its Class A Common Stock for each $1,000 liquidation preference ofPreferred Stock (based on the aggregate liquidation preference to be outstandingon May 1, 2001) plus any dividends accrued on such Preferred Stock after May 1,2001. In conjunction with the restructuring proposal, the Company would solicitconsents from holders of outstanding Discount Notes and Preferred Stock toamendments to the Indenture governing the Discount Notes and to the Certificateof Designation governing the Preferred Stock that would eliminate or modifycertain restrictive covenants and other provisions contained in the Indentureand the Certificate of Designation and would substantially eliminate thepreferences of the Preferred Stock, including the reduction of the liquidationpreference from $1,000 to $0.01 per share and the elimination of the right ofholders to be paid dividends on shares of Preferred Stock. Also, the Companywould issue to Investcorp S.A. (or one or more of its affiliates or designees)up to 15,000 shares of a new series of 13% convertible exchangeable preferredstock (the “New Preferred Stock”) and 1,854,422 common stock purchasewarrants for a total purchase price of up to $15,000,000. 

On April 6, 2001, theCompany initiated the exchange offer and consent solicitation contemplated bythe Restructuring Agreement. On May 10, 2001, the Company completed the exchangeoffer and consent solicitation, thereby implementing each of the elements of theRestructuring Agreement. All of the outstanding Discount Notes and 99.96% of thePreferred Stock shares were tendered and exchanged in the exchange offer. As aresult of the exchange, (1) the Company had an aggregate principal amount atmaturity of $100,276,000 of New Notes outstanding and an aggregate liquidationpreference of $15,000,000 (as of May 10, 2001) of New Preferred Stockoutstanding, (2) warrants were issued to holders of Discount Notes, toholders of Preferred Stock, and to Investcorp S.A. representing the right topurchase an aggregate of approximately 15%, 5% and 15%, respectively, of thetotal number of shares of all classes of the Company’s common stock on afully diluted basis (excluding shares issuable upon conversion of the NewPreferred Stock, each share of which are initially convertible into 150 sharesof Class A Common Stock), and (3) the Company paid $15,000,000 in cashas partial consideration for the tendered Discount Notes. 

The reduction in theliquidation preference of the Preferred Stock was completed on May 10, 2001, ascontemplated by the Restructuring Agreement. The carrying amount of thePreferred Stock was reduced from $57,595,000 to $576, and the amount of thereduction, net of unamortized deferred financing costs related to the issuanceof the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directlytransferred to the Company’s Accumulated Deficit account. With the exchange
                                       42
of the New Notes for the Discount Notes, the carrying value of the accretedprincipal of the Discount Notes was reduced to $68,890,000, and the amount ofthe reduction, net of the aggregate cash payment of $15,000,000, was directlytransferred to the Company’s Long-term Accrued Interest account. Subsequentto their issuance, the carrying amount of the New Notes increases as the resultof accretion and results in a corresponding decrease in the carrying amount ofLong-term Accrued Interest. Interest expense on the New Notes is recognized suchthat a constant effective interest rate is applied to the aggregate carryingamount of the New Notes and Long-term Accrued Interest for all periods betweenthe issuance date and the maturity date of the New Notes. 

In connection with theThird Amendment to the Credit Facility and the implementation of theRestructuring Agreement, the Company incurred a non-recurring charge of$9,045,000. This charge resulted from the write-off of approximately $1,500,000of unamortized deferred financing costs incurred when the Credit Facility wasobtained, the write-off of approximately $3,400,000 of unamortized deferredfinancing costs related to the issuance of the Discount Notes, and therecognition of various investment advisory, legal and other fees associated withthese events of $4,145,000. 

The New Notes were issuedat a discount and interest on the New Notes accretes until August 1, 2004. Cashinterest payments will be paid semi-annually in arrears beginning on February 1,2005 based on the fully accreted value of the New Notes and a 12% cash interestpayment rate. The New Notes mature on August 1, 2007. 

At any time on or prior toAugust 1, 2003, the New Notes may be redeemed, in whole but not in part, at theoption of the Company upon the occurrence of a “Change of Control” (asdefined) in accordance with the prescribed procedures and the payment of anyapplicable premium (as defined). Upon the occurrence of a Change in Control,unless all New Notes have been called for redemption, each holder of the NewNotes will have the right to require, in accordance with the prescribedprocedures, the Company to repurchase all or any part of the New Notes at aprice equal to 101% of the accreted value of the New Notes. The New Notes mustbe redeemed in whole on August 1, 2007. 

Upon the voluntary orinvoluntary liquidation of the Company, holders of the New Notes will beentitled to be paid in full 100% of principal and accrued interest out of theassets available for distribution after holders of senior debt have been paid infull. The New Notes are unsecured, subordinate to existing and future seniordebt of the Company, but senior in right with all existing and futuresubordinated debt of the Company. Certain of the subsidiaries of the Companyhave jointly and severally guaranteed the Company’s payment obligations(subject to maximum amounts per subsidiary) under the New Notes (see Note R).Each New Note guaranteed by such subsidiary is subordinated to any senior debtof such guarantor. The Company derives substantially all of its income fromoperations through its subsidiaries and consequently, the New Notes areeffectively subordinated to the potential claims of creditors of all of thesubsidiaries of the Company irrespective of subsidiary guarantees. The New Notesalso contain certain restrictive covenants which limit the ability of theCompany to incur debt, issue preferred stock, merge or dispose of substantiallyall of its assets. 

Interest expense charged tooperations for the years ended December 31, 2000, 2001 and 2002 was $23,007,000,$13,270,000 and $8,991,000, respectively. 

As of December 31, 2001 and2002, the Company’s long-term debt, excluding the current portion,consisted of the following: 
                                                 2001           2002                                         ------------   ------------12% Senior subordinated discount notes   due 2007 ..........................   $ 74,225,000   $ 83,399,000Mortgages payable ....................     16,903,000     16,601,000Revolving loans under Credit Facility      22,750,000           --Loans under Secured Credit Facility ..           --       43,015,000                                         ------------   ------------                                         $113,878,000   $143,015,000                                         ============   ============
As of December 31, 2002,future long-term debt maturities associated with the Company’s debt are asfollows: 
           2003         $        303,000           2004               15,161,000           2005               43,035,000           2006                   20,000           2007               83,420,000           Thereafter          1,379,000                          --------------                            $143,318,000                            ============
Substantially all of theCompany’s assets are subject to liens under long-term debt or operatinglease agreements. The Company believes that, taken together, its current cashbalances, internally generated cash flow and availability under its creditfacilities should result in the Company having adequate cash resources to meetits debt service and other financial obligations for at least the next twelvemonths. 
                                       43I.  CAPITAL LEASE OBLIGATION
Until September 27, 2000,the Company, through a wholly owned limited partnership, leased and operatedfour facilities in Ohio (the “Cleveland Facilities”) which it acquiredin 1996 through capital leases. Each of the four leases contained an option topurchase the facility beginning July 1, 2001 and each lease was guaranteed bythe Company. The guaranty provided that failure by the Company to have aspecified minimum consolidated net worth at the end of any two consecutivequarters would be an event of default under the guaranty, which in turn would bean event of default under each lease. As a result of a restructuring charge, theCompany’s consolidated net worth as of September 30, 1999 (as calculatedfor purposes of this requirement) had fallen below the required level. TheCompany anticipated that its net worth would continue to be below the requiredlevel at December 31, 1999, which would have resulted in an event of defaultunder each of these leases with the Company potentially facing the loss of theseoperations. Such default could also have triggered cross-defaults under theCompany’s other lease and debt obligations. In December 1999, the Companypaid $5 million to its landlord and obtained an option (the “NewOption”) to acquire the Cleveland Facilities. The Company borrowed $5million from an affiliate of Investcorp S.A. to fund this payment. The NewOption allowed the Company to exercise its right to purchase the ClevelandFacilities beginning as of the date of the New Option, required the Company tocomplete the acquisition prior to December 31, 2000 and provided a waiver of thenet worth covenant through that date. The Company exercised the New Option onJune 30, 2000. 

On September 27, 2000, theCompany terminated the Cleveland Facilities capital leases and assigned itspurchase rights for these facilities to an investment entity organized byInvestcorp, for $5.0 million, which simultaneously acquired the ClevelandFacilities. On that date, the Company entered into new operating leases for eachof the Cleveland Facilities with combined annual rent expense of approximately$5.9 million. The Company used the proceeds of the purchase rights assignment torepay the $5.0 million note payable from an affiliate of Investcorp S.A. As aresult of the capital lease termination, the Company recorded a non-recurringcharge of $8.9 million. The principal components of this charge included thewrite-off of capital leased assets in excess of related capital lease obligation($5.7 million) and the write-off of deferred financing costs ($1.8 million)related to the Company’s Credit Facility. In order to complete theCleveland Facility leasing transaction, the Company was required to obtain therelease of certain collateral held by the bank group which provided the CreditFacility. The Company obtained the release of the collateral as part of anamendment to the Company’s Credit Facility, which also resulted in apermanent reduction of the Company’s maximum borrowings under the CreditFacility from $250 million to $150 million and an increase in the Company’sborrowing rate. As a result of the permanent reduction in funds availablethrough the Credit Facility, the Company was required to write off aproportionate amount of the deferred financing costs incurred when the CreditFacility was originally obtained. 

On December 21, 2001, theCleveland Facilities were sold to an unaffiliated real estate investment trustand the Company entered into new operating leases with that entity. 
J. RETIREMENT PLANS
The Company maintains anemployee 401(k) defined contribution plan. All employees who have worked atleast one thousand hours and have completed one year (nine months effectiveJanuary 1, 2002) of continuous service are eligible to participate in the plan.The plan is subject to the provisions of the Employee Retirement Income SecurityAct of 1974. Employee contributions to this plan may be matched at thediscretion of the Company. The Company contributed $298,000, $385,000 and$323,000 to the plan in 2000, 2001 and 2002, respectively. 

In September 1995, theCompany established a Supplemental Executive Retirement Plan (the“SERP”) to provide benefits to key employees. Participants may deferup to 25% of their compensation which is matched by the Company at a rate of 50%(up to 10% of base salary). Vesting in the matching portion occurs in January ofthe second year following the plan year in which contributions were made. TheCompany amended the SERP effective January 1, 2003 to eliminate additionalemployer matching contributions effective as of that date. 
K. INCOME TAXES
As required by SFAS 109,the Company annually evaluates the positive and negative evidence bearing uponthe realizability of its deferred tax assets. The Company has considered therecent and historical results of operations and concluded; in accordance withthe applicable accounting methods that it is more likely than not that a certainportion of the deferred tax assets will not be realizable. To the extent that anasset will not be realizable, a valuation allowance is established. The taxeffects of temporary differences giving rise to deferred tax assets as ofDecember 31, 2001 and 2002 are as follows: 
                                          2001           2002                                        ------------    ------------Deferred tax assets:     Reserves .......................   $  3,046,000    $ 11,971,000     Rental payments ................        687,000         330,000     Interest payments ..............     20,466,000      22,471,000     Net operating loss carryforwards     19,211,000      18,298,000     Other ..........................        414,000         187,000     Valuation allowance ............    (29,411,000)    (37,961,000)                                        ------------    ------------     Total deferred tax assets ......   $ 14,413,000    $ 15,296,000                                        ============    ============Deferred tax liabilities:     Depreciation & Amortization ....  $ 14,413,000    $ 15,296,000                                        ============    ============                                       44
The Company continuallyreviews its deferred tax accounts and in the fourth quarter of 2002 recorded anincremental net deferred tax asset and corresponding valuation allowance of approximately$6,689,000. 

Significant components ofthe provision for income taxes for the years ended December 31, 2000, 2001 and2002 are as follows: 
                                  2000          2001          2002                           -----------   -----------   -----------Current:     Federal     State .............   $    70,000   $   225,000   $   240,000                           -----------   -----------   -----------Total current ..........        70,000       225,000       240,000                           -----------   -----------   -----------Deferred:     Federal ...........    11,596,000          --            --     State .............     2,656,000          --            --                           -----------   -----------   -----------Total deferred .........    14,252,000          --            --                           -----------   -----------   -----------Total income tax expense   $14,322,000   $   225,000   $   240,000                           ===========   ===========   ===========
The reconciliation ofincome tax computed at statutory rates to income tax for the years endedDecember 31, 2000, 2001 and 2002 are as follows: 
                                                   2000                       2001                 2002                                                   ----                       ----                 ----Statutory rate............................$  (7,834,000)   35.0%   $  (5,837,000) 35.0%  $ (1,897,000)  35.0%State income tax, net of federal benefit..   (1,765,000)    7.9          146,000  (0.9)       (88,000)   1.4Permanent differences.....................      198,000    (0.9)         287,000  (1.7)        364,000  (7.0)Change in valuation allowance.............   23,461,000  (104.8)       5,336,000 (32.0)      1,861,000 (34.1)Net operating loss - rate differential....       90,000    (0.4)         156,000  (0.9)            -      -Other.....................................      172,000    (0.8)         137,000  (0.8)            -      -                                           ------------  -------   -------------  ------  ------------  ------                                           $ 14,322,000   (64.0%)   $    225,000  (1.3)%  $    240,000  (4.7%)                                           ============  =======   =============  ======  ============  ======L.  CAPITAL STOCK
Common Stock

On August 11, 1998, as aresult of the Merger, the Company authorized the issuance of 500,000 shares ofpreferred stock with a par value of $.01 per share and 19,000,000 shares(comprised of five classes) of common stock, each with a par value of $.01 pershare, consisting of Harborside Class A Common Stock, Harborside Class B CommonStock, Harborside Class C Common Stock, Harborside Class D Common Stock andCommon Stock (collectively “Harborside Common Stock”). Effective April4, 2001, the Company’s Certificate of Incorporation was amended to (a)increase the authorized number of shares of the Company’s Class A CommonStock from 1,200,000 shares to 11,700,000 shares and (b) increase the authorizednumber of shares of the Company’s Common Stock from 9,500,000 shares to20,000,000 shares. On November 19, 2001, the Company’s Certificate ofIncorporation was again amended to increase the authorized number of shares ofthe Company’s Class C Common Stock from 1,580,000 shares to 2,280,000shares. 

The numbers of shares ofHarborside Common Stock authorized and outstanding as of December 31, 2001 and2002 are as follows: 
                                                  2001                   2002                                                  ----                   ----                                        Authorized  Outstanding  Authorized   Outstanding                                          Shares       Shares       Shares       Shares                                        ----------   ----------   ----------   ----------TitleHarborside Class A Common Stock .....   11,700,000      661,332   11,700,000      661,332Harborside Class B Common Stock .....    6,700,000    5,940,000    6,700,000    5,940,000Harborside Class C Common Stock .....    2,280,000    1,275,167    2,280,000    1,255,834Harborside Class D Common Stock .....       20,000       20,000       20,000       20,000Common Stock ........................   20,000,000         --     20,000,000         --                                        ----------   ----------   ----------   ----------Total ...............................   40,700,000    7,896,499   40,700,000    7,877,166                                        ==========   ==========   ==========   ==========
Holders of shares ofHarborside Class A Common Stock and Common Stock are entitled to one vote pershare on all matters as to which stockholders may be entitled to vote pursuantto Delaware General Corporate Law (“the DGCL”). Holders of shares ofHarborside Class D Common Stock are entitled to 330 votes per share on allmatters as to which stockholders may be entitled to vote pursuant to the DGCL.Holders of Harborside Class B Common Stock or Harborside Class C Common Stockwill not have any voting rights, except that the holders of the Harborside ClassB Common Stock and Harborside Class C Common Stock will have the right to voteas a class to the extent required under the laws of the State of Delaware. 
                                       45
Upon the occurrence of asale of 100% of the outstanding equity securities or substantially all of theassets of the Company, a merger as a result of which the ownership of theHarborside Common Stock is changed to the extent of 100%, or a public offeringof any equity securities of the Company, each share of Harborside Class A CommonStock, Harborside Class B Common Stock, Harborside Class C Common Stock andHarborside Class D Common Stock will convert into one share of Common Stock ofthe Company. 

