UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(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, 2000OR[   ] 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
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 x       No      Not Applicable

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. [   ].   Not Applicable 

At March 30, 2001, theregistrant had 7,925,832 shares of Common Stock outstanding. 
Documents incorporated by reference:SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in thisForm 10-K, including information set forth under the caption“Management’s Discussion and Analysis of Financial Condition andResults of Operations”, constitute “Forward-Looking Statements”within the meaning of the Private Securities Litigation Reform Act of 1995 (the“Reform Act”). The Company desires to take advantage of certain“safe harbor” provisions of the Reform Act and is including thisspecial note to enable the Company to do so. Forward-looking statements includedin this Form 10-K, or hereafter included in other publicly available documentsfiled with the Securities and Exchange Commission, reports to the Company’sstockholders and other publicly available statements issued or released by theCompany involve known and unknown risks, uncertainties, and other factors whichcould cause the Company’s actual results, performance (financial oroperating) or achievements to differ materially from the future results,performance (financial or operating) or achievements expressed or implied bysuch forward-looking statements. The Company believes the following importantfactors could cause such a material difference 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 of  significant  factors  should  not be  construed  asexhaustive or as an admission  regarding the adequacy of disclosures  previouslymade by the Company.2TABLE OF CONTENTS                                                                                PAGE                                        PART IITEM 1. BUSINESS                                                                 4ITEM 2. PROPERTIES                                                               12ITEM 3. LEGAL PROCEEDINGS                                                        13ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                      13                                        PART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED         STOCKHOLDER MATTERS                                                     14ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA                       15ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL         CONDITION AND RESULTS OF OPERATIONS                                     17ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES         ABOUT MARKET RISK                                                       24ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                              25ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON         ACCOUNTING AND FINANCIAL DISCLOSURE                                     52                                        PART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                      52ITEM 11. EXECUTIVE COMPENSATION                                                  53ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND           MANAGEMENT                                                            55ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                          57                                        PART IVITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON           FORM 8-K                                                              58SIGNATURES                                                                       643
**PART I**
**ITEM 1. BUSINESS**

**GENERAL OVERVIEW**
Harborside HealthcareCorporation and its subsidiaries (the “Company” or“Harborside”) provide high quality long-term care, subacute care andother specialty medical services in four principal regions: the Southeast(Florida), the Midwest (Ohio and Indiana), New England (Connecticut,Massachusetts, New Hampshire and Rhode Island), and the Mid-Atlantic (New Jerseyand Maryland). Within these regions, as of December 31, 2000, the Companyoperated 50 licensed long-term care facilities (18 owned, 31 leased and onemanaged) with a total of 6,124 licensed beds. 

The Company providestraditional 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. Aspart of its subacute services, the Company provides physical, occupational andspeech rehabilitation 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 created inMarch 1996, in anticipation of an initial public offering (the “IPO”),in order to combine under its control the operations of various long-term carefacilities and ancillary businesses (the “Predecessor Entities”) whichhad operated since 1988. The Company completed the IPO on June 14, 1996 andissued 3,600,000 shares of common stock at $11.75 per share. Immediately priorto the IPO the owners of the Predecessor Entities contributed their interests insuch Predecessor Entities to the Company and received 4,400,000 shares of theCompany’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 connection with the merger, Harborside alsoentered into a new $250 million collateralized credit facility. In the thirdquarter of 1998, Harborside recorded a charge to income from operations of $37million ($29 million after taxes) for direct and other costs related to themerger transaction. In connection with the merger and the related refinancings,the Company exercised purchase options for seven facilities which had beenfinanced through synthetic leases. As a result of the transaction, and pursuantto the 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. 

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 most of its facilities. Eachfacility is managed by an on-site licensed administrator who is responsible forthe overall operation of the facility, including the quality of care provided.The medical needs of patients at the Company’s licensed skilled nursingfacilities are supervised by a medical director, who is a licensed physician.Although treatment of patients is the responsibility of their own attendingphysicians, who are not employed by the Company, the medical director monitorsall aspects of delivery of care. The Company also provides support services,including dietary services, therapeutic recreational activities, socialservices, housekeeping and laundry services, pharmaceutical and medical suppliesand routine rehabilitation therapy. 