Restricted Stock

On September 29, 2000, theCompany issued 664,500 shares of restricted Class C common stock (the“Restricted Shares”) to employees of the Company. As part of thisrestricted stock issuance, 507,705 options granted on August 11, 1998 topurchase shares of the Company’s Class C common stock at $25.00 per sharewere cancelled. The purpose of the restricted stock issuance was to betterenable the Company to retain and motivate key employees. The Restricted Sharesgenerally vest over varying periods of time through December 31, 2003. As ofDecember 31, 2002, 467,501 Restricted Shares were vested. Unvested shares arerestricted as to disposition and subject to forfeiture under certaincircumstances. The value of the Restricted Shares on the date of grant wasapproximately $7,000. 

Preferred Stock

In connection with theMerger on August 11, 1998, the Company issued 40,000 shares of Preferred Stock.The holders of the Preferred Stock were entitled to receive quarterly dividendpayments in arrears beginning November 1, 1998. Dividends were payable in cashor in additional shares of Preferred Stock, at the option of the Company, untilAugust 1, 2003. After August 1, 2003, dividends were to be paid only in cash.During the years ended December 31, 1999, 2000 and 2001, all dividends exceptfor fractional shares amounting to $20,000, $18,000 and $6,000, respectively,were paid in additional shares. 

In March 2001, the Companyentered into the Restructuring Agreement with Investcorp S.A. and the holders ofmore than a majority in interest of the Company’s Discount Notes andPreferred Stock for purposes of implementing a restructuring of the DiscountNotes and the Preferred Stock (See Note H). On May 10, 2001, the Companycompleted an exchange offer and consent solicitation, thereby implementing eachof the elements of the Restructuring Agreement. As part of the exchange offer,99.96% of the Preferred Stock shares were tendered and warrants were issued toholders of the Preferred Stock representing the right to purchase (at anexercise price of $0.01 per share) an aggregate of approximately 5% of the totalnumber of shares of all classes of the Company’s common stock on a fullydiluted basis (excluding shares issuable upon conversion of the New PreferredStock, each share of which are initially convertible into 150 shares ofClass A Common Stock). As contemplated by the Restructuring Agreement, onMay 10, 2001, the liquidation preference of the Preferred Stock was reduced from$1,000 to $0.01 per share and the carrying amount of the Preferred Stock wasreduced from $57,595,000 to $576. The amount of this reduction, net ofunamortized deferred financing costs related to the issuance of the PreferredStock (approximately $1,011,000 at May 10, 2001), was directly transferred tothe Company’s Accumulated Deficit account. 

In connection with thefinancial restructuring, the Company issued 15,000 shares of New Preferred Stockfor a purchase price of $15,000,000. The New Preferred Stock had an initialliquidation preference of $15,000,000 and is entitled to dividends at thegreater of: (a) a rate of 13% per annum compounded quarterly and payable inadditional shares of New Preferred Stock, or at any time while no New Notes areoutstanding, in cash and (b) an amount equal to the dividends payable onoutstanding shares of Class A Common Stock, payable quarterly in the same formas such dividends are payable. The New Preferred Stock is mandatorily redeemableon February 1, 2008. Shares of the New Preferred Stock will generally not beredeemable by the Company until August 1, 2004 and thereafter will be redeemableat a premium, which will decline ratably to par by August 1, 2007. In the eventof a Change in Control (as defined), the Company may redeem the New PreferredStock as a whole, but not in part, at a price equal to 100% of the applicableliquidation preference including accrued but unpaid dividends and a “makewhole premium” until August 1, 2004. If the Company does not redeem the NewPreferred Stock in the event of a Change in Control, the holders of the NewPreferred Stock may require the Company to make an offer to purchase theoutstanding shares of New Preferred Stock at a price equal to 101% of theapplicable liquidation preference. Each share of the New Preferred stock isconvertible: (a) into 150 shares of the Company’s Class A Common Stock atany time at the option of the holder; (b) and subject to compliance with certainfinancial covenants, will also be exchangeable into the New Notes of the Companydue 2008, at the option of the Company on any dividend payment date, subject tocertain requirements and procedures. The exchange debentures would ranksurbordinate to the New Notes. 

Upon any voluntary orinvoluntary liquidation of the Company, holders of the New Preferred Stock willbe entitled to be paid out of the assets available for distribution, theliquidation preference per share plus an amount equal to all accumulated andunpaid dividends, before any distribution is made to the holders of HarborsideCommon Stock. Holders of the New Preferred Stock have no voting rights except asprovided by law and in the Certificate of Designation. In the event thatdividends are not paid for any six quarterly periods, or upon certain otherevents, the number of directors constituting the Company’s Board ofDirectors would be adjusted to permit the holders of the majority of the thenoutstanding New Preferred Stock, voting separately as a class, to elect twodirectors. 

The Certificate ofDesignation also contains certain restrictive covenants that limit theCompany’s restricted subsidiaries from making certain payments orinvestments and which limit the Company’s ability to incur debt, issuepreferred stock, merge or dispose of substantially all of its assets. 
                                       46
As of December 31, 2002,preferred stock dividends accrete based on the following schedule: 
     2003       $ 2,526,000     2004         2,871,000     2005         3,262,000     2006         3,708,000     2007         4,214,000Thereafter          380,000              -------------                $16,961,000                ===========
Common Stock Warrants

As part of the financial restructuring(See Note H), the Company issued Common Stock Warrants (the“Warrants”) to holders of the Discount Notes, to holders of thePreferred Stock, and to Investcorp S.A. representing the right to purchase anaggregate of approximately 15%, 5% and 15%, respectively, of the total number ofshares of all classes of the Company’s common stock on a fully dilutedbasis (excluding shares issuable upon conversion of the New Preferred Stock,each share of which are initially convertible into 150 shares of Class A CommonStock). Warrants to purchase an aggregate total of 4,326,641 shares were issuedon May 10, 2001. Each warrant entitles the holder thereof to purchase one shareof Class A Common Stock at an exercise price of $0.01 per share. The Warrantswill be exercisable at the earliest to occur of (a) a Change of Control, (b) aninitial public offering of the Company’s Common Stock, (c) the fullredemption of all of the New Notes at the Company’s option and (d) August1, 2009. 

Earnings (Loss) per Common Share Computation

Basic earnings (loss) percommon share is computed by dividing net earnings (loss) less preferred stockdividends by the weighted average number of common shares outstanding. Commonshares outstanding exclude nonvested Restricted Shares in the amounts of171,000, 578,000 and 343,000 for the years ended December 31, 2000, 2001 and2002, respectively. The computation of diluted earnings (loss) per share issimilar to that of basic earnings (loss) per share except that the number ofcommon shares is increased to reflect the number of additional common sharesthat would have been outstanding if the dilutive potential common shares hadbeen issued. Dilutive potential common shares for the Company consist of sharesissuable upon exercise of the Company’s stock options. 

The following table setsforth the computation of basic and diluted earnings (loss) per common share forthe years ended December 31, 2000, 2001 and 2002: 
                                                                          2000            2001            2002                                                                  ------------    ------------    ------------Numerator:     Net loss ................................................... $(36,706,000)   $(16,902,000)   $ (5,659,000)     Preferred stock dividends ..................................   (6,853,000)     (3,774,000)     (2,223,000)                                                                  ------------    ------------    ------------     Loss applicable to common shares ........................... $(43,559,000)   $(20,676,000)   $ (7,882,000)                                                                  ============    ============    ============Denominator:Weighted average shares outstanding .............................    7,432,000       7,913,000       7,884,000     Adjustment for nonvested Restricted Shares .................     (171,000)       (578,000)       (343,000)                                                                  ------------    ------------    ------------     Denominator for basic and diluted loss per common share -     adjusted weighted - average shares and assumed conversions..    7,261,000       7,335,000       7,541,000                                                                  ============    ============    ============     Basic and diluted loss per common share .................... $      (6.00)   $      (2.82)   $      (1.05)                                                                  ============    ============    ============
For the years endedDecember 31, 2000, 2001 and 2002, the weighted-average shares outstanding forthe following potentially dilutive securities were excluded from the computationof diluted loss per common share because the effect would have beenantidilutive: 
                                                        2000        2001        2002                                                   ---------   ---------   ---------Options to purchase common stock ...............     492,512     214,131   1,006,415Non-vested shares of restricted stock ..........     170,664     578,420     342,702Conversion rights of convertible preferred stock        --     1,494,960   2,515,749Warrants to purchase common stock ..............        --     2,797,499   4,326,641                                                   ---------   ---------   ---------                                                     663,176   5,085,010   8,191,507                                                   =========   =========   =========
Stock Option Plans

During 1996, theCompany established two stock option plans, the 1996 Stock Option Plan forNon-employee Directors (the “Director Plan”) and the 1996 Long-TermStock Incentive Plan (the “Stock Plan”). Directors of the Company whowere not employees, or affiliates of the Company, were eligible to participatein the Director Plan. On the date of the IPO, each of the four non-employee
                                       47
directors was granted options to acquire 15,000 shares of the Company’scommon stock at the IPO price. On January 1 of each year, each non-employeedirector received an additional grant for 3,500 shares at the fair market valueon the date of grant. Options issued under the Director Plan became exercisableon the first anniversary of the date of grant and terminated upon the earlier often years from date of grant or one year from date of termination as a director.Through the Directors Retainer Fee Plan, non-employee directors of the Companycould also elect to receive all or a portion of their director fees in shares ofthe Company’s common stock. The Stock Plan was administered by the StockPlan Committee of the Board of Directors which was composed of outside directorswho were not eligible to participate in this plan. The Stock Plan authorized theissuance of non-qualified stock options, incentive stock options, stockappreciation rights, restricted stock and other stock-based awards. Optionsgranted during the years ended December 31, 1996 and 1997, were granted withexercise prices equal to or greater than the fair market value of the stock onthe date of grant. Options granted under the stock plan during 1996 and 1997vested over a three-year period and had a maximum term of ten years. A maximumof 800,000 shares of common stock were reserved for issuance in connection withthese plans. 

In connection with theMerger, all holders of options issued through the Director Plan and the StockPlan had the right to retain their options or to have their options convertedinto cash at $25.00 per underlying share less the applicable exercise price (andtaxes required to be withheld by the Company). Holders of options representingoptions to purchase 109,994 shares of stock retained their options while theremainder (representing 648,923 options) exercised their right to convert theiroptions into cash. 

In connection with theMerger, the Company adopted the Harborside Healthcare Corporation StockIncentive Plan (the “Stock Option Plan”). The Stock Option Plan isadministered by the Board of Directors of the Company. The Board of Directorsdesignates which employees of the Company will be eligible to receive awardsunder the Stock Option Plan, and the amount, timing, and other terms andconditions applicable to such awards. All options granted under the Stock OptionPlan during 1998 were granted with an exercise price equal to $25.00, equal tothe fair market value of the stock on the date of grant. Options granted underthe Stock Option Plan during 1998 were to vest at the end of a seven year periodor earlier if certain financial performance criteria were met. All optionsgranted under the Stock Option Plan during 1998 and still outstanding as ofSeptember 29, 2000 were cancelled on that date in connection with the issuanceof the Restricted Shares. A maximum of 1,600,000 shares have been reserved forissuance in connection with the Stock Option Plan. 

Information with respect tooptions granted under the Director Plan, the Stock Plan and the Stock OptionPlan is as follows: 
Options Outstanding:                Number       Exercise Price    Weighted-Average                                    of Shares        Per Share      Exercise Price                                    ---------       ----------     ----------------Balance at December 31, 1999         637,226      $   8.15 - $25.00    $22.94-----------------------------------------------------------------------------------Cancelled                          (527,232)      $  25.00             $25.00Balance at December 31, 2000         109,994      $   8.15 - $21.69    $13.07-----------------------------------------------------------------------------------Granted                              883,000      $   1.25             $ 1.25-----------------------------------------------------------------------------------Balance at December 31, 2001         992,994      $   1.25 - $21.69    $ 2.53-----------------------------------------------------------------------------------Granted                               50,500      $   1.25             $ 1.25-----------------------------------------------------------------------------------Balance at December 31, 2002       1,043,494      $   1.25 - $21.69    $ 2.50===================================================================================
As of December 31, 2000,there were 109,994 exercisable options at a weighted-average exercise price of$13.07. As of December 31, 2001, there were 336,244 exercisable options at aweighted-average exercise price of $5.12. At December 31, 2002, there were564,119 exercisable options at a weighted-average exercise price of $3.55. 

In 1996, the Companyadopted SFAS 123, “Accounting for Stock-Based Compensation.” SFAS 123requires that companies either recognize compensation expense for grants ofstock, stock options, and other equity instruments based on fair value, orprovide pro forma disclosure of net income and earnings per share in the notesto the financial statements. The Company has adopted the disclosure provisionsof SFAS 123, and has applied Accounting Principles Board Opinion 25 and relatedinterpretations in accounting for its plans. Accordingly, no compensation costhas been recognized for its stock option plans. Had compensation cost for theCompany’s stock-based compensation plans been determined based on the fairvalue at the grant dates as calculated in accordance with SFAS 123, theCompany’s unaudited pro forma net loss and pro forma net loss per share forthe years ended December 31, 2000, 2001 and 2002 would have been reduced to theamounts indicated below: 
                           2000                                  2001                             2002                           ----                                  ----                             ----                 Loss              Loss              Loss             Loss             Loss            Loss                 Applicable to     Per Common        Applicable to    Per Common       Applicable to   Per Common                 Common Shares     Share Diluted     Common Shares    Share Diluted    Common Shares   Share Diluted                 -------------     -------------     -------------    -------------    -------------   -------------      AsReported         $(43,559,000)        $(6.00)        $(20,676,000)    $(2.82)          $(7,882,000)    $(1.05)     Pro   Forma         $(43,559,000)        $(6.00)        $(20,676,000)    $(2.82)          $(7,882,000)    $(1.05)                                       48
The weighted average fairvalue of options granted was $0 in 2001 and 2002. The fair value for each stockoption is estimated on the date of grant using the Black-Scholes option-pricingmodel with the following weighted-average assumptions: an expected life of fiveyears, no dividend yield, and a risk-free interest rate of 4.75%. Expectedvolatility of 0% (except for 109,994 in options held by senior management; suchoptions have an assumed volatility of 40%) was assumed for the year endedDecember 31, 2001 and 2002. 
M. CONTINGENCIES
The Company is involved inlegal actions and claims in the ordinary course of its business. It is theopinion of management, based on the advice of legal counsel, that suchlitigation and claims will be resolved without material effect on theCompany’s consolidated financial position, results of operations orliquidity. 

The Company self-insuresfor health benefits provided to a majority of its employees. The Companymaintains stop-loss insurance such that the Company’s liability for lossesis limited. The Company recognizes an expense for estimated health benefitclaims incurred including claims but not reported at the end of each year. 

The Company self-insures for most workers’ compensationclaims. The Company maintains stop-loss insurance such that the Company’sliability for losses is limited. The Company accrues for estimated workers’compensation claims including claims incurred but not reported at the end ofeach year. 