Each facility offers anumber of individualized therapeutic activities designed to enhance the qualityof life of its patients. These activities include entertainment events, musicalproductions, trips, arts and crafts and volunteer and other programs thatencourage 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 substantially all of its existing facilitiesin such areas as complex medical, cardiac recovery, digestive, immuno-suppresseddisease, post-surgical, wound, CVA/stroke care, hemodialysis, infusion therapy,and diabetes and pain management. 
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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 range inage from late teens to the elderly, and typically require high levels of nursingcare and the services of physicians, therapists, dietitians, clinicalpharmacists or psycho/social counselors. Certain patients may also require lifesupport or monitoring equipment. Because patient goals are generallyrehabilitation-oriented, lengths of stay in distinct subacute units aregenerally not expected to substantially exceed 30 days. 

The Company has designedclinical pathways for these subacute units in the areas of orthopedicrehabilitation, CVA/stroke recovery, cardiac recovery, pulmonary rehabilitationand wound care management. These clinical pathways are designed to achievespecified measurable outcomes in an efficient and cost-effective manner. TheCompany’s subacute units and the clinical pathways used in these units aredesigned to attract commercial insurance and managed care organizations, such asHMOs and PPOs. The Company has personnel dedicated to actively market itssubacute units to commercial insurers and managed care organizations. TheCompany will continue to develop additional clinical pathways based on marketopportunities. 

Alzheimer’s Care. TheCompany has also developed units that provide care for patients withAlzheimer’s disease. As of December 31, 2000, the Company operateddedicated Alzheimer’s units at ten facilities. 

OPERATIONS

Facilities. Each of theCompany’s facilities is supervised by a licensed facility administrator whois responsible for all aspects of the facility’s operations. The facilityadministrator oversees (i) a director of nursing who supervises a staff ofregistered nurses, licensed practical nurses and certified nursing aides, (ii) adirector of admissions who is responsible for developing local marketingstrategies and programs and (iii) various other departmental supervisors. TheCompany also contracts with one or more licensed physicians at each facility toserve as medical directors for the purpose of supervising the medical managementof patients. 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’sfacilities oversee personnel who provide dietary, maintenance, laundry,housekeeping, therapy and social services. In addition, a business office staffat each facility routinely performs administrative functions, including billing,payroll and accounts payable processing. The Company’s corporate andregional staff provide support services such as quality assurance, managementtraining, clinical consultation and support, management information systems,risk management, human resource policies and procedures, operational support,accounting and reimbursement expertise. 

Regions. The Company seeksto cluster its long-term care facilities in selected geographic regions toestablish a strong competitive position as well as to position the Company as ahealthcare provider of choice to managed care and private payors in thesemarkets. The Company’s facilities currently serve four principal geographicregions: the Southeast (Florida), the Midwest (Ohio and Indiana), New England(Connecticut, Massachusetts, New Hampshire and Rhode Island), and theMid-Atlantic (New Jersey and Maryland). The Company maintains regional operatingoffices in Palm Harbor, Florida; Indianapolis, Indiana; Topsfield,Massachusetts; West Hartford, Connecticut; and Peterborough, New Hampshire. Eachregion is supervised by a regional director of operations who directs theefforts of a team of professional support staff in the areas of clinicalservices, marketing, bookkeeping, human resources and engineering. Other Companystaff, who are principally based in the regions, provide support and assistanceto all of the Company’s facilities in the areas of subacute services,managed care contracting, reimbursement services, risk management, dataprocessing and training. Financial control is maintained through financial andaccounting policies established at the corporate level for use at each facility.The Company has standardized operating policies and procedures and continuallymonitors operating performance to assure consistency and 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. Accordingly, in late 1995 the Company began a program to seekaccreditation from JCAHO for the Company’s facilities. As of December 31,2000, 33 of the Company’s facilities 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 market
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the 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. 

The Company believes itsmarketing program has demonstrated its effectiveness. The Company’s averageannual occupancy rates for the fiscal years ended December 31, 1998, 1999 and2000 were 92.3%, 90.9% and 90.1% respectively. In comparison, a study ofapproximately 1,500 nursing facilities conducted by the U.S. Department ofHealth and Human Services found that in 1995 nursing facilities operated atapproximately 87% of capacity. 