During the year endedDecember 31, 1998, the Company implemented a general and professional liabilityinsurance program which, for the period from September 1, 1998 to August 31,2001, limited the Company’s self-retention risk for this program to amaximum of $25,000 per year. The Company implemented a new general andprofessional liability program effective, September 1, 2001, which resulted inthe Company maintaining an unaggregated self-insured retention of $2,000,000 peroccurrence for locations outside of Florida and completely retaining risk at theFlorida facilities. As of December 1, 2002, the Company’s unaggregatedself-insured retention increased to $10,000,000 per occurrence for locationsoutside of Florida. As of December 31, 2002, the Company maintains a ClaimsReserve in the amount of $8,721,000 for estimated unpaid losses including unreported claims. Theliabilities for incurred but not reported claims not covered by third-partyinsurance are discounted at 8% to obtain their present value based on estimatedclaim payments as determined by an independent actuary. The amount of thereserve was determined through an estimation process that used information fromboth the Company’s records as well as industry data. The Company uses anindependent actuary to help estimate the required general and professionalliability reserve. Factors reviewed include the frequency of expected claims,the average cost per claim, emerging industry trends, changes in regulatoryenvironment and the expected effect of various operational and risk managementinitiatives. The Company will continue to evaluate its insurance reserverequirements on a quarterly basis. Required adjustments to the Company’sgeneral and professional liability reserve will be recorded in the accountingperiod in which the change in estimate occurs. 

The Company owns a 75%interest in a partnership which owns one facility. The Company accounts for itsinvestment in this partnership using the equity method. The Company hasguaranteed a loan of approximately $5,600,000 made to this partnership torefinance a loan which funded the construction of the facility and providedworking capital. The loan is also collateralized by additional collateralpledged by the non-affiliated partner. The loan was to mature on May 31, 2002,but was extended by the lender. The loan currently matures on March 31, 2003,but the Partnership is currently negotiating replacement financing with thelender on terms substantially similar to the existing financing. The partnershipagreement states that each partner will contribute an amount in respect of anyliability incurred by a partner in connection with a guarantee of thepartnership’s debt, so that partners each bear their proportionate share ofany liability based on their percentage ownership of the partnership. 
N.  DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The methods and assumptionsused to estimate the fair value of each class of financial instruments, forthose instruments for which it is practicable to estimate that value, and theestimated fair values of the financial instruments are as follows: 

Cash and Cash Equivalents
The carrying amountapproximates fair value because of the short effective maturity of theseinstruments. 

Note Receivable

The carrying value of thenote receivable approximates its fair value at December 31, 2001 and 2002, basedon the yield of the note and the present value of expected cash flows. 

Long-term Debt

The fair value of theCompany’s fixed rate long-term debt is estimated based on the quoted marketprices for the same or similar issues or on the current rates offered to theCompany for debt of the same remaining maturities. At December 31, 2002, thefair market value of the Company’s New Notes was approximately $54,149,000.The book value of the Company’s New Notes was $83,399,000. The Companyestimates that the fair value of its remaining fixed rate debt approximates itscarrying amount. 
                                       49O.  RELATED PARTY TRANSACTIONS
A former affiliate of theCompany provides data processing services to the Company in return for a monthlyfee. Total service charges under this arrangement were $1,083,000, $979,000 and$759,000, for the years ended December 31, 2000, 2001 and 2002, respectively. 

At the time of the Merger,Investcorp International Inc. received a $6,000,000 management advisory andconsulting service fee which is being expensed on a straight-line basis over thelife of the related five year agreement. The expense recognized by the Companyin connection with this management agreement during the years ended December 31,2000, 2001 and 2002 was $1,200,000, $1,200,000 and $1,200,000, respectively. 

As of December 31, 2001 thenet payable due to Bowie, L.P. was approximately $0.4 million. As of December31, 2002 the net payable due to Bowie, L.P. was approximately $1.3 million. 
P.  FACILITY REORGANIZATION COSTS
During the year endedDecember 31, 2001, the Company recorded a non-recurring charge of $1,080,000 inconnection with its decision to revise the marketing approach for facilitiesoperated through subsidiaries in Florida. The Company determined that a localcommunity-based marketing approach would better serve the needs of thesefacilities. The marketing approach stresses ties to the local community andrequired renaming these facilities in order to emphasize this approach. Inconnection with this effort, the Company also restructured certain of itssubsidiaries effective October 1, 2001. In order to implement this strategy, theCompany recognized certain non-recurring marketing, legal and other expenses. 
Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION
Certain of theCompany’s subsidiaries are precluded from guaranteeing the debt of theparent company (the “Non-Guarantors”), based on current agreements ineffect. The Company’s remaining subsidiaries (the “Guarantors”)are not restricted from serving as guarantors of the parent company debt. TheGuarantors are comprised of Harborside Healthcare Limited Partnership, BelmontNursing Center Corp., Orchard Ridge Nursing Center Corp., Oakhurst Manor NursingCenter Corp., Riverside Retirement Limited Partnership, Harborside ConnecticutLimited Partnership, Harborside of Florida Limited Partnership, Harborside ofOhio Limited Partnership, Harborside Healthcare Baltimore Limited Partnership,Harborside of Cleveland Limited Partnership, Harborside of Dayton LimitedPartnership, Harborside Massachusetts Limited Partnership, Harborside of RhodeIsland Limited Partnership, Harborside North Toledo Limited Partnership,Harborside Healthcare Advisors Limited Partnership, Harborside Toledo Corp., KHICorporation, Harborside Danbury Limited Partnership, Harborside AcquisitionLimited Partnership V, Harborside Acquisition Limited Partnership VI, HarborsideAcquisition Limited Partnership VII, Harborside Acquisition Limited PartnershipVIII, Harborside Acquisition Limited Partnership IX, Harborside AcquisitionLimited Partnership X, Sailors, Inc., New Jersey Harborside Corp., BridgewaterAssisted Living Limited Partnership, Maryland Harborside Corp., HarborsideHomecare Limited Partnership, Harborside Rehabilitation Limited Partnership,Harborside Healthcare Network Limited Partnership and Harborside Health ICorporation. 