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 licensed bed capacity of its facilities, (ii) the occupancyrates, (iii) the payor mix of its facilities and the rates of reimbursementamong payor categories (private and other, Medicare and Medicaid) and (iv) theextent to which subacute and other specialty medical and ancillary services areutilized by the patients and paid for by the respective payment sources. TheCompany employs specialists to monitor reimbursement rules, policies and relateddevelopments in order to comply with all reporting requirements and to assistthe Company in receiving reimbursements. Although Medicare and higher acuitypatients generally produce the highest revenue per patient day, costs associatedwith the higher acuity needs of these patients also tend to be higher. TheCompany believes that private patients generally produce the Company’shighest profit margins, while Medicaid patients generally produce the lowestprofit margins. 
  The following table identifies the Company's percentage of net revenues attributable to each of its payor sourcesfor the periods indicated:                  PERCENTAGE OF TOTAL NET REVENUES BY PAYOR (1)                             YEAR ENDED DECEMBER 31,                             ----------------------                                 1998         1999       2000                                 ----         ----       ----Private and other..........    30.2%          28.9%      25.8%Medicare...................    27.7           21.8       25.0Medicaid...................    42.1           49.3       49.2                            -------        -------     ------  Total....................   100.0%         100.0%     100.0%                            =======        =======     ======(1)  Total net revenues exclude net revenues of the Larkin Chase Center which is     owned by the 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.
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. Althoughprivate pay rates are generally established on a facility-specific fee schedule,rates charged for individual cases may vary widely because, in the case ofmanaged care, they are either negotiated on a case-by-case basis with the payoror are fixed by contract. Rates charged to private pay patients are not subjectto regulatory control in any of the states in which the Company operates. 

Medicare. Substantially allof the Company’s facilities are certified Medicare providers. Medicare is afederally funded and administered health insurance program primarily designedfor individuals who are age 65 or over and are entitled to receive SocialSecurity benefits. The Medicare program consists of two parts. The first part,Part A, covers inpatient hospital services and certain services furnished byother 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 nursing carefacilities following a minimum three-day stay in an acute care hospital. Part Acovered services include skilled nursing care, rehabilitative therapy treatment,social services, pharmaceuticals, medical supplies in addition to otherservices. Part A coverage for services delivered in a skilled nursing facilityis limited to a specified term (generally 100 days per calendar year), requiresbeneficiaries to share some of the cost of covered services through the paymentof a deductible and a co-insurance payment and requires beneficiaries to meetcertain qualifying criteria. The second part of the Medicare program, Part B,covers the services of doctors, suppliers of medical items and services andvarious types of outpatient services. Part B services include physical, speechand occupational therapy and durable medical equipment and other ancillaryservices of the type provided by long-term care or acute care facilities. Priorto December 31, 1998 there were no limits on duration of coverage for Part Bservices, but there was a co-insurance requirement for most services covered byPart B. 

Through December 31, 1998,the Medicare Part A program reimbursed the Company for covered services under acost-based reimbursement system for its allowable direct and indirect costs. InAugust of 1997, the Balanced Budget Act of 1997 ( the “BBA”) wasenacted. The BBA provided a prospective payment system (“PPS”) forskilled nursing facilities to be implemented for cost reporting years beginningon or after July 1, 1998. The Company’s facilities began to be reimbursedby the BBA beginning January 1, 1999. During the first three years of PPS, thePart A Medicare per diem rates are based on a blend of facility-specific ratesand federal rates. Beginning in the fourth year, the per diem rates will bebased solely 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. Various Federal actions during the past two years have restored some ofthe funding eliminated through enactment of the BBA. However, despite theseactions, the Company’s Part A Medicare per diem rate remains substantiallylower than the rate received prior to the enactment of the BBA. TheCompany’s Part A Medicare per diem rate increased to $322 in 2000. See“Government Regulation ” and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”
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 The BBA alsoimplemented a prospective payment system for Part B services. Prior to January1, 1999, the Company was reimbursed for Part B services on a cost reimbursementbasis. Beginning January 1, 1999, Medicare Part B services began beingreimbursed on a fee screen basis. These fee screens are revised by the HealthCare Financing Administration (“HCFA”) on an annual basis. The BBAalso imposed an annual limitation on Part B therapy charges of $1,500 perbeneficiary. 

Medicaid. Substantially allof the Company’s facilities participate in the Medicaid program of thestates in which they are located. Medicaid is a state-administered reimbursementprogram for indigent patients financed by state funds and matching federalfunds. Although administered under Federal regulations, states have substantialflexibility to design programs and determine reimbursement rates, and as aresult, individuals programs and reimbursement rates vary significantly fromstate 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 inthe past and could be in the future, adversely affected by the continuingefforts of governmental 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. During 1999, the Company installed new clinical andaccounts receivable systems at all of its facilities. The Company’sclinical system captures the data necessary to obtain proper reimbursement fromthe Federal Part A Medicare program as well as certain state Medicaid programs.The Company’s clinical system also provides data essential to theCompany’s clinical services, continuous quality improvement program. TheCompany is now in the process of implementing an internet-based training systemto supplement its existing computer-based training programs. 