The information whichfollows presents the condensed consolidating financial position as of December31, 2001 and 2002; the condensed consolidating results of operations for theyears ended December 31, 2000, 2001 and 2002; and the condensed consolidatingcash flows for the years ended December 31, 2000, 2001 and 2002 of (a) theparent company only (“the Parent”), (b) the combined Guarantors, (c)the combined Non-Guarantors, (d) eliminating entries and (e) the Company on aconsolidated basis. 
                                       50Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                                 Condensed Consolidating Balance Sheet                                                        As of December 31, 2001                                       (dollars in thousands except share and per share amounts)                                                        Parent     Guarantors Non-Guarantors  Elimination  Consolidated                                                       ---------    --------- --------------  -----------  ------------ASSETSCurrent assets:   Cash and cash equivalents .......................   $    --      $   7,886   $    1,363    $    --      $   9,249   Accounts receivable, net of allowance    for  doubtful accounts .........................        --         32,531       12,971         --         45,502   Intercompany receivable .........................     141,929         --           --       (141,929)        --   Prepaid expenses and other ......................       1,400        9,308          920         --         11,628                                                       ---------    ---------    ---------    ---------    ---------Total current assets ...............................     143,329       49,725       15,254     (141,929)      66,379Restricted cash ....................................        --          5,130          768         --          5,898Investments in limited partnerships ................      15,584         --          4,044      (19,628)        --Property and equipment, net ........................        --         87,815       21,174         --        108,989Deferred financing and other non-current assets, net ...........................         677        2,330          909         --          3,916Other assets, net ..................................         700         --           --           --            700Note receivable ....................................        --          7,487         --           --          7,487                                                       ---------    ---------    ---------    ---------    ---------Total assets .......................................   $ 160,290    $ 152,487    $  42,149    $(161,557)   $ 193,369                                                       =========    =========    =========    =========    =========LIABILITIESCurrent liabilities:   Current maturities of long-term debt ............   $   2,500    $      22    $     254    $    --      $   2,776   Accounts payable ................................        --         12,514        2,197         --         14,711   Intercompany payable ............................        --        112,416       13,567     (125,983)        --   Employee compensation and benefits ..............        --         16,153        3,117         --         19,270   Other accrued liabilities .......................        --          5,800        1,078         --          6,878   Accrued interest ................................         147         --           --           --            147   Current portion of deferred income ..............        --           --           --            521          521                                                       ---------    ---------    ---------    ---------    ---------Total current liabilities ..........................       2,647      146,905       20,213     (125,462)      44,303Claims reserve .....................................        --          1,467         --           --          1,467Long-term portion of deferred income ...............        --            534        1,474         (521)       1,487Long-term debt .....................................      96,975        1,481       15,422         --        113,878Long-term accrued interest .........................      47,115         --           --           --         47,115                                                       ---------    ---------    ---------    ---------    ---------Total liabilities ..................................     146,737      150,387       37,109     (125,983)     208,250                                                       ---------    ---------    ---------    ---------    ---------13% Convertibleexchangeable preferred stock, redeemable,$.01 par value with a liquidationvalue of $1,000 per share; 100,000 sharesauthorized; 16,286 shares issued and outstanding ...      16,286         --           --           --         16,286STOCKHOLDERS' EQUITY (DEFICIT)Common stock, $.01 par value, 40,700,000shares authorized, 15,275,664 shares issued ........         153        2,569        3,885       (6,454)         153Additional paid-in capital .........................     187,748         --           --            228      187,976Common stock in treasury,at cost, 7,379,165 shares ..........................    (183,746)        --           --           --       (183,746)Retained earnings (accumulated deficit) ............      (6,888)     (25,224)      (5,919)       2,481      (35,550)Partners' equity ...................................        --         24,755        7,074      (31,829)        --                                                       ---------    ---------    ---------    ---------    ---------Total stockholders' equity (deficit) ...............      (2,733)       2,100        5,040      (35,574)     (31,167)                                                       ---------    ---------    ---------    ---------    ---------Total liabilities and stockholders'equity (deficit) ...................................   $ 160,290    $ 152,487    $  42,149    $(161,557)   $ 193,369                                                       =========    =========    =========    =========    =========                                       51Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                           HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                                 Condensed Consolidating Balance Sheet                                                        As of December 31, 2002                                       (dollars in thousands except share and per share amounts)                                                       Parent     Guarantors Non-Guarantors Elimination  Consolidated                                                       ---------   ---------    ---------    ---------   ------------ASSETSCurrent assets:   Cash and cash equivalents .......................   $    --      $  19,544    $     624    $    --     $   20,168   Accounts receivable, net of allowance    for  doubtful accounts .........................        --         35,286       11,692         --         46,978   Intercompany receivable .........................     118,476         --           --       (118,476)        --   Prepaid expenses and other ......................         864       13,286        1,003         --         15,153                                                       ---------    ---------    ---------    ---------   ----------Total current assets ...............................     119,340       68,116       13,319     (118,476)      82,299Restricted cash ....................................        --          6,024          587         --          6,611Investments in limited partnerships ................      15,584         --          4,044      (19,628)        --Property and equipment, net ........................        --         96,195       20,510         --        116,705Deferred financing and other non-current assets, net ...........................        --          7,477          676         --          8,153Other assets, net ..................................          88         --           --           --             88Note receivable ....................................        --          7,487         --           --          7,487                                                       ---------    ---------    ---------    ---------    ---------Total assets .......................................   $ 135,012    $ 185,299    $  39,136    $(138,104)   $ 221,343                                                       =========    =========    =========    =========    =========LIABILITIESCurrent liabilities:   Current maturities of long-term debt   ..........   $    --      $      25    $     278    $    --      $     303   Accounts payable ................................        --         13,290        1,358         --         14,648   Intercompany payable ............................        --         87,843       14,662     (102,505)        --   Employee compensation and benefits ..............        --         23,114        2,925         --         26,039   Other accrued liabilities .......................        --          5,045          915         --          5,960   Accrued interest ................................        --            482         --           --            482   Current portion of deferred income ..............        --           --           --            395          395                                                       ---------    ---------    ---------    ---------    ---------Total current liabilities ..........................        --        129,799       20,138     (102,110)      47,827Claims reserve .....................................        --          8,218          503         --          8,721Long-term portion of deferred income ...............        --            184        1,105         (395)         894Long-term debt .....................................      83,399       44,472       15,144         --        143,015Long-term accrued interest .........................      41,667         --           --           --         41,667                                                       ---------    ---------    ---------    ---------    ---------Total liabilities ..................................     125,066      182,673       36,890     (102,505)     242,124                                                       ---------    ---------    ---------    ---------    ---------13% Convertibleexchangeable preferred stock, redeemable,$.01 par value with a liquidationvalue of $1,000 per share; 100,000 sharesauthorized; 18,509 shares issued and outstanding ...      18,509         --           --           --         18,509STOCKHOLDERS' EQUITY (DEFICIT)Common stock, $.01 par value, 40,700,000shares authorized, 15,275,664 shares issued ........         153        2,569        3,885       (6,454)         153Additional paid-in capital .........................     185,526         --           --            227      185,753Common stock in treasury,at cost, 7,398,498 shares ..........................    (183,746)        --           --           --       (183,746)Accumulated other comprehensive loss ...............        (241)        --           --           --           (241)Retained earnings (accumulated deficit) ............     (10,255)     (24,698)      (8,713)       2,457      (41,209)Partners' equity ...................................        --         24,755        7,074      (31,829)        --                                                       ---------    ---------    ---------    ---------    ---------Total stockholders' equity (deficit) ...............      (8,563)       2,626        2,246      (35,599)     (39,290)                                                       ---------    ---------    ---------    ---------    ---------Total liabilities and stockholders'equity (deficit) ...................................   $ 135,012    $ 185,299    $  39,136    $(138,104)   $ 221,343                                                       =========    =========    =========    =========    =========                                       52Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                            Condensed Consolidating Statement of Operations                                                 For the year ended December 31, 2000                                                        (dollars in thousands)                                                         Parent    Guarantors Non-Guarantors Elimination  Consolidated                                                       ---------    ---------    ---------    ---------    ---------Total net revenues .................................   $    --      $ 222,479    $ 102,217    $  (2,024)   $ 322,672                                                       ---------    ---------    ---------    ---------    ---------Expenses:   Facility operating ..............................        --        177,732       84,072       (2,024)     259,780   General and administrative ......................        --         17,993         --           --         17,993   Service charges paid to former affiliate ........        --          1,083         --           --          1,083   Amortization of prepaid management fee ..........       1,200         --           --           --          1,200   Depreciation and amortization ...................       1,808        6,469        1,933         --         10,210   Facility rent ...................................        --         15,629        8,646         --         24,275   Loss on termination of capital lease ............        --          8,914         --           --          8,914   Management fees paid to affiliates ..............        --         (6,045)       6,045         --           --                                                       ---------    ---------    ---------    ---------    ---------Total expenses .....................................       3,008      221,775      100,696       (2,024)     323,455                                                       ---------    ---------    ---------    ---------    ---------Income (loss) from operations ......................      (3,008)         704        1,521         --           (783)Other:   Interest expense, net ...........................       4,028       15,941        1,706         --         21,675Other income .......................................        --           --           --            (74)         (74)                                                       ---------    ---------    ---------    ---------    ---------Income (loss) before income taxes ..................      (7,036)     (15,237)        (185)          74      (22,384)Income tax expense .................................      14,322         --           --           --         14,322                                                       ---------    ---------    ---------    ---------    ---------Net income (loss) ..................................   $ (21,358)   $ (15,237)   $    (185)   $      74    $ (36,706)                                                       =========    =========    =========    =========    =========                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                            Condensed Consolidating Statement of Operations                                                 For the year ended December 31, 2001                                                        (dollars in thousands)                                                         Parent    Guarantors Non-Guarantors Elimination  Consolidated                                                       ---------    ---------    ---------    ---------    ---------Total net revenues .................................   $    --      $ 250,547    $ 102,686    $  (6,495)   $ 346,738                                                       ---------    ---------    ---------    ---------    ---------Expenses:   Facility operating ..............................        --        202,412       86,277       (6,495)     282,194   General and administrative ......................          67       18,976         --           --         19,043   Service charges paid to former affiliate ........        --            979         --           --            979   Amortization of prepaid management fee ..........       1,200         --           --           --          1,200   Depreciation and amortization ...................         525        6,717        2,113         --          9,355   Facility rent ...................................        --         20,476        8,413         --         28,889   Financial restructuring costs ...................       8,645          400         --           --          9,045   Facility reorganization costs ...................        --          1,080         --           --          1,080   Management fees paid to affiliates ..............        --         (6,489)       6,489         --           --                                                       ---------    ---------    ---------    ---------    ---------Total expenses .....................................      10,437      244,551      103,292       (6,495)     351,785Income (loss) from operations ......................     (10,437)       5,996         (606)        --         (5,047)Other:   Interest expense, net ...........................       2,278        7,813        1,854         --         11,945Other income .......................................        --           --           --           (315)        (315)                                                       ---------    ---------    ---------    ---------    ---------Income (loss) before income taxes ..................     (12,715)      (1,817)      (2,460)         315      (16,677)Income tax expense .................................         225         --           --           --            225                                                       ---------    ---------    ---------    ---------    ---------Net income (loss) ..................................   $ (12,940)   $  (1,817)   $  (2,460)   $     315    $ (16,902)                                                       =========    =========    =========    =========    =========                                       53Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                    HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                            Condensed Consolidating Statement of Operations                                                 For the year ended December 31, 2002                                                        (dollars in thousands)                                                         Parent    Guarantors Non-Guarantors Elimination  Consolidated                                                       ---------    ---------    ---------    ---------    ---------Total net revenues .................................   $    --      $ 336,950    $  73,053    $  (9,779)   $ 400,224                                                       ---------    ---------    ---------    ---------    ---------Expenses:   Facility operating ..............................        --        280,707       61,121       (9,779)     332,049   General and administrative ......................         114       20,106         --           --         20,220   Service charges paid to former affiliate ........        --            759         --           --            759   Amortization of prepaid management fee ..........       1,200         --           --           --          1,200   Depreciation and amortization ...................         227        7,391        2,271         --          9,889   Facility rent ...................................        --         24,618        5,993         --         30,611   Refinancing costs ...............................         450        2,385         --           --          2,835   Management fees paid to affiliates ..............        --         (4,742)       4,742         --           --                                                       ---------    ---------    ---------    ---------    ---------Total expenses .....................................       1,991      331,224       74,127       (9,779)     397,563Income (loss) from operations ......................      (1,991)       5,726       (1,074)        --          2,661Other:   Interest expense, net ...........................       1,136        5,200        1,720         --          8,056Other expense ......................................        --           --           --             24           24                                                       ---------    ---------    ---------    ---------    ---------Income (loss) before income taxes ..................      (3,127)         526       (2,794)         (24)      (5,419)Income tax expense .................................         240         --           --           --            240                                                       ---------    ---------    ---------    ---------    ---------Net income (loss) ..................................   $  (3,367)   $     526    $  (2,794)   $     (24)   $  (5,659)                                                       =========    =========    =========    =========    =========                                       54Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                            Condensed Consolidating Statement of Cash Flows                                                 For the year ended December 31, 2000                                                        (dollars in thousands)                                                           Parent    Guarantors Non-Guarantors Elimination Consolidated                                                          ---------   --------    ------------ ----------- ---------Operating activities:Net cash provided by operating activities .............   $   5,029   $ 19,097    $  2,240     $   --     $ 26,366                                                          ---------   --------    --------     --------   --------Investing activities:     Additions to property and equipment ..............       --        (4,467)     (1,732)        --       (6,199)     Additions to deferred financing and      other non-current assets ........................        (11)       (275)        168         --         (118)     Transfers to restricted cash, net ................       --        (2,290)        (95)        --       (2,385)                                                          --------    --------    --------     --------   --------Net cash used by investing activities .................        (11)     (7,032)     (1,659)        --       (8,702)                                                          --------    --------    --------     --------   --------Financing activities:         Payment of note payable to affiliate .........     (5,000)       --          --           --       (5,000)     Payment of long-term debt ........................       --           (19)       (205)        --         (224)     Principal payments of capital lease obligation ...       --        (3,084)       --           --       (3,084)     Dividends paid on exchangeable preferred stock ...        (18)       --          --           --          (18)                                                          --------    --------    --------     --------   --------Net cash used by financing activities .................     (5,018)     (3,103)       (205)        --       (8,326)                                                          --------    --------    --------     --------   --------Net increase in cash and cash equivalents .............       --         8,962         376         --        9,338Cash and cash equivalents, beginning of year ..........       --           355       1,031         --        1,386                                                          --------    --------    --------     --------   --------Cash and cash equivalents, end of year ................   $   --      $  9,317    $  1,407     $   --     $ 10,724                                                          ========    ========    ========     ========   ========Supplemental Disclosure:    Interest paid .....................................   $  1,325    $  5,243    $    561     $   --     $  7,129    Income taxes paid .................................   $    130    $   --      $   --       $   --     $    130    Accretion of preferred dividends ..................   $  6,835    $   --      $   --       $   --     $  6,835                                       55Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                            Condensed Consolidating Statement of Cash Flows                                                 For the year ended December 31, 2001                                                        (dollars in thousands)                                                           Parent    Guarantors  Non-Guarantors  Elimination Consolidated                                                          -------- ------------  --------------  -----------Operating activities:Net cash provided by operating activities .............   $  7,404       7,959    $  3,872       $   --      $ 19,235                                                          --------    --------    --------       --------    --------Investing activities:     Additions to property and equipment ..............       --        (7,973)     (3,609)          --       (11,582)     Additions to deferred financing and      other non-current assets ........................       --          (386)       --             --          (386)     Transfers to restricted cash, net ................       --        (1,014)        (79)          --        (1,093)                                                          --------    --------    --------       --------    --------Net cash used by investing activities .................       --        (9,373)     (3,688)          --       (13,061)                                                          --------    --------    --------       --------    --------Financing activities:         Issuance of New Preferred Stock ..............     15,000        --          --             --        15,000         Payment to holders of Discount Notes .........    (15,000)       --          --             --       (15,000)     Receipt in connection with lease .................        102        --          --             --           102     Payment on revolving line of credit ..............     (7,500)       --          --             --        (7,500)     Payment of long-term debt ........................       --           (17)       (228)          --          (245)     Dividends paid on preferred stock ................         (6)       --          --             --            (6)                                                           -------    --------    --------       --------    --------Net cash used by financing activities .................     (7,404)        (17)       (228)          --        (7,649)                                                           --------   --------    --------       --------    --------Net decrease in cash and cash equivalents .............       --        (1,431)        (44)          --        (1,475)Cash and cash equivalents, beginning of year ..........       --         9,317       1,407           --        10,724                                                          --------    --------    --------       --------    --------Cash and cash equivalents, end of year ................   $   --      $  7,886    $  1,363       $   --      $  9,249                                                          ========    ========    ========       ========    ========Supplemental Disclosure:    Interest paid .....................................   $  1,175    $  4,030    $    958       $   --      $  6,163    Income taxes paid .................................   $    257    $   --      $   --         $   --      $    257    Accretion of preferred dividends ..................   $  3,768    $   --      $   --         $   --      $  3,768                                       56Q.  CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                          HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                            Condensed Consolidating Statement of Cash Flows                                                 For the year ended December 31, 2002                                                        (dollars in thousands)                                                          Parent    Guarantors Non-Guarantors  Elimination  Consolidated                                                          --------  --------    -------------  -----------  ------------Operating activities:Net cash provided by operating activities .............   $  25,579  $ (9,287)   $     824   $     --     $ 17,116                                                          ---------  --------    ---------   ----------   --------Investing activities:     Additions to property and equipment ..............       --       (14,935)     (1,491)        --      (16,426)     Additions to deferred financing and      other non-current assets ........................       --        (6,219)       --           --       (6,219)     Transfers (to) from restricted cash, net .........       --          (894)        181         --         (713)     Purchase of interest rate cap ....................       (329)       --          --           --         (329)                                                          --------    --------    --------    ---------   --------Net cash used by investing activities .................       (329)    (22,048)     (1,310)        --      (23,687)                                                          --------    --------    --------    ---------   --------Financing activities:     Payment on revolving line of credit ..............    (25,250)       --          --           --      (25,250)     Borrowings under secured credit facility .........       --        43,015        --           --       43,015     Payment of long-term debt ........................       --           (22)       (253)        --         (275)                                                          --------    --------    --------    ---------   --------Net cash provided (used) by financing activities ......    (25,250)     42,993        (253)        --       17,490                                                          --------    --------    --------    ---------   --------Net increase (decrease) in cash and cash equivalents ..       --        11,658        (739)        --       10,919Cash and cash equivalents, beginning of year ..........       --         7,886       1,363         --        9,249                                                          --------    --------    --------    ---------   --------Cash and cash equivalents, end of year ................   $   --      $ 19,544    $    624    $    --     $ 20,168                                                          ========    ========    ========    =========   ========Supplemental Disclosure:    Interest paid .....................................   $    688    $  3,148    $  1,041    $    --     $  4,877    Income taxes paid .................................   $    226    $   --      $   --      $    --     $    226    Accretion of preferred dividends ..................   $  2,223    $   --      $   --      $    --     $  2,223                                       57R.  SUMMARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The Company’sunaudited quarterly financial information follows: 
                                                     Year Ended December 31, 2000                                                     ----------------------------                                                   First         Second            Third           Fourth                                                  Quarter       Quarter           Quarter          Quarter       Total                                             -------------    -------------    -------------    -------------    --------------Total net revenues ........................   $  78,976,000    $  79,414,000    $  80,927,000    $  83,355,000    $ 322,672,000Income (loss) from operations .............       2,075,000        2,379,000       (6,219,000)         982,000         (783,000)Loss before income taxes .............................      (3,949,000)      (3,325,000)     (11,944,000)      (3,166,000)     (22,384,000)Income tax (benefit) expense ..............      (1,540,000)      (1,297,000)      (4,658,000)      21,817,000       14,322,000                                              -------------    -------------    -------------    -------------    -------------Net loss ..................................      (2,409,000)      (2,028,000)      (7,286,000)     (24,983,000)     (36,706,000)Preferred stock dividends .................      (1,630,000)      (1,685,000)      (1,741,000)      (1,797,000)      (6,853,000)                                              -------------    -------------    -------------    -------------    -------------Loss applicable tocommon shares .............................      (4,039,000)      (3,713,000)      (9,027,000)     (26,780,000)     (43,559,000)                                              =============    =============    =============    =============    =============Loss per common share:   Basic and Diluted ......................   $       (0.56)   $       (0.51)   $       (1.24)   $       (3.69)   $      (6.00)                                              =============    =============    =============    =============    ============                                                     Year Ended December 31, 2001                                                     ----------------------------                                                    First          Second            Third    Fourth                                                   Quarter         Quarter          Quarter          Quarter         Total                                              -------------    -------------    -------------    -------------    -------------Total net revenues ........................   $  82,086,000    $  86,127,000    $  88,210,000    $  90,315,000    $ 346,738,000Income (loss) from operations .............      (1,767,000)      (4,815,000)       1,593,000          (58,000)      (5,047,000)Loss before income taxes .............................      (6,436,000)      (7,734,000)        (455,000)      (2,052,000)     (16,677,000)Income tax expense ........................            --               --               --            225,000          225,000                                              -------------    -------------    -------------    -------------    -------------Net loss ..................................      (6,436,000)      (7,734,000)        (455,000)      (2,277,000)     (16,902,000)Preferred stock dividends .................      (1,860,000)        (905,000)        (497,000)        (512,000)      (3,774,000)                                              -------------    -------------    -------------    -------------    -------------Loss applicable tocommon shares .............................      (8,296,000)      (8,639,000)        (952,000)      (2,789,000)     (20,676,000)                                              =============    =============    =============    =============    =============Loss per common share:   Basic and Diluted ......................   $       (1.13)   $       (1.18)   $       (0.13)   $      (0.38)    $      (2.82)                                              =============    =============    =============    ============     ============                                                     Year Ended December 31, 2002                                                     ----------------------------                                                  First           Second            Third            Fourth                                                 Quarter          Quarter          Quarter          Quarter         Total                                              -------------    -------------    -------------    -------------    -------------Total net revenues ........................   $  94,511,000    $ 101,011,000    $ 103,756,000    $ 100,946,000    $ 400,224,000Income (loss) from operations .............       2,094,000        2,263,000         (638,000)      (1,058,000)       2,661,000Income (loss) before income taxes .............................           1,000          457,000       (2,349,000)      (3,528,000)      (5,419,000)Income tax expense ........................          60,000           60,000           60,000           60,000          240,000                                              -------------    -------------    -------------    -------------    -------------Net income (loss) .........................         (59,000)         397,000       (2,409,000)      (3,588,000)      (5,659,000)Preferred stock dividends .................        (529,000)        (547,000)        (564,000)        (583,000)      (2,223,000)                                              -------------    -------------    -------------    -------------    -------------Loss applicable tocommon shares .............................        (588,000)        (150,000)      (2,973,000)      (4,171,000)      (7,882,000)                                              =============    =============    =============    =============    =============Loss per common share (1):   Basic and Diluted ......................   $       (0.08)   $       (0.02)   $       (0.39)   $       (0.55)   $      (1.05)                                              =============    =============    =============    =============    ============(1) Due to rounding, the addition of loss per common share by quarter may notequal total loss per common share for the year.                                       58
**ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

DIRECTORS

The Company pays no additionalremuneration to its employees or to executives of Investcorp S.A. for serving asdirectors. 

The following table setsforth certain information regarding the current directors and executive officersof the Company: 

Name and Principal Offices with the Company
 NAME                    AGE   POSITION ----                    ---   --------Stephen L. Guillard      53    Chairman, Chief Executive Officer and DirectorDamian N. Dell'Anno      43    President, Chief Operating Officer and DirectorWilliam H. Stephan       46    Senior Vice President, Chief Financial Officer and DirectorLars  C. Haegg           37    DirectorJames O. Egan            54    DirectorWilliam C. McCollum      31    DirectorBruce Tully              53    Director
Stephen L. Guillard hasserved as Chief Executive Officer of the Company since March 21, 1996 (andPresident from March 21, 1996 through August 30, 2001) and of the predecessorsof the Company since May 1988 and as a Director and Chairman of the Board of theCompany since its incorporation in March 1996. Mr. Guillard previously served asChairman, President and Chief Executive Officer of Diversified Health Services(“DHS”), a long-term care company which Mr. Guillard co-founded in1982. DHS operated approximately 7,500 long-term care and assisted living bedsin five states. Mr. Guillard has a total of 29 years of experience in thelong-term care industry and is a licensed Nursing Home Administrator. 

Damian N. Dell’Annohas served as President of the Company since August 30, 2001, as Chief OperatingOfficer since March 21, 1996 and as a Director since August 1998. Mr.Dell’Anno previously had served as Executive Vice President of Operationsof the Company since March 21, 1996 and its predecessors since 1994. From 1993to 1994, he served as the head of the specialty services group for thepredecessors of the Company and was instrumental in developing theCompany’s rehabilitation therapy business. From 1989 to 1993, Mr.Dell’Anno was Vice President of Reimbursement for the predecessors of theCompany. From 1988 to 1989, Mr. Dell’Anno served as Director of Budget,Reimbursement and Cash Management for The Mediplex Group, Inc.(“Mediplex”), a long-term care company. Mr. Dell’Anno has a totalof 19 years of experience in the long-term care industry. 