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 facilitiesoperated by the Company are licensed under applicable state laws and possess therequired Certificates of Need (“CON”) from responsible stateauthorities. 

Substantially all of theCompany’s facilities are certified or approved as providers under theMedicaid and Medicare programs. Both the initial and continuing qualification ofa long-term care facility to participate in such programs depend upon manyfactors, including accommodations, equipment, services, non-discriminationpolicies against indigent patients, patient care, quality of life,patients’ rights, safety, personnel, physical environment and adequacy ofpolicies, procedures and controls. Licensing, certification and other applicablestandards vary from jurisdiction to jurisdiction and are revised periodically.State agencies survey or inspect all long-term care facilities on a regularbasis to determine whether such facilities are in compliance with therequirements for participation in government-sponsored third-party payorprograms. In some cases, or upon repeat violations, the reviewing agency has theauthority to take various adverse actions against a facility, including theimposition of fines, temporary suspension of admission of new patients to thefacility, suspension or decertification from participation in the state Medicaidprogram or the Medicare program, offset of amounts due against future billingsto the Medicare or Medicaid programs, denial of payments under the stateMedicaid program for new admissions, reduction of payments, restrictions on theability to acquire new facilities and, in extreme circumstances, revocation of afacility’s license or closure of a facility. 
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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 tosome 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 in which the Company operates have adopted CON or similarlaws that generally require that a state agency determine that a need existsprior to the construction of new facilities, the addition or reduction oflicensed beds or services, the implementation of other changes, the incurrenceof certain capital expenditures, and, in certain states, the approval of certainacquisitions and changes in ownership or the closure of a facility.Indiana’s CON program expired as of June 30, 1998. State CON approval isgenerally issued for a specific project or number of beds, specifies a maximumexpenditure, is sometimes subject to an inflation adjustment, and requiresimplementation of the proposal within a specified period of time. Failure toobtain the necessary state approval can result in the inability of the facilityto provide the service, operate the facility or complete the acquisition,addition or other change and can also result in adverse reimbursement action orthe imposition of sanctions or other adverse action on the facility’slicense. 

Medicare. A substantialportion of the Company’s revenues are derived from the Medicare program.See “Sources of Revenues.” Substantially all of the Company’sfacilities 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 facilities following a minimumthree-day stay in an acute care hospital. Part A covered services includeskilled nursing care, rehabilitative therapy treatment, social services,pharmaceuticals, medical supplies in addition to other services. Part A coveragefor services delivered in a skilled nursing care facility is limited to aspecified term (generally 100 days per calendar year), requires beneficiaries toshare some of the cost of covered services through the payment of a deductibleand a co-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. Prior to December 31, 1998there were no limits on duration of coverage for Part B services, but there wasa co-insurance requirement for most services covered by Part B. 

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 is 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 do not have a transitional period. Allother facilities are being “phased-in” by a formula effective with thecost report period beginning on or after July 1, 1998 and through which MedicarePPS will blend 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. When fully implemented,Medicare PPS will result in each skilled nursing facility being reimbursed on aper diem rate (the “Federal per diem rate”) basis with acuity-basedper diem rates being established as applicable to all Medicare Part Abeneficiaries who are residents of the skilled nursing facility. Theacuity-based per diem rates are determined by classifying each patient into oneof forty-four resource utilization groups (“RUG’) using the datacaptured by completing the minimum data assessment (“MDS”) required byHCFA. Each RUG classification is assigned its own Federal per diem rate by HCFA.The Federal per diem rates will be all-inclusive rates through which the skillednursing facility is reimbursed for its routine, ancillary and capital costs.During the transition period, the per diem rates for each facility consist of ablending of facility-specific costs and Federal per diem rates. The unadjustedFederal per diem rates to be applied to days of covered skilled nursing facilityservices furnished during the first year, the case mix classification system tobe applied with respect to such services, and the factors to be applied inmaking area wage adjustments with respect to such services, are included in theMedicare PPS regulations. The Federal Medicare PPS rates were developed by HCFAbased on a blend of allowable costs from hospital-based and freestanding skillednursing facility cost reports for reporting periods beginning in Federal FiscalYear 1995 (i.e., October 1, 1994 -- September 30, 1995). The data used indeveloping the Federal rates incorporate an estimate of the amounts payableunder Part B for covered skilled nursing facility services furnished duringFederal Fiscal Year 1995 to individuals who were residents of a facility andreceiving Part A covered services. HCFA updated costs to the first year ofMedicare PPS using a skilled nursing facility market basket index standardizedfor facility differences in case-mix and for geographic variations in wages.Providers that received “new provider” exemptions from the routinecost limits were excluded from the database used to compute the federal paymentrates. In addition, costs related to payments for exceptions to the routine costlimits are excluded from the database used to compute the federal payment rates.The facility-specific portion is based on each facility’s Medicare costreport for cost reporting periods beginning in Federal Fiscal Year 1995,
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including routine cost limit exception and exemption payments up to 150% of theroutine cost limit, the allowable costs to be updated under Medicare PPS for theskilled nursing facility market basket minus 1% through 1999 and the fullskilled nursing facility market basket after 1999. A variety of otheradjustments are made in developing the Medicare PPS rates pursuant to the BBAand the regulations. As noted, except in the case of “new facilities,”in the first year of the transition to Medicare PPS, the per diem ratesconsisted of a blend of 25% federal per diem rates and 75% facility-specificcosts. Thereafter, the facility-specific cost portion will decrease by 25% peryear until in the fourth year, the rate will be 100% Federal per diem rates.“New facilities” are on 100% Federal per diem rates for cost reportingperiods beginning on or after July 1, 1998. 

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 aprospective payment system for Part B services. Prior to January 1, 1999, theCompany was reimbursed for Part B services on a cost reimbursement basis.Beginning January 1, 1999, Medicare Part B services began being reimbursed on afee screen basis. These fee screens are revised by the Health Care FinancingAdministration (“HCFA”) on an annual basis. The BBA also imposed anannual limitation on Part B therapy charges of $1,500 per beneficiary andimposed a future requirement to implement consolidated billing for Part Bservices. 

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 beginning on April 1, 2000. These increased rates were to stay ineffect until the later of (a) October 1, 2000 or (b) the date HCFA implements arevised PPS system that more accurately reimburses the costs of caring formedically complex patients. The BBRA also provides for a four percent increasein the Federal per diem rates for all RUG categories for a two-year periodbeginning October 1, 2000. The BBRA also excluded costs for certain supplies andservices that were formerly required to be reimbursed by a skilled nursingfacility’s PPS rate. The BBRA also eliminated the annual providerlimitations on Part B therapy charges per beneficiary for calendar year 2000 and2001. 

In April 2000, HCFApublished a proposed rule which detailed proposed changes to the RUGclassification system and the related Federal per diem rates. The proposed rulewas intended to more accurately match payment rates to the costs of careincurred for each RUG classification level. On July 31, 2000, HCFA issued afinal rule that indefinitely postponed any modifications to the RUGclassification system implemented by the BBA. 

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 increased the existing nursing rate component of the Federal per diem rate,for each RUG category, by 16.66% from April 1, 2001 through September 30, 2002.In addition, BIPA will eliminate the 20% add-on for three of the fifteenrehabilitation services RUG categories and substitute a 6.7% add-on for allfifteen rehabilitation services RUG categories. BIPA also extended themoratorium on the annual limitation on Part B therapy charges of $1,500 perbeneficiary through calendar year 2002 and repealed the BBA requirement toimplement consolidated billing for Part B services. The Company believes thatthe primary effect of the BIPA on the Company will be to increase theCompany’s Medicare Part A per diem rate from $322 in 2000 to $340 in 2001. 

Medicaid. Substantially allof the Company’s facilities participate in the Medicaid program of thestates in which they are located. Medicaid is a state-administered reimbursementprogram for indigent patients financed by state funds and matching federalfunds. Although administered under Federal regulations, states have substantialflexibility to design programs and determine reimbursement rates, and as aresult, individuals programs and reimbursement rates vary significantly fromstate 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 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 and who meetother requirements. 

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 the
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state 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. Althoughthere is usually no settlement based upon actual costs incurred subsequent tothe cost report filing, subsequent audits may provide a basis for the stateprogram 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’slong-term care facilities has at least one medical director that is a licensedphysician. The medical directors may from time to time refer their patients tothe Company’s facilities in their independent professional judgment. Thephysician anti-referral restrictions and prohibitions could, among other things,require the Company to modify its contractual arrangements with its medicaldirectors or prohibit its medical directors from referring patients to theCompany. 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 InsurancePortability and Accountability Act of 1997 (“HIPAA”) became effectiveon January 1, 1997 and broadened the scope of fraud and abuse laws to includeall health plans, whether or not they are reimbursed under Federal programs.HIPAA also mandated the adoption of regulations designed to (a) standardizetransaction formats and billing codes for documenting medical services andprocessing medical claims; and (b) protect the privacy and security ofindividually identifiable health information. Final HIPAA regulations thatstandardize transactions and code sets were issued in during the fourth quarter2000. The regulations do not require healthcare providers to submit claimselectronically, but do require standard formatting for those that do so. TheCompany currently submits most claims electronically and expects to continue todo so. The Company will be required to comply with HIPAA transaction and codeset standards beginning in October 2002. 