William H. Stephan has served as Senior Vice President and ChiefFinancial Officer of the Company since March 21, 1996 and its predecessors sincejoining the Company in 1994. Mr. Stephan has served as a Director of the Companysince August 1998. From 1986 to 1994, Mr. Stephan was a Manager in the healthcare practice of Coopers & Lybrand LLP. His clients there included long-termcare facilities, continuing care retirement centers, physician practices andacute care hospitals. Mr. Stephan is a Certified Public Accountant and a memberof the Healthcare Financial Management Association. 

Lars C. Haegg has served as a Director of Investcorp S.A. since1998. Prior to joining Investcorp S.A., Mr. Haegg worked with McKinsey &Company where he was responsible for leading consulting teams for media, retailand electronics clients. Mr. Haegg previously worked with Strategic PlanningAssociates (now Mercer Management Consulting) in the telecommunications andconsumer goods sectors. He is a director of Stratus Computer SystemsInternational S.A. and H.S. TelePacific Holdings Corp. 

James O. Egan has served as a Director of Investcorp S.A. sinceJanuary 1999. Prior to joining Investcorp S.A., he was employed by KPMG, anaccounting firm, as a Partner; Riverwood International, a paperboard, packagingand machinery company, as Senior Vice President and Chief Financial Officer; andCoopers & Lybrand LLP, an accounting firm, as a Partner. He is a director ofCSK Auto Corporation, Werner Holding Co. (DE), Inc., IWO Holdings, Inc.(Independent Wireless One Corporation) and Jostens Inc. 

William C. McCollum has served as a Director of Investcorp S.A.since May 1996. Prior to joining Investcorp S.A., Mr. McCollum was a financialAnalyst with Chase Securities Inc. He is a director of the Neptune TechnologyGroup Holdings Inc. 

Bruce Tully has served as a Director of Investcorp S.A. sinceJune 2002. Prior to joining Investcorp S.A., Mr. Tully co-founded a venturecapital firm, funded in part by Deutsche Bank. Mr. Tully had previously been anemployee of Bankers Trust (which was acquired by Deutsche Bank in 1999)providing debt, equity, and merger and acquisition services for some of thecountry’s premier financial sponsors firms. 
                                       59
EXECUTIVE OFFICERS

The following table setsforth certain information with respect to the executive officers of the Company: 
NAME                      AGE   POSITION----                      ---   --------Stephen L. Guillard       53    Chief Executive Officer and DirectorDamian N. Dell'Anno       43    President, Chief Operating Officer and DirectorWilliam H. Stephan        46    Senior Vice President, Chief Financial Officer and DirectorBruce J. Beardsley        39    Senior Vice President of AcquisitionsSteven Raso               38    Senior Vice President of Operations *Information on Mr. Guillard, Mr. Dell'Anno and Mr. Stephan appears above.
Bruce J. Beardsley hasserved as Senior Vice President of Acquisitions since March 21, 1996 and itspredecessors since 1994. From 1992 to 1994, he was Vice President of Planningand Development of the Company with responsibility for the development ofspecialized services, planning and engineering. From 1990 to 1992, he was anAssistant Vice President of the Company responsible for risk management andadministrative services. From 1988 to 1990, Mr. Beardsley served as SpecialProjects Manager of the Company. Prior to joining the Company in 1988, Mr.Beardsley was a commercial and residential real estate appraiser. 

Steven V. Raso served as Senior Vice President of Operationsfrom 1998 to 2003. From 1994 to 1998, he served as Vice President ofReimbursement for the Company and he served as Director of Reimbursement andBudgets from 1989 to 1994. In these capacities, Mr. Raso was responsible forvarious aspects of Company Operations, including the Medicare and Medicaidreimbursement cost reporting functions, including audits, appeals, licensing andrate determinations. Mr. Raso also oversaw the budgeting, accounts receivableand compliance departments within the Company.

* Mr. Raso's service as the Company's Senior Vice President ofOperations ceased in March 2003. 
                                       60
**ITEM 11. EXECUTIVE COMPENSATION**
SUMMARY COMPENSATION TABLE
The following table setsforth the cash and non-cash compensation for 2002, 2001 and 2000 awarded to orearned by the Chief Executive Officer and the four other most highly compensatedexecutive officers of the Company (collectively, the “Named ExecutiveOfficers”). 
                                    Annual Compensation                     Long Term Compensation                                    -------------------                     ----------------------                                                                            Awards          Payouts                                                       Other                    Securities                                                       Annual      Restricted   Underlying All OtherName and                                     Bonus     Compen-     Stock        Options/   Compen-Principal Position         Year   Salary     (1)(2)    sation      Award(s)(3)  SARs       sation (4)------------------         ----   -------   -------    ---------   -----------  ----       ----------Stephen L. Guillard        2002  $ 496,159 $ 125,000  $  -         $     -            -    $  36,977Chief Executive            2001    423,094    95,000     -               -      320,000       34,794Officer                    2000    397,523    86,250     -            1,550           -       28,280Damian N. Dell'Anno        2002    347,319    70,000     -               -            -       20,420President and Chief        2001    300,780    70,000     -               -      150,000       17,768Operating Officer          2000    281,259    45,000     -            1,010           -       13,750William H. Stephan         2002    297,681    60,000     -               -            -       15,566Senior Vice                2001    253,842    55,000     -               -      105,000       13,349President and              2000    227,692    38,000     -              700           -       11,295Chief FinancialOfficerBruce J. Beardsley         2002    272,886    55,000     -               -            -       16,573Senior Vice                2001    238,078    50,000     -               -      105,000       14,415President of               2000    226,249    40,000     -              700           -       11,000AcquisitionsSteven V. Raso             2002    198,462    40,000     -               -            -       12,686Senior Vice                2001    181,538    35,000     -               -       67,500       11,515President of               2000    177,499    28,000     -              490           -        8,750Operations(1)  On May 23, 2001, in recognition of the successful completion of the     Company's financial restructuring plan, the Company's Board of Directors     awarded bonus payments in the amounts of $95,000, $70,000, $55,000, $50,000     and $35,000 to Messrs. Guillard, Dell'Anno, Stephan, Beardsley and Raso,     respectively.(2)  On September 27, 2002 the Board of Directors, in recognition of the     successful refinancing of the Company's Credit Facility, awarded bonus     payments in the amounts of $125,000, $70,000, $60,000, $55,000 and $40,000     to Messrs. Guillard, Dell'Anno, Stephan, Beardsley and Raso, respectively.(3)  On September 29, 2000, the Company granted 155,000, 101,000, 70,000, 70,000     and 49,000 shares of restricted stock to Messrs. Guillard, Dell'Anno,     Stephan, Beardsley and Raso, respectively. As part of this stock issuance,     options granted on August 11, 1998 to purchase shares of the Company's     Class C common stock at $25.00 per share in the amounts of 160,904,     104,666, 72,641, 72,641, and 50,771 shares for Messrs. Guillard, Dell'Anno,     Stephan, Beardsley and Raso, respectively, were cancelled. One-third of the     shares of restricted stock vest annually beginning on December 31, 2001. As     of December 31, 2001, the aggregate restricted stock holdings for each of     the Named Executive Officers consisted of the following: Mr. Guillard,     155,000 shares with a value of $1,510; Mr. Dell'Anno, 101,000 shares with a     value of $1,010; Mr. Stephan, 70,000 shares with a value of $700; Mr.     Beardsley, 70,000 shares with a value of $700; and Mr. Raso, 49,000 shares     with a value of $490.(4)  Includes matching contributions made by the Company under its Supplemental     Executive Retirement Plan and 401(k) Plan.                                       61OPTION/SAR GRANTS IN LAST FISCAL YEAR
The Company did not grantany stock options or stock appreciation rights to its named executives during2002. 
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEARAND FISCAL YEAR END OPTION/SAR VALUES
The following table setsforth information concerning the aggregate number of exercisable andunexercisable stock options and stock appreciation rights held by the namedexecutives as of the end of 2002. No stock options were exercised by the NamedExecutive Officers during 2002. 
                               NUMBER OF                               SECURITIES                 VALUE OF                               UNDERLYING                 UNEXERCISED                               UNEXERCISED                IN-THE MONEY                               OPTIONS/SARS AT            OPTIONS/SARS AT                               FISCAL YEAR END            FISCAL YEAR END                               EXERCISABLE/                EXERCISABLE/         NAME                  UNEXERCISABLE            UNEXERCISABLE (1)         ----                  -------------            -----------------       Stephen L. Guillard       160,000/160,000                  $   -       Damian N. Dell'Anno         85,560/75,000                      -       William H. Stephan          90,832/52,500                      -       Bruce J. Beardsley          91,662/52,500                      -       Steven V. Raso              55,690/33,750                      -(1)  Underlying shares are not publicly traded and are subject to repurchase by     the Company under certain circumstances at the employee's cost or at the     then current value of the underlying share, as determined by the Company's     Board of Directors upon the termination of the employee's employment with     the Company. None of these options are classified as in-the-money for     purposes of this table. The Company has not established any recent     valuations for such shares. 
EMPLOYMENT AGREEMENTS

The Company has enteredinto employment agreements with Messrs. Guillard, Dell’Anno, Stephan,Beardsley and Raso (collectively, the “Employment Agreements”). Underthe terms of the Employment Agreements, Mr. Guillard serves as Chief ExecutiveOfficer of the Company, Mr. Dell’Anno serves as President and ChiefOperating Officer of the Company, Mr. Stephan serves as Senior Vice Presidentand Chief Financial Officer of the Company, Mr. Beardsley serves as Senior VicePresident of Acquisitions of the Company and Mr. Raso serves as Senior VicePresident of Operations of the Company. Through March 31, 1999, Messrs.Guillard, Dell’Anno, Stephan, Beardsley and Raso received minimum annualbase salaries of $345,000, $225,000, $190,000, $200,000 and $140,000,respectively. The salaries of Messrs. Guillard, Dell’Anno, Stephan,Beardsley and Raso were to be increased to $375,000, $240,000, $200,000,$215,000 and $150,000, respectively, effective April 1, 1999. Through December31, 1999, Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso electedto forgo the scheduled compensation adjustments. In January 2000, the amounts ofcompensation due to these individuals as a result of these elective deferralswere paid by the Company, and as of January 1, 2000, the salaries of Messrs.Guillard, Dell’Anno, Stephan, Beardsley, and Raso were increased to$375,000, $270,000, $200,000, $215,000 and $170,000, respectively. On March 1,2000, Mr. Stephan’s salary was increased to $225,000. On August 11, 2001,the salaries of Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Rasowere increased to $500,000, $350,000, $300,000, $275,000 and $200,000,respectively. 

In response to a reductionin Federal funding of the Medicare program, Messrs. Guillard, Dell’Anno,Stephan, Beardsley and Raso voluntarily elected to reduce their salaries by tenpercent effective December 1, 2002. The salaries of Messrs. Guillard,Dell’Anno, Stephan, Beardsley and Raso were reduced to $450,000, $315,000,$270,000, $247,500 and $180,000, respectively, effective December 1, 2002. Underthe terms of these Employment Agreements, the salaries of each officer will besubject to further adjustment at the discretion of the Compensation Committee ofthe Board of Directors of the Company. 

The Employment Agreementsalso provide (i) for an annual bonus to be paid to Messrs. Guillard,Dell’Anno, Stephan, Beardsley and Raso, part of which will be based uponachievement of specific performance targets and part of which will bediscretionary, in maximum amounts of 120% of base salary in the case of Mr.Guillard, 96% of base salary in the case of Mr. Dell’Anno and 78% of basesalary in the cases of Messrs. Stephan, Beardsley and Raso, and (ii) that upontermination of employment prior to an initial public offering, the Company willhave certain rights to call from such officers shares of Harborside Common Stockowned by such officers (including shares underlying then-exercisable stockoptions), and such officers will have certain rights to put such shares to anaffiliate of Investcorp (subject to a right of first refusal in favor of theCompany). 

Each officer has the rightto terminate his Employment Agreement on 30 days notice. The Company has theright to terminate an Employment Agreement without obligation for severance onlyfor Good Cause (as defined in the Employment Agreements). The Employment
                                       62
Agreements provide for severance benefits to be paid in the event anofficer’s employment is terminated if such termination is, in the case oftermination by the Company, without Good Cause, or, in the case of terminationby an officer, for Good Reason (as defined in the Employment Agreements). If theCompany terminates the employment of an officer without Good Cause or theofficer terminates his employment for Good Reason, the officer will be entitledto receive severance benefits which will include (i) the vesting of the pro rataportion of stock options subject to vesting in the then current yearattributable to the part of the year that the officer was employed, (ii) theability to exercise vested stock options for the period ending on the earlier ofthe date that is 180 days from the date his employment is terminated or thespecific expiration date stated in the options, and (iii) in the case of Mr.Guillard, for the period ending 30 months after termination, in the case of Mr.Dell’Anno, for the period ending 24 months after termination, and in thecases of Messrs. Stephan, Beardsley and Raso, for the period ending 18 monthsafter termination, payment of the officer’s compensation at the rate mostrecently in effect; subject to such officer’s compliance withnoncompetition and nonsolicitation covenants for such 18, 24 or 30 month period,as applicable. 

SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

Effective September 15,1995, Harborside established a Supplemental Executive Retirement Plan(“SERP”) to provide benefits for key employees of Harborside.Participants may defer up to 25% of their salary and bonus compensation bymaking contributions to the SERP. Amounts deferred by the participant arecredited to his or her account and are always fully vested. Through December 31,2002, Harborside matched 50% of amounts contributed until 10% of base salary hadbeen contributed. In response to a recent reduction in Federal funding of theMedicare program, the Company amended the SERP effective January 1, 2003 toeliminate additional employer matching contributions effective as of that date.Matching contributions made by Harborside become vested as of January 1 of thesecond year following the end of the plan year for which contributions werecredited, provided the employee is still employed with Harborside on that date.In addition, participants will be fully vested in such matching contributionamounts in the case of death or permanent disability or at the discretion ofHarborside. Participants are eligible to receive benefits distributions uponretirement or in certain pre-designated years. Participants may not receivedistributions prior to a pre-designated year, except in the case of termination,death or disability or demonstrated financial hardship. Only amounts contributedby the employee may be distributed because of financial hardship. Althoughamounts deferred and Company matching contributions are deposited in a“rabbi trust,” they are subject to risk of loss. If Harborside becomesinsolvent, the rights of participants in the SERP would be those of an unsecuredgeneral creditor of Harborside. 

STOCK INCENTIVE PLAN
In connection with theMerger, the Company adopted the Harborside Healthcare Corporation StockIncentive Plan (the “Stock Option Plan”). Initially, 806,815 shareswere made available to be awarded under the Stock Option Plan, representingapproximately 10% of the shares of common stock of Harborside outstandingimmediately after the Merger, determined after giving effect to the exercise ofthe options issued or issuable under the Stock Option Plan. Options to purchase602,996 shares of Class C Common Stock were granted to members of theCompany’s management upon consumation of the Merger. All options grantedunder the Stock Option Plan during 1998 were granted with an exercise priceequal to $25.00, equal to the fair market value of the stock on the date ofgrant. Options granted under the Stock Option Plan during 1998 were to vest atthe end of a seven year period or earlier if certain financial performancecriteria were met. All options granted under the Stock Option Plan during 1998and still outstanding as of September 29, 2000 were cancelled on that date inconnection with the issuance of the Restricted Shares. 