Final HIPAA privacyregulations were published in during the fourth quarter 2000. Those regulationsapply to “protected health information,” which is defined asindividually identifiable health information transmitted or maintained in anyform or medium, excluding certain education records and student medical records.The privacy regulations seek to limit the use and disclosure of most paper and
10
oral communications, 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 healthcare to the individual orpayment for that healthcare. HIPAA provides for the imposition of civil orcriminal penalties if protected health information is improperly disclosed. TheCompany must comply with the privacy regulations by April 2003. 

HIPAA’s securityregulations have not yet been finalized. The proposed security regulationsspecify administrative procedures, physical safeguards, and technical servicesand mechanisms designed to ensure the privacy of protected health information.The Company will be required to comply with the security regulations twenty-sixmonths after the regulations become final. 

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 ofHIPAA compliance. There can be no assurances that compliance with HIPAAregulations will not have an adverse effect on the Company’s results ofoperations, cash flows or its financial position. 

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. Connecticut has imposed a moratorium on theaddition of any new skilled nursing facility beds, including chronic andconvalescent nursing facility beds and rest home beds with nursing supervision,until the year 2002. Massachusetts has imposed a moratorium on the addition ofany new skilled nursing facility beds until May 1, 2003, except that an existingfacility can add up to 12 beds without being subject to CON review. NewHampshire has imposed an indefinite moratorium on the addition of any new bedsto skilled nursing facilities, intermediate care homes and rehabilitation homes.Ohio has imposed a moratorium until June 30, 2001 on the addition of any newskilled nursing facility beds. Rhode Island has imposed an indefinite moratoriumon the issuance of any new initial licenses for skilled nursing facilities andon the increase in the licensed bed capacity of any existing licensed skillednursing facility, except that an existing facility may increase its licensed bedcapacity to the greater of 10 beds or 10% of the facility’s licensed bedcapacity. The other states in which the Company conducts business do notcurrently have a moratorium on new skilled nursing facility beds in effect.Although New Jersey does not have a “moratorium” on new skillednursing facility beds, with the exception of the Add-a-bed program (in which afacility may request approval from the state licensure agency to increase totallicensed skilled nursing beds, including hospital based subacute care beds, byno more than 10 beds or 10% of its licensed bed capacity, whichever is less,(every five years), without obtaining CON approval), New Jersey only acceptsapplications for a CON for additional skilled nursing facility beds when thestate CON agency issues a call for beds. There is presently no call foradditional beds, and no call is expected to be made in the near future. Arelaxation of CON requirements could lead to an increase in competition. Inaddition, as cost containment measures have reduced occupancy rates at acutecare hospitals, a number of these hospitals have converted portions of theirfacilities into subacute units. In the states in which the Company currentlyoperates, these conversions are subject to state CON regulations. The Companybelieves that the application of the new Medicare PPS rules have made suchconversions less desirable. New Jersey enacted legislation permitting acute carehospitals to offer subacute care services under their existing hospitallicenses, subject to first obtaining CON approval pursuant to an expedited CONreview process. 

EMPLOYEES

As of December 31, 2000,the Company employed approximately 8,100 facility-based personnel on a full- andpart-time basis. The Company’s corporate and regional staff consisted of140 persons as of such date. Approximately 650 employees at seven of theCompany’s facilities are covered by collective bargaining agreements.Additionally, the Company is currently negotiating collective bargainingagreements at two other facilities covering approximately 150 employees.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-payor
11
revenues 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

The Company carries generalliability, professional liability, comprehensive property damage and otherinsurance coverages that management considers adequate for the protection of itsassets and operations based on the nature and risks of its business, historicalexperience and industry standards. The Company’s current general andprofessional liability insurance policy expires on September 1, 2001. TheCompany is currently in discussions with its insurance advisors to reviewvarious replacement options. At this time, the Company estimates that its annualcost for professional and general liability insurance will increase from $2.5million to $6.0 million effective September 1, 2001. There can be no assurance,however, that the coverage limits of the Company’s insurance policies willbe adequate or that insurance will continue to be available to the Company oncommercially reasonable terms in the future. A successful claim against theCompany not covered by, or in excess of, its insurance coverage could have amaterial adverse effect on the Company. Claims against the Company, regardlessof their merit or eventual outcome, may also have a material adverse effect onthe Company’s business and reputation, may lead to increased insurancepremiums and may require the Company’s management to devote time andattention to matters unrelated to the Company’s business. The Company isself-insured (subject to contributions by covered employees) with respect tomost of the healthcare benefits and workers’ compensation benefitsavailable to its employees. The Company believes that it has adequate resourcesto cover any self-insured claims and the Company maintains excess liabilitycoverage to protect it against unusual claims in these areas. However, there canbe no assurance that the Company will continue to have such resources availableto it or that substantial claims will not be made against the Company. 

**ITEM 2. PROPERTIES**

The following tablesummarizes certain information regarding the Company’s facilities as ofDecember 31, 2000: 
SUMMARY OF FACILITIES                                                  YEAR            OWNED/        LICENSEDFACILITY                       LOCATION         ACQUIRED      LEASED/MANAGED      BEDS--------                       --------        -----------    ---------------     -----SOUTHEAST REGION Florida  Brevard                      Rockledge           1994              Leased        100  Clearwater                   Clearwater          1990              Owned         120  Gulf Coast                   New Port Richey     1990              Owned         120  Naples                       Naples              1989              Leased        120  Ocala                        Ocala               1990              Owned         180  Palm Harbor                  Palm Harbor         1990              Owned         120  Pinebrook                    Venice              1989              Leased        120  Sarasota                     Sarasota            1990              Leased        120  Tampa Bay                    Oldsmar             1990              Owned         120                                                                                 ------                                                                                 1,120MIDWEST REGION Ohio  Defiance                     Defiance            1993              Leased        100  Northwestern Ohio            Bryan               1993              Leased        189  Swanton                      Swanton             1995              Leased        100  Perrysburg                   Perrysburg          1990              Owned         100  Troy                         Troy                1989              Leased        195  Beachwood                    Beachwood           1996              Leased        274  Broadview                    Broadview Heights   1996              Leased        159  Westlake I                   Westlake            1996              Leased        153  Westlake II                  Westlake            1996              Leased        106  Dayton                       Dayton              1997              Owned         100  Laurelwood                   Dayton              1997              Owned         115  New Lebanon                  New Lebanon         1997              Owned         126  Point Place                  Toledo              1998              Owned          98  Sylvania                     Sylvania            1998              Owned         150 Indiana  Decatur                      Indianapolis        1988              Owned          88  Indianapolis                 Indianapolis        1988              Leased        104  New Haven                    New Haven           1990              Leased        120  Terre Haute                  Terre Haute         1990              Owned         120                                                                                 ------                                                                                 2,39712NEW ENGLANDREGIONConnecticut Arden House                   Hamden              1997              Leased         360 Governor's House              Simsbury            1997              Leased          73 Madison House                 Madison             1997              Leased          90 The Reservoir                 West Hartford       1997              Leased          75 Willows                       Woodbridge          1997              Leased          90 Glen Hill                     Danbury             1998              Owned (1)      100 Glen Crest                    Danbury             1998              Owned (1)       49Massachusetts  Maplewood                    Amesbury            1997              Leased         120  Cedar Glen                   Danvers             1997              Leased         100  Danvers-Twin Oaks            Danvers             1997              Leased         101  North Shore                  Saugus              1997              Leased          80  The Stone Institute          Newton Upper Falls  1997              Managed        106New Hampshire  Applewood                    Winchester          1996              Leased          70  Crestwood                    Milford             1996              Leased          82  Milford                      Milford             1996              Leased          52  Northwood                    Bedford             1996              Leased         147  Pheasant Wood                Peterborough        1996              Leased          99  Westwood                     Keene               1996              Leased          87Rhode Island Greenwood                     Warwick             1998              Owned          136 Pawtuxet                      Warwick             1998              Owned          131                                                                                 ------                                                                                  2,148MID-ATLANTIC REGIONMaryland Harford Gardens               Baltimore           1997              Leased         163 Larkin Chase Center           Bowie               1994              Owned (2)      120New Jersey Woods Edge                    Bridgewater         1988              Leased         176                                                                                 ------                                                                                    459                                                                     Total        6,124                                                                                  =====(1)  Indicates an owned facility financed through a synthetic lease.(2)  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.
The Company maintains itsCorporate offices in Boston as well as regional offices in Palm Harbor, Florida;Indianapolis, Indiana; Topsfield, Massachusetts; West Hartford, Connecticut; andPeterborough, New Hampshire. The Company considers its properties to be in goodoperating condition and suitable for the purposes for which they are being 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 submitted to a vote of the Company's stockholders during the last quarter of the Company's fiscalyear ended December 31, 2000.13
**PART II**

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

The Company completed itsinitial public offering and shares began trading on June 14, 1996. TheCompany’s common stock was listed on the New York Stock Exchange under thesymbol “HBR”. 