Effective November 19,2001, the Company granted options to purchase 883,000 shares of common stockwith an exercise price equal to $1.25 per share. These options becomeexercisable to the extent of one-fourth of the number of option shares onDecember 31, 2001, one-fourth of the number of option shares on December 31,2002, one-fourth of the number of option shares on December 31, 2003 andone-fourth of the number of option shares on December 31, 2004. In certaincircumstances, vesting of these options is accelerated. These options terminate(with certain exceptions) thirty days after the seventh anniversary of theirdate of grant. All options granted under the Stock Option Plan during 2001 weregranted with an exercise price not less than the fair market value of the stockon the date of grant. 

Effective September 25,2002, the Company granted options to purchase 50,500 shares of common stock withan exercise price equal to $1.25 per share. These options become exercisable tothe extent of one-fourth of the number of option shares on December 31, 2002,one-fourth of the number of option shares on December 31, 2003, one-fourth ofthe number of option shares on December 31, 2004 and one-fourth of the number ofoption shares on December 31, 2005. In certain circumstances, vesting of theseoptions is accelerated. These options terminate (with certain exceptions) thirtydays after the seventh anniversary of their date of grant. All options grantedunder the Stock Option Plan during 2002 were granted with an exercise price notless than the fair market value of the stock on the date of grant. 

The Stock Option Plan isadministered by the Board of Directors of the Company. The Board of Directorsdesignates which employees of the Company will be eligible to receive awardsunder the Stock Option Plan, and the amount, timing, and other terms andconditions applicable to such awards. A maximum of 1,600,000 shares have beenreserved for issuance in connection with the Stock Option Plan. 
                                       63
**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

The following tableprovides equity compensation plan information at December 31, 2002: 
                                                 Equity Compensation Plan Information                                                                                          Number of securities                                    Number of securities                                  remaining available for                                    to be issued                Weighted-average          future issuance under                                    upon exercise               exercise price of         equity compensation plans                                    outstanding options,        outstanding options,      (excluding securities         Plan category              warrants and rights         warrants and rights       reflected in column (a))         -------------              -------------------         -------------------       ------------------------                                          (a)                           (b)                        (c)         Equity compensation           plans approved by           security holders               1,043,494                        $2.50                       1,500         Equity compensation           plans not approved           by security holders                -                              -                           -                                        -----------                      -------                  ----------                 Total                    1,043,494                        $2.50                       1,500                                        ===========                      =======                  ==========
PRINCIPAL SHAREHOLDERS

The Company is authorizedto issue shares of five classes of common stock, each with a par value of $0.01,consisting of Class A Common Stock (“Harborside Class A CommonStock”), Class B Common Stock (“Harborside Class B CommonStock”), Class C Common Stock (“Harborside Class C CommonStock”), Class D Common Stock (“Harborside Class D Common Stock”)and Common Stock (“Common Stock”) (collectively “HarborsideCommon Stock”). Harborside Class A Common Stock, Harborside Class D CommonStock and Common Stock are the only classes of the Company’s common stockthat have the power to vote. Holders of Harborside Class B Common Stock andHarborside Class C Common Stock do not have any voting rights, except that theholders of Harborside Class B Common Stock and Harborside Class C Common Stockhave the right to vote as a class to the extent required under the laws of theState of Delaware. 

As of March 1, 2003, therewere 661,332 shares of Harborside Class A Common Stock, 20,000 shares ofHarborside Class D Common Stock and no shares of Common Stock outstanding.Holders of shares of Harborside Class A Common Stock and Common Stock of theCompany are entitled to one vote per share on all matters as to whichstockholders may be entitled to vote pursuant to the DGCL. Holders of HarborsideClass D Common Stock are entitled to 330 votes per share on all matters as towhich stockholders may be entitled to vote pursuant to the DGCL. 

As a result of theconsummation of the Merger, the New Investors beneficially own all of theoutstanding Harborside Class D Common Stock, constituting approximately 91% ofthe outstanding voting power of the Company, and pre-Merger stockholders,including certain members of management, beneficially own all of the outstandingHarborside Class A Common Stock, constituting approximately 9% of theoutstanding voting power of the Company. In addition, the New Investors own5,940,000 shares of Harborside Class B Common Stock and 640,000 shares ofHarborside Class C Common Stock. 

The following table setsforth certain information regarding the beneficial ownership of the voting stockof the Company as of March 1, 2003. The table sets forth, as of that date, (i)each person known by the Company to be the beneficial owner of more than 5% ofany class of voting stock of the Company, (ii) each person who was a director ofthe Company or a Named Executive Officer of the Company and (iii) all directorsof the Company and executive officers of the Company as a group. None of theCompany’s directors or officers own shares of Harborside Class D CommonStock. Unless otherwise indicated, each of the stockholders shown in the tablebelow has sole voting and investment power with respect to the sharesbeneficially owned. 
                                       64                        HARBORSIDE CLASS A COMMON STOCK                                          (9% Of Voting Power)Name and address of               Number of   Number of               Percent ofBeneficial Owner (1)             Shares (2) Options (3)        Total   Class (4)--------------------             ---------- ------------       -----   ---------George Krupp (5)                   196,079        --          196,079       29.6Douglas Krupp (5)                  196,079        --          196,079       29.6Stephen L. Guillard                177,688        --          177,688       26.9Damian N. Dell'Anno                 47,563    10,560           58,123        8.7Bruce J. Beardsley                      --    39,162           39,162        5.6William H. Stephan                     400    38,332           38,732        5.5Steven V. Raso                          --    21,940           21,940        3.2Lars C. Haegg                           --        --               --         --James O. Egan                           --        --               --         --William C. McCollum                     --        --               --         --Bruce Tully                             --        --               --         --All directors and executiveofficers asa group (9 persons)     225,651   109,994          335,645       43.5HARBORSIDE CLASS D COMMON STOCK                                          (91% Of Voting Power)                                            Number of         Percent ofName and address of Beneficial Owner        Shares (2)         Class------------------------------------        ----------         -----INVESTCORP S.A. (6)(7)....................    20,000            100.0SIPCO Limited (8).........................    20,000            100.0CIP Limited (9)(10).......................    18,400             92.0Ballet Limited (9)(10)....................     1,840              9.2Denary Limited (9)(10)....................     1,840              9.2Gleam Limited (9)(10).....................     1,840              9.2Highlands Limited (9)(10).................     1,840              9.2Nobel Limited (9)(10).....................     1,840              9.2Outrigger Limited (9)(10).................     1,840              9.2Quill Limited (9)(10).....................     1,840              9.2Radial Limited (9)(10)....................     1,840              9.2Shoreline Limited (9)(10).................     1,840              9.2Zinnia Limited (9)(10)....................     1,840              9.2INVESTCORP Investment Equity Limited (7)..     1,600              8.0(1)  The address of each person listed in the table as a holder of Harborside     Class A Common Stock is c/o Harborside Healthcare Corporation, One Beacon     Street, Boston, Massachusetts 02108.(2)  As used in the table above, a beneficial owner of a security includes any     person who, directly or indirectly, through contract, arrangement,     understanding, relationship, or otherwise has or shares (i) the power to     vote, or direct the voting of, such security or (ii) investment power which     includes the power to dispose, or to direct the disposition of, such     security.(3)  Includes shares of stock that are subject to options exercisable within 60     days of March 1, 2002.(4)  Reflects the percentage such shares and options represent of the number of     outstanding shares of such class of the Company's common stock after giving     effect to the exercise of options owned by such person or persons.(5)  The shares beneficially owned by George Krupp are owned of record by The     George Krupp 1994 Family Trust ("GKFT"). The shares beneficially owned by     Douglas Krupp are owned of record by The Douglas Krupp 1994 Family Trust     ("DKFT"). The trustees of both GKFT and DKFT are Lawrence I. Silverstein,     Paul Krupp and M. Gordon Ehrlich (the "Trustees"). The Trustees share     control over the power to dispose of the assets of GKFT and DKFT and thus     each may be deemed to beneficially own the shares held by GKFT and DKFT;     however, each of the Trustees disclaims beneficial ownership of all of such     shares.(6)  Investcorp S.A. does not directly own any stock in the Company. The number     of shares shown as owned by Investcorp S.A. includes all of the shares     owned by INVESTCORP Investment Equity Limited (See note (7) below).     Investcorp S.A. owns no stock in Ballet Limited, Denary Limited, Gleam     Limited, Highlands Limited, Noble Limited, Outrigger Limited, Quill     Limited, Radial Limited, Shoreline Limited, Zinnia Limited, or in the     beneficial owners of these entities (See note (10) below). Investcorp S.A.     may be deemed to share beneficial ownership of the shares of voting stock     of the Company held by these entities because the entities have entered     into revocable management services or similar agreements with an affiliate     of Investcorp S.A., pursuant to which each such entities has granted such     affiliate the authority to direct the voting and disposition of the Company     voting stock owned by such entity for so long as such agreement is in     effect. Investcorp S.A. is a Luxembourg corporation with its address at 37     rue Notre-Dame, Luxembourg.                                       65(7)  INVESTCORP Investment Equity Limited is a Cayman Islands corporation, and a     wholly owned subsidiary of Investcorp S.A., with its address at P.O. Box     1111, West Wind Building, George Town, Grand Cayman, Cayman Islands.(8)  SIPCO Limited may be deemed to control Investcorp S.A. through its     ownership of a majority of a company's stock that indirectly owns a     majority of Investcorp's shares. SIPCO Limited's address is P.O. Box 1111,     West Wind Building, George Town, Grand Cayman, Cayman Islands.(9)  CIP Limited ("CIP") owns no stock in the Company. CIP indirectly owns less     than 0.1% of the stock in each of Ballet Limited, Denary Limited, Gleam     Limited, Highlands Limited, Noble Limited, Outrigger Limited, Quill     Limited, Radial Limited, Shoreline Limited and Zinnia Limited (See note     (10) below). CIP may be deemed to share beneficial ownership of the shares     of voting stock of the Company held by such entities because CIP acts as a     director of such entities and the ultimate beneficial stockholders of each     of those entities have granted to CIP revocable proxies in companies that     own those entities' stock. None of the ultimate beneficial owners of such     entities beneficially owns individually more than 5% of the Company's     voting stock.(10) Each of CIP Limited, Ballet Limited, Denary Limited, Gleam Limited,     Highlands Limited, Noble Limited, Outrigger Limited, Quill Limited, Radial     Limited, Shoreline Limited and Zinnia Limited is a Cayman Islands     corporation with its address at P.O. Box 2197, West Wind Building,     GeorgeTown, Grand Cayman, Cayman Islands.
**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

None.

**ITEM 14.  CONTROLS AND PROCEDURES**

Our management, includingour Chief Executive Officer and Chief Financial Officer, conducted an evaluationof the effectiveness of our disclosure controls and procedures (as defined inRules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, asamended) within 90 days of the date of filing this annual report on Form 10-K.Based on that evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures are effective inensuring that all material information required to be filed in this annualreport has been made known to them in a timely fashion. 

There have been nosignificant changes in internal controls, or in factors that could significantlyaffect internal controls, subsequent to the date our Chief Executive Officer andChief Financial Officer completed their evaluation. 
PART IV
**ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**
(a)         1.       Financial Statements:See Index to ConsolidatedFinancial Statements in Item 8 of this annual report.         2.       Financial Statement Schedules:                  None.3.       ExhibitsThe exhibits listed in the accompanying index to exhibits are incorporated byreference herein or are filed as part of this annual report.ExhibitNumber Description of Exhibit      2.1**              Agreement and Plan of Merger dated as of April 15, 1998      3.1(a)****#        Amended and Restated Certificate of Incorporation of the Registrant      3.1(b)****         Certificate of Designation of the Registrant with respect to the Exchangeable                         Preferred Stock      3.1(c)**           Amended and Restated By-laws of the Registrant      3.1(d)****         Form of Certificate of Incorporation of certain registrants, as amended                                       66      3.2(a)****         Certificate of Incorporation of Sailors, Inc.      3.1(e)***          Amended Certificate of Designation of the Registrant for the Redeemable Preferred                         Stock (formerly known as131/2% Exchangeable Preferred Stock)      3.1(f)***          Certificate of Designation of the Registrant for the 13% Convertible Exchangeable                         Preferred Stock      3.2(b)****         Form A of Articles of Organization, Articles of Amendment and Articles of Merger of                         certain registrants      3.2(c)****         Form B of Articles of Organization of certain registrants      3.2(d)****         Form of First Amendment to and Restatement of Agreement of Limited Partnership of                         certain registrants      3.2(e)****         Form of Agreement of Limited Partnership of certain registrants      3.2(f)****         Amended and Restated Agreement of Limited Partnership of Harborside Healthcare                         Limited Partnership, dated as of May 12, 1987, as amended and restated as of                         July 1, 1995      3.2(g)****         Agreement of Limited Partnership of KHC Partners, Limited Partners, dated as of May                         28, 1987, as amended      3.2(h)****         Form A of Certificate of Limited Partnership of certain registrants      3.2(i)****         Form B of Certificate of Limited Partnership of certain registrants      3.2(j)****         Certificate of Limited Partnership of Bridgewater Assisted Living Limited Partnership      3.2(k)****         First Amendment to and Restatement of Certificate of Limited Partnership of KHC                         Partners Limited Partnership (now known as Harborside Healthcare Advisors Limited                         Partnership)      3.2(l)****         First Amendment to and Restatement of Certificate of Limited Partnership of Harborside                         Acquisition Limited Partnership IV (now known as Harborside Danbury Limited                         Partnership)      3.2(m)****         Certificate of Formation and Agreement of Limited Partnership of Riverside Retirement                         Limited Partnership, as amended      3.2(n)****         Certificate of Limited Partnership of Harborside Healthcare Limited Partnership      3.2(o)****         Form A of By-laws of certain registrants      3.2(p)****         Form B of By-laws of certain registrants      4.1****            Indenture between MergerCo and the Trustee, dated as of July 31, 1998, with respect to                         the Notes      4.2****            Supplemental Indenture between the Registrant, the Guarantors and the Trustee, dated                         as of August 11, 1998      4.3****#           Form of New Note      4.4****            Registration Rights Agreement, dated July 31, 1998, between the Registrant                         (as successor to MergerCo) and the Placement Agents, relating to the Old Notes      4.5****            Certificate of Designation of the Registrant with respect to the Exchangeable                         Preferred Stock (filed as Exhibit 3.1.(b))      4.6****            Form of Stock Certificate representing New Preferred Stock      4.7****            Registration Rights Agreement, dated July 31, 1998, between the Registrant                         (as successor to MergerCo) and the Placement Agents, relating to the Old                         Preferred Stock (filed as Exhibit 1.3)      4.8****            Form of Letter of Transmittal (filed as Exhibit 1.4)      4.9***             Second Supplemental Indenture, dated as of May 10, 2001, between the Registrant,                         the Guarantors as defined therein and United States Trust Company of New York,                         as trustee, relating to the 11% Senior Subordinated Discount Notes due 2008                                       67      4.10***            Indenture, dated as of May 10, 2001, among the Registrant, the Guarantors as                         defined therein and United States Trust Company of New York, as trustee, relating                         to the 12% Senior Subordinated Discount Notes due 2007     10.1(a)*            Facility Lease Agreement, dated as of December 31, 1995, between Meditrust Tri-States,                         Inc. and HHCI Limited Partnership (New Haven Facility)     10.1(b)*            Facility Lease Agreement, dated as of December 31, 1995, between Meditrust Tri-States,                         Inc. and HHCI Limited Partnership (Indianapolis Facility)     10.1(c)*            Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Ohio,                         Inc. and HHCI Limited Partnership (Troy Facility)     10.1(d)*            Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Florida,                         Inc. and HHCI Limited Partnership (Sarasota Facility)     10.1(e)*            Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Florida,                         Inc. and HHCI Limited Partnership (Pinebrook Facility)     10.1(f)*            Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of Florida,                         Inc. and HHCI Limited Partnership (Naples Facility)     10.1(g)*            Facility Lease Agreement, dated as of December 31, 1995, between Meditrust of New                         Jersey, Inc. and HHCI Limited Partnership (Woods Edge Facility)     10.1(h)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust Tri-States, Inc. and HHCI Limited Partnership (New Haven Facility)     10.1(i)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust Tri-States, Inc. and HHCI Limited Partnership (Indianapolis Facility)     10.1(j)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of Ohio, Inc. and HHCI Limited Partnership (Troy Facility)     10.1(k)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of Florida, Inc. and HHCI Limited Partnership (Sarasota Facility)     10.1(l)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of Florida, Inc. and HHCI Limited Partnership (Pinebrook Facility)     10.1(m)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of Florida, Inc. and HHCI Limited Partnership (Naples Facility)     10.1(n)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of New Jersey, Inc. and HHCI Limited Partnership (Woods Edge Facility)     10.2(a)*            Loan Agreement,dated October 13, 1994, among Meditrust Mortgage Investments, Inc.                         and Bay Tree Nursing Center Corporation, Belmont Nursing Center Corporation,                         Countryside Care Center Corporation, Oakhurst Manor Nursing Center Corporation,                         Orchard Ridge Nursing Center Corporation, Sunset Point Nursing Center Corporation,                         West Bay Nursing Center Corporation and Harborside Healthcare Limited Partnership.     10.2(b)*            Guaranty, dated October 14, 1994, to Meditrust Mortgage Investments, Inc. from                         Harborside Healthcare Limited Partnership     10.2(c)*            Environmental Indemnity Agreement, dated October 13, 1994, by and among Bay Tree                         Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside Care                         Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard Ridge Nursing                         Center Corporation, Sunset Point Nursing Center Corporation, West Bay Nursing                         Center Corporation and Harborside Healthcare Limited Partnership and Meditrust                         Mortgage Investments, Inc.     10.2(d)*            Consolidated and Renewed Promissory Note, dated October 13, 1994, from Bay Tree                         Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside Care                         Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard Ridge Nursing                         Center Corporation, Sunset Point Nursing Center Corporation, West Bay Nursing                         Center Corporation and Harborside Healthcare Limited Partnership and Meditrust                         Mortgage Investments, Inc.                                       68     10.2(e)*            Negative Pledge Agreement, dated October 13, 1994, by and among Douglas Krupp,                         George Krupp, Bay Tree Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside                         Care Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard                         Ridge Nursing Center Corporation, Sunset Point Nursing Center Corporation, West                         Bay Nursing Center Corporation and Harborside Healthcare Limited Partnership and                         Meditrust Mortgage Investments, Inc.     10.2(f)*            Affiliated Party Subordination Agreement, dated October 13, 1994, by and among                         Bay Tree Nursing Center Corporation, Belmont Nursing Center Corporation, Countryside                         Care Center Corporation, Oakhurst Manor Nursing Center Corporation, Orchard Ridge                         Nursing Center Corporation, Sunset Point Nursing Center Corporation, West Bay Nursing                         Center Corporation and Harborside Healthcare Limited Partnership and Meditrust                         Mortgage Investments, Inc.      10.2(g)*           First Amendment to Loan Agreement, dated May 17, 1996, by and among Meditrust                         Mortgage Investments, Inc. and Bay Tree Nursing Center Corporation, Belmont Nursing                         Center Corporation, Countryside Care Center Corporation, Oakhurst Manor Nursing Center                         Corporation, Orchard Ridge Nursing Center Corporation, Sunset Point Nursing                         Center Corporation, West Bay Nursing Center Corporation and Harborside                         Healthcare Limited Partnership     10.3(a)*            Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New                         Hampshire Inc. and Harborside New Hampshire Limited Partnership (Westwood Facility)     10.3(b)*            Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New                         Hampshire Inc. and Harborside New Hampshire Limited Partnership (Pheasant Wood                         Facility)     10.3(c)*            Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New                         Hampshire Inc. and Harborside New Hampshire Limited Partnership (Crestwood Facility)     10.3(d)*            Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New                         Hampshire Inc. and Harborside New Hampshire Limited Partnership (Milford Facility)     10.3(e)*            Facility Lease Agreement, dated as of January 1, 1996, between Meditrust of New                         Hampshire Inc. and Harborside New Hampshire Limited Partnership (Applewood Facility)     10.3(f)*            Facility Lease Agreement, dated as of December 31, 1996, between Meditrust of New                         Hampshire Inc. and Harborside New Hampshire Limited Partnership (Northwood Facility)     10.3(g)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership                         (Westwood Facility)     10.3(h)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership                         (Pheasant Wood Facility)     10.3(i)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership                         (Crestwood Facility)     10.3(j)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership                         (Milford Facility)     10.3(k)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership                         (Applewood Facility)     10.3(l)*            First Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of New Hampshire, Inc. and Harborside New Hampshire Limited Partnership                         (Northwood Facility)     10.4(a)*            Facility Lease Agreement, dated as of March 31, 1995, between Meditrust of Ohio, Inc.                         and Harborside of Toledo Limited Partnership (Swanton Facility)     10.4(b)*            First Amendment to Facility Lease Agreement, dated as of December 31, 1995, by and                         between Harborside Toledo Limited Partnership and Meditrust of Ohio, Inc. (Swanton                         Facility)     10.4(c)*            Second Amendment to Facility Lease Agreement, dated as of May 17, 1996, by and between                         Meditrust of Ohio, Inc. and Harborside Toledo Limited Partnership (Swanton Facility)     10.5*               Amended and Restated Agreement of Limited Partnership of Bowie Center Limited                         Partnership, dated April 7, 1993     10.6*               Agreement of Lease, dated March 16, 1993, between Bryan Nursing Home, Inc. and                         Harborside of Ohio Limited Partnership (Defiance and Northwestern Ohio Facilities)                                       69     10.7*               First Amendment to Agreement of Lease, dated June 1, 1993, by and between Bryan                         Nursing Home, Inc. and Harborside Ohio Limited Partnership     10.8*               Option to Purchase Agreement, dated March 16, 1993, by and between Bryan Nursing Home,                         Inc. and Harborside Ohio Limited Partnership     10.9(a)*            Lease, dated September 30, 1994, between Rockledge T. Limited Partnership and                         Harborside of Florida Limited Partnership (Brevard Facility)     10.9(b)*            Lease Guaranty, dated September 30, 1994, to Rockledge T. Limited Partnership from                         Harborside Healthcare Limited Partnership     10.9(c)*            Indemnity Agreement, dated September 30, 1994, between Rockledge T. Limited                         Partnership, Harborside of Florida Limited Partnership, Harborside Healthcare Limited                         Partnership and Southtrust Bank of Alabama     10.9(d)*            Assignment and Security Agreement, dated September 30, 1994, to Rockledge T. Limited                         Partnership, Harborside of Florida Limited Partnership and Southtrust Bank of Alabama     10.9(e)*            Subordination Agreement (Lease), dated September 30, 1994, between Rockledge T.                         Limited Partnership, Harborside of Florida Limited Partnership and Southtrust Bank of                         Alabama     10.9(f)*            Subordination Agreement (Management), dated September 30, 1994, by and among Rockledge                         T. Limited Partnership, Harborside of Florida Limited Partnership, Harborside                         Healthcare Limited Partnership and Southtrust Bank of Alabama     10.10(a)****+       Employment Agreement, dated as of August 11, 1998, between the Registrant and Stephen                         L. Guillard     10.10(b)****+       Employment Agreement, dated as of August 11, 1998, between the Registrant and Damian                         Dell'Anno     10.10(c)****+       Employment Agreement, dated as of August 11, 1998, between the Registrant and Bruce                         Beardsley     10.10(d)****+       Employment Agreement, dated as of August 11, 1998, between the Registrant and William                         Stephan     10.10(e)****+       Employment Agreement, dated as of August 11, 1998, between the Registrant and Steven                         Raso     10.11(a)****+       Management Stock Incentive Plan, established by the Registrant as of August 11, 1998     10.11(b)****+       Form of Stock Option Agreement pursuant to Management Stock Incentive Plan     10.11(c)+           Form of Restricted Stock Agreement pursuant to Management Stock Incentive Plan     10.12(a)*+          1996 Long-Term Stock Incentive Plan     10.12(b)*+          Form of Nonqualified Stock Option Agreement pursuant to the 1996 Long-Term Stock                         Incentive Plan     10.13****+          Form of Put/Call Agreement, dated August 11, 1998, between the Registrant and each of                         Messrs. Guillard, Dell'Anno, Beardsley, Stephan and Raso     10.14*+             Supplemental Executive Retirement Plan of the Registrant     10.15*              Administrative Services Agreement, dated April 15, 1988, between the Registrant and                         The Berkshire Companies Limited Partnership ("BCLP")     10.16*              Agreement to Lease, dated as of May 3, 1996, among Westbay Manor Company,                         Westbay Manor II Development Company, Royal View Manor Development Company,                         Beachwood Care Center Limited Partnership, Royalview Manor Company, Harborside                         Health I Corporation and Harborside Healthcare Limited Partnership     10.17*              Guaranty by Harborside in favor of Westbay Manor Company, Westbay Manor II Development                         Company, Royalview Manor Development Company and Beachwood Care Center Limited                         Partnership     10.18****           Master Rights Agreement, dated as of August 11, 1998, by and among the Registrant,                         BCLP, certain affiliates of BCLP and the New Investors                                       70     10.19 (a)****       Credit Agreement, dated as of August 11, 1998, among the Registrant, Chase Securities,                         Inc., as Arranger, Morgan Stanley Senior Funding, Inc. and BT Alex. Brown                         Incorporated, as Co-Arrangers, Bankers Trust Company, as Documentation Agent, Morgan                         Stanley Senior Funding, Inc., as Syndication Agent, The Chase Manhattan Bank, as                         Administrative Agent, and the lenders party thereto (the "Lenders")     10.19 (b)           First Amendment to Credit Agreement, dated as of March 30, 1999, among the Registrant,                         Morgan Stanley Senior Funding, Inc. and BT Alex. Brown Incorporated, as Co-Arrangers,                         Bankers Trust Company, as Documentation Agent, Morgan Stanley Senior Funding Inc., as                         Syndication Agent, The Chase Manhattan Bank, as Administrative Agent, and the Lenders     10.19 (c)           SECOND AMENDMENT, dated as of September 25, 2000 to the       Credit Agreement, dated                         as of August 11, 1998 among HARBORSIDE HEALTHCARE CORPORATION, a Delaware corporation,                         the other entities listed on the signature pages thereof, as joint and several                         borrowers thereunder, the banks and other financial institutions or entities parties                         thereto, CHASE SECURITIES INC., as arranger, MORGAN STANLEY SENIOR FUNDING, INC. and                         BT ALEX. BROWN INCORPORATED, as co-arrangers, MORGAN STANLEY SENIOR FUNDING, INC., as                         syndication agent, BANKERS TRUST COMPANY, as documentation agent, and THE CHASE                         MANHATTAN BANK, as administrative agent for the Lenders.     10.19 (d)           THIRD AMENDMENT, dated as of March 28, 2001, to the Credit Agreement, dated as                         of August 11, 1998 (as amended, supplemented or otherwise modified from time to time,                         the "Credit Agreement"), among HARBORSIDE HEALTHCARE CORPORATION, a Delaware corporation                        (the "Company"), the other entities listed on the signature pages thereof, as joint                         and several borrowers thereunder (the Company and such other entities being,                         collectively, the "Borrowers"), the banks and other financial institutions or                         entities parties thereto (the "Lenders"), CHASE SECURITIES INC., as arranger,                         MORGAN STANLEY SENIOR FUNDING, INC. and BT ALEX. BROWN INCORPORATED, as co-arrangers,                         MORGAN STANLEY SENIOR FUNDING, INC., as syndication agent, BANKERS TRUST COMPANY,                         as documentation agent, and THE CHASE MANHATTAN BANK, as administrative agent for                         the Lenders (in such capacity, the "Administrative Agent")     10.21****           HHC 1998-1 Trust Credit Agreement, $238,125,000 Credit Facility, dated as of August                         11, 1998, among the Registrant, Chase Securities Inc., as Arranger, Morgan Stanley                         Senior Funding, Inc. and BT Alex. Brown Incorporated, as Co-Arrangers, Bankers Trust                         Company, as Documentation Agent, Morgan Stanley Senior Funding, Inc., as Syndication                         Agent, The Chase Manhattan Bank, as Administrative Agent, and the lenders party thereto     10.22****           Participation Agreement, dated as of August 11, 1998, among Harborside of Dayton                         Limited Partnership, as Lessee, HHC 1998-1 Trust, as Lessor, Wilmington Trust Company,                         BTD Harborside Inc., Morgan Stanley Senior Funding, Inc. and CSL Leasing, Inc., as                         Investors, The Chase Manhattan Bank, as Agent, and the lenders party thereto     10.23****           Lease, dated August 11, 1998, between HHC 1998-1 Trust, as Lessor, and Harborside of                         Dayton Limited Partnership, as Lessee     10.24****           Accounts Receivable Intercreditor Agreement (Leased Facilities), dated as of August                         11, 1998, among (i) The Chase Manhattan Bank, as administrative agent, (ii) HHC 1998-1                         Trust, (iii) CSL Leasing, Inc., BTD Harborside, Inc. and Morgan Stanley Senior                         Funding, Inc. and (iv) Meditrust Company LLC     10.25****           Accounts Receivable Intercreditor Agreement (Mortgaged Facilities), dated as of August                         11, 1998, among (i) The Chase Manhattan Bank, as administrative agent, (ii) HHC 1998-1                         Trust, (iii) CSL Leasing, Inc., BTD Harborside, Inc. and Morgan Stanley Senior                         Funding, Inc. and (iv) Meditrust Mortgage Investments, Inc.     10.27****           Agreement for Management Advisory, Strategic Planning and Consulting Services,                         dated August 11, 1998, between the Registrant (as successor to MergerCo) and III     10.28****           Second Amendment to Loan Agreement, Consent to Merger and Confirmation of Guaranties,                         dated as of July 31, 1998, by and among Bay Tree Nursing Center Corp., Countryside                         Cave Center Corp., Sunset Point Nursing Center Corp., West Bay Nursing Center Corp.,                         Harborside Healthcare Limited Partnership, Harborside Healthcare Corporation and                         Meditrust Mortgage Investments, Inc.     10.29****           Omnibus Amendment to Facility Lease Agreements, Consent to Merger and Confirmation                         of Guaranties, dated as of July 31, 1998, by and among Harborside New Hampshire                         Limited Partnership, Harborside Toledo Limited Partnership, HHCI Limited Partnership,                         Harborside Healthcare Limited Partnership, Harborside Healthcare Corporation and                         Meditrust Company LLC     10.30***            LEASE dated September 26, 2000, by and between, HHC BEACHWOOD, INC. as LANDLORD AND                         HARBORSIDE OF CLEVELAND LIMITED PARTNERSHIP as TENANT                                       71     10.31***            LEASE dated September 26, 2000, by and between, HHC BROADVIEW, INC. as LANDLORD AND                         HARBORSIDE OF CLEVELAND LIMITED PARTNERSHIP as TENANT     10.32***            LEASE dated September 26, 2000, by and between, HHC WESTBAY, INC. as LANDLORD AND                         HARBORSIDE CLEVELAND LIMITED PARTNERSHIP as TENANT     10.33*****          Series A Warrant Agreement, dated as of May 10, 2001, between the Registrant                         and United States Trust Company of New York, as warrant agent     10.34*****          Series B Warrant Agreement, dated as of May 10, 2001, between the Registrant                         and United States Trust Company of New York, as warrant agent     10.35*****          Warrant Registration Rights Agreement, dated as of May 10, 2001, by the Registrant                         for the benefit of holders of Series A Warrants and Series B Warrants     10.36*****          Preferred Stock Registration Rights Agreement, dated as of May 10, 2001, between                         the Registrant and the investors listed on the signature pages thereto     10.37+              Senior Officer Stock Option Agreement Pursuant to the Harborside Healthcare Stock                         Incentive Plan.     10.38+              Stock Option Agreement Pursuant to the Harborside Healthcare Stock Incentive Plan.     21.1                Subsidiaries of the Registrant     99.3(b)             Loan and Security Agreement dated September 13, 2002      *                  Incorporated by reference to the Registrant's Registration Statement on                         Form S-1 (Registration No. 333-3096)      **                 Incorporated by reference to the Registrant's Registration Statement on                         Form S-4(Registration No. 333-51633)      ***                Incorporated by reference to the Registran's Quarterly Report on Form 10-Q for the                         quarter ended September 30, 2000 (Registration No. 333-64679)      ****               Incorporated by reference to the Registrant's Registration Statement on Form S-4                         (Registration No. 333-64679)      *****              Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q                         for the quarter ended June 30, 2001 (Registration No. 333-64679)      #                  Replaces previously filed exhibit      +                  Management contract or compensation plan or arrangement required to be filed as                         an exhibit.    (b)                  Reports on Form 8-K:                         None                                       72
**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, on the 31st day of March 2003. 
                                       HARBORSIDE HEALTHCARE                                       CORPORATION                                       By   /s/ Stephen L. Guillard                                            -----------------------                                           Chairman, Chief Executive Officer                                           and Director
Pursuant to therequirements of the Securities and Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated 
/s/ Stephen L. Guillard        Chairman, Chief Executive Officer and Director                  March 31, 2003-----------------------                               (Principal Executive Officer)/s/ Damian N. Dell'Anno        President, Chief Operating Officer and Director                 March 31, 2003-----------------------/s/ William H. Stephan         Senior Vice President, Chief Financial Officer and Director     March 31,2003----------------------                               (Principal Financial and Accounting Officer)/s/ Lars C. Haegg              Director                                                        March 31, 2003-----------------/s/ James O. Egan              Director                                                        March 31, 2003-----------------/s/ William C. McCollum        Director                                                        March 31, 2003-----------------------/s/ Bruce Tully                Director                                                        March 31, 2003---------------                                       73
**CERTIFICATIONS**
I, Stephen L. Guillard, certify that:     1.   I have reviewed this annual report on Form 10-K of Harborside          Healthcare Corporation;     2.   Based on my knowledge, this annual report does not contain any untrue          statement of a material fact or omit to state a material fact          necessary to make the statements made, in light of the circumstances          under which such statements were made, not misleading with respect to          the period covered by this annual report;     3.   Based on my knowledge, the financial statements, and other financial          information included in this annual report, fairly present in all          material respects the financial condition, results of operations and          cash flows of Harborside Healthcare Corporation as of, and for, the          periods presented in this annual report;     4.   Harborside Healthcare Corporation's other certifying officer and          I are responsible for establishing and maintaining disclosure controls          and procedures (as defined in Exchange Act Rules 13a-14 and          15d-14) for Harborside Healthcare Corporation and we have:     a)   designed such disclosure controls and procedures to ensure that          material information relating to Harborside Healthcare Corporation,          including its consolidated subsidiaries, is made known to us by others          within these entities, particularly during the period in which this          annual report is being prepared;     b)   evaluated the effectiveness of Harborside Healthcare Corporation's          disclosure controls and procedures as of a date within 90 days prior          to the filing date of this annual report (the "Evaluation Date"); and     c)   presented in this annual report our conclusions about the          effectiveness of the disclosure controls and procedures based on our          evaluation as of the Evaluation Date;     5.   Harborside Healthcare Corporation's other certifying officer and I          have disclosed, based on our most recent evaluation, to Harborside          Healthcare Corporation's auditors and Harborside Healthcare          Corporation's board of directors:     a)   all significant deficiencies in the design or operation of internal          controls which could adversely affect Harborside Healthcare          Corporation's ability to record, process, summarize and report          financial data and have identified for Harborside Healthcare          Corporation's auditors any material weaknesses in internal          controls; and     b)   any fraud, whether or not material, that involves management or other          employees who have a significant role in Harborside Healthcare          Corporation's internal controls; and     6.   Harborside Healthcare Corporation's other certifying officer and I          have indicated in this annual report whether or not there were          significant changes in internal controls or in other factors that          could significantly affect internal controls subsequent to the date of          our most recent evaluation, including any corrective actions with          regard to significant deficiencies and material weaknesses.Date:    March 31, 2003                                                              /s/ Stephen L. Guillard                                                              ------------------------------------------                                                              Stephen L. Guillard,                                                              Chairman and Chief Executive Officer                                       74I, William H. Stephan, certify that:   1.   I have reviewed this annual report on Form 10-K of Harborside          Healthcare Corporation;     2.   Based on my knowledge, this annual report does not contain any untrue          statement of a material fact or omit to state a material fact          necessary to make the statements made, in light of the circumstances          under which such statements were made, not misleading with respect to          the period covered by this annual report;     3.   Based on my knowledge, the financial statements, and other financial          information included in this annual report, fairly present in all          material respects the financial condition, results of operations and          cash flows of Harborside Healthcare Corporation as of, and for, the          periods presented in this annual report;     4.   Harborside Healthcare Corporation's other certifying officer and          I are responsible for establishing and maintaining disclosure controls          and procedures (as defined in Exchange Act Rules 13a-14 and          15d-14) for Harborside Healthcare Corporation and we have:     a)   designed such disclosure controls and procedures to ensure that          material information relating to Harborside Healthcare Corporation,          including its consolidated subsidiaries, is made known to us by others          within these entities, particularly during the period in which this          annual report is being prepared;     b)   evaluated the effectiveness of Harborside Healthcare Corporation's          disclosure controls and procedures as of a date within 90 days prior          to the filing date of this annual report (the "Evaluation Date"); and     c)   presented in this annual report our conclusions about the          effectiveness of the disclosure controls and procedures based on our          evaluation as of the Evaluation Date;     5.   Harborside Healthcare Corporation's other certifying officer and I          have disclosed, based on our most recent evaluation, to Harborside          Healthcare Corporation's auditors and Harborside Healthcare          Corporation's board of directors:     a)   all significant deficiencies in the design or operation of internal          controls which could adversely affect Harborside Healthcare          Corporation's ability to record, process, summarize and report          financial data and have identified for Harborside Healthcare          Corporation's auditors any material weaknesses in internal          controls; and     b)   any fraud, whether or not material, that involves management or other          employees who have a significant role in Harborside Healthcare          Corporation's internal controls; and     6.   Harborside Healthcare Corporation's other certifying officer and I          have indicated in this annual report whether or not there were          significant changes in internal controls or in other factors that          could significantly affect internal controls subsequent to the date of          our most recent evaluation, including any corrective actions with          regard to significant deficiencies and material weaknesses.Date:    March 31, 2003                                                              /s/ William H. Stephan                                                              ------------------------------------------                                                              William H. Stephan,                                                              Senior Vice President and Chief Financial                                                              Officer                                       75                                                   Harborside Healthcare Corporation                                                           One Beacon Street                                                           Boston, MA 02210March 30, 2003Securities and Exchange Commission450 Fifth Avenue, N.W.Washington, D.C.  20549Ladies and Gentlemen:In accordance with Item601(b)(4)(iii) of Regulation S-K, Harborside Healthcare Corporation (the"Company") has not filed herewith any instrument with respect to longterm debt not being registered where the total number of securities authorizedthereunder does not exceed ten percent (10%) of the total assets of the Companyand its subsidiaries on a consolidated basis. The Company hereby agrees tofurnish a copy of any such agreement to the Securities and Exchange Commissionupon request.                                                                    Very truly yours,                                                                    HARBORSIDE HEALTHCARE CORPORATION                                                                    By: /s/ William H. Stephan                                                                        ----------------------                                                                        Chief Financial Officer                                       76Exhibit 21.1Subsidiaries of Harborside Healthcare Corporation as of December 31, 2001:                                                 Jurisdiction of                                                 Incorporation or        Name                                     Organization              Doing Business As        -----                                    ------------              -----------------1.    Bay Tree Nursing Center Corp.              Massachusetts2.    Belmont Nursing Center Corp.               Massachusetts             Harborside Healthcare - Perrysburg3.    Bowie Center Limited Partnership           Maryland                  Larkin Chase Nursing and Restorative Center4.    Countryside Care Center Corp.              Massachusetts             Harborside Healthcare -Terre Haute5.    Harborside of Cleveland       Limited Partnership                       Massachusetts             Harborside Healthcare - Beachwood                                                                           Rehabilitation and Nursing Center                                                                           Harborside Healthcare - Broadview Heights                                                                           Rehabilitation and Nursing                                                                           Center                                                                           Harborside Healthcare - Westlake I                                                                           Rehabilitation and Nursing Center                                                                           Harborside Healthcare - Westlake II                                                                           Rehabilitation and Nursing Center6.   Huntington Place Limited Partnership        Florida                   Huntington Place Rehabilitation and     (f/k/a Harborside Florida Limited                                     Nursing Center     Partnership)7.    Harborside of Ohio Limited Partnership     Massachusetts             Harborside Healthcare - Northwest Ohio                                                                           Harborside Healthcare - Defiance8.    Harborside Funding Limited Partnership     Massachusetts9.    Harborside Health I Corporation            Delaware                  Harborside Nursing Homes, Inc.10.  Harborside Healthcare Advisors              Massachusetts       Limited Partnership11.  Harborside Healthcare Limited               Massachusetts             Allicor       Partnership                                                         Harborside Healthcare Management                                                                           Limited Partnership12.  Harborside Healthcare Network               Florida       Limited Partnership13.  Harborside Homecare Limited                 Massachusetts             Behavioral Health Care       Partnership                                       7714.  Harborside New Hampshire                    Massachusetts             Harborside Nursing Facilities Limited       Limited Partnership                                                 Partnership                                                                           Harborside Healthcare - Applewood                                                                           Rehabilitation and Nursing Center                                                                           Harborside Healthcare - Crestwood                                                                           Rehabilitation and Nursing Center                                                                           Harborside Healthcare - Milford                                                                           Rehabilitation and Nursing Center                                                                           Harborside Healthcare - Northwood                                                                           Rehabilitation and Nursing Center                                                                           Harborside Healthcare - Pheasantwood                                                                           Rehabilitation and Nursing Center                                                                           Harborside Healthcare - Westwood                                                                           Rehabilitation and Nursing Center15.  Harborside Rehabilitation Limited           Massachusetts             Theracor Rehabilitation Services       Partnership                                                         Ready Nurse16.  Harborside Toledo Corporation               Massachusetts17.  Harborside Toledo Limited Partnership       Massachusetts             Harborside Healthcare - Swanton18.  HHCI Limited Partnership                    Massachusetts             Harborside Healthcare - New Haven                                                                           Harborside Healthcare - Woods Edge                                                                           Harborside Healthcare - Indianapolis                                                                           Harborside Healthcare - Troy19.  KHI Corporation                             Delaware20.  Maryland Harborside Corp.                   Massachusetts21.  Oakhurst Manor Nursing Center               Massachusetts       Corp.22.  Orchard Ridge Nursing Center                Massachusetts       Corp.23.  Riverside Retirement Limited Partnership    Massachusetts             Harborside Healthcare - Decatur24.  Sunset Point Nursing Center Corp.           Massachusetts25.  West Bay Nursing Center Corp.               Massachusetts26.  Harborside Healthcare Baltimore Limited       Partnership                               Massachusetts             Harborside Healthcare - Harford Gardens27.  Harborside Massachusetts       Limited Partnership                       Massachusetts             Harborside Healthcare - North Shore                                                                           Harborside Healthcare - Maplewood                                                                           Harborside Healthcare - Cedar Glen                                                                           Harborside Healthcare - Danvers28.  Harborside of Dayton       Limited Partnership                       Massachusetts             Harborside Healthcare - Laurelwood                                                                           Harborside Healthcare - New Lebanon                                                                           Harborside Healthcare - Dayton                                       7829.  Harborside Connecticut       Limited Partnership                       Massachusetts             Harborside Healthcare - Arden House                                                                           Harborside Healthcare - Governor's House                                                                           Harborside Healthcare - Willows                                                                           Harborside Healthcare - Madison House                                                                           Harborside Healthcare - Reservoir30.  Harborside Rhode Island     Limited Partnership                         Massachusetts             Harborside Healthcare - Greenwood                                                                           Harborside Healthcare - Pawtuxet Village31.  Harborside North Toledo     Limited Partnership                         Massachusetts             Harborside Healthcare - Sylvania                                                                           Harborside Healthcare - Point Place32.  Harborside Danbury     Limited Partnership                         Massachusetts             Harborside Healthcare - Glen Hill                                                                           Harborside - Glen Crest33.  Harborside Acquisition     Limited Partnership V                       Massachusetts34.  Harborside Acquisition     Limited Partnership VI                      Massachusetts35.  Harborside Acquisition     Limited Partnership VII                     Massachusetts36.  Harborside Acquisition     Limited Partnership VIII                    Massachusetts37.  Harborside Acquisition     Limited Partnership IX                      Massachusetts38.  Harborside Acquisition     Limited Partnership X                       Massachusetts39.  Sailors, Inc.                               Delaware40.  New Jersey Harborside Corp.                 Massachusetts41.  Bridgewater Assisted Living                 New Jersey42.  Harborside Healthcare Management, LLC       Delaware43.  Harborside Administrative Services, LLC     Delaware                  Harborside Healthcare44.  Florida Administrative Services, LLC        Delaware                  Compass Healthcare Services45.  Florida Holdings I, LLC                     Delaware46.  Florida Holdings II, LLC                    Delaware47.  Florida Holdings III, LLC                   Delaware48.  1775 Huntington Lane, LLC                   Delaware                                       7949.  2600 Highlands Boulevard North, LLC         Delaware                  Bay Tree Rehabilitation and Nursing Center50.  2900 Twelfth Street North, LLC              Delaware                  Lakeside Pavilion Rehabilitation and                                                                           Nursing Center51.  1501 SE 24th Road, LLC                      Delaware                  Oakhurst Rehabilitation and                                                                           Nursing Center52.  4927 Voorhees Road, LLC                     Delaware                  Orchard Ridge Rehabilitation and                                                                           Nursing Center53.  1240 Pinebrook Road, LLC                    Delaware                  Pinebrook Rehabilitation and                                                                           Nursing Center54.  4602 Northgate Court, LLC                   Delaware                  Springwood Rehabilitation and                                                                           Nursing Center55.  1980 Sunset Point Road, LLC                 Delaware                  Sunset Point Rehabilitation and                                                                           Nursing Center56.  3865 Tampa Road North, LLC                  Delaware                  West Bay Rehabilitation and Nursing Center57.  Massachusetts Holdings I, LLC               Delaware58.  Ohio Holdings I, LLC                        Delaware59.  Marietta Healthcare, LLC                    Delaware                  Marietta Nursing and Rehabilitation Center60.  Mashpee Healthcare, LLC                     Delaware                  Harborside Healthcare - Mashpee61.  Wakefield Healthcare, LLC                   Delaware                  Harborside Healthcare - Wakefield62.  Falmouth Healthcare, LLC                    Delaware                  Harborside Healthcare - Falmouth63.  Westfield Healthcare, LLC                   Delaware                  Harborside Healthcare - Westfield64.  LTC Leasing, LLC                            Delaware                                       80*******************