As a result of the August11, 1998 merger noted in the General Overview, the Company’s common stockwas de-listed from the New York Stock Exchange on August 11, 1998. There iscurrently no established public trading market for the Company’s commonstock. 

The number of stockholdersof record for each class of common stock as of March 1, 2001 is as follows: 
Class of Common Stock               Number of Holders of Record---------------------               ---------------------------Class A                                     42Class B                                     15Class C                                     40Class D                                     11
The Company has neverdeclared or paid any dividends on its common stock since its formation in 1996.The Company does not anticipate paying cash dividends on its Common Stock forthe 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. 
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**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, 2000 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 filing. 
                                  SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA                                (in thousands, except share, per share and other data)                                                             YEAR ENDED DECEMBER 31,                                                            -------------------------                                                             1996           1997           1998           1999           2000                                                        ---------      ---------      ---------      ---------      ---------Statement of operations data: Total net revenues ...............................     $ 165,412      $ 221,777      $ 311,044      $ 300,615      $ 322,672                                                        ---------      ---------      ---------      ---------      ---------Expenses: Facility operating ...............................       132,207        176,404        246,000        248,795        259,780 General and administrative .......................         7,811         10,953         15,422         17,808         17,993 Service charges paid to  affiliate ...............           700            708          1,291          1,173          1,083 Amortization of prepaid management fee ...........          --             --              500          1,200          1,200 Special compensation and other ...................         1,716           --             --             --             -- Depreciation and amortization ....................         3,029          4,074          6,350         10,249         10,210 Facility rent ....................................        10,223         12,446         22,412         22,394         24,275 Merger costs .....................................          --             --           37,172           --             -- Restructuring costs ..............................          --             --             --            5,745           -- Loss on termination of capital lease .............          --             --             --             --            8,914                                                        ---------      ---------      ---------      ---------      ---------Total expenses ....................................       155,686        204,585        329,147        307,364        323,455                                                        ---------      ---------      ---------      ---------      --------- Income (loss) from operations ....................         9,726         17,192        (18,103)        (6,749)          (783)Other: Interest expense, net ............................         4,634          5,853         11,271         20,895         21,675 Other expense (income) ...........................           263            189           (167)           261            (74)                                                        ---------      ---------      ---------      ---------      ---------Income (loss) before income taxes and extraordinary loss ...............................         4,829         11,150        (29,207)       (27,905)       (22,384)Income tax expense (benefit) ......................           809          4,347         (5,020)       (10,304)        14,322                                                        ---------      ---------      ---------      ---------      ---------Income (loss) before extraordinary loss ...........         4,020          6,803        (24,187)       (17,601)       (36,706)Extraordinary loss on early retirement of debt, net of tax ...................        (1,318)          --             --             --             --                                                        ---------      ---------      ---------      ---------      ---------Net income (loss) .................................         2,702          6,803        (24,187)       (17,601)       (36,706)Preferred stock dividends .........................          --             --           (2,296)        (6,004)        (6,853)                                                        ---------      ---------      ---------      ---------      ---------Earnings (loss) available for common shares........      $  2,702      $   6,803      $ (26,483)     $ (23,605)     $ (43,559)                                                        =========      =========      =========      =========      =========Earnings (loss) per common share:   Basic ..........................................                    $    0.85      $   (3.42)     $   (3.25)     $   (6.00)                                                                       =========      =========      =========      =========   Diluted ........................................                    $    0.84      $   (3.42)     $   (3.25)     $   (6.00)                                                                       =========      =========      =========      =========Pro forma data (1):Historical income before income   taxes and extraordinary loss                          $ 4,829Pro forma income taxes                                       799                                                        --------Pro forma income before    extraordinary loss                                     4,030Extraordinary loss, net of tax                            (1,318)                                                        --------Pro forma net income                                     $ 2,712                                                        ========Pro forma earnings per common share(basic and diluted):Pro forma income before extraordinary loss               $  0.63Extraordinary loss                                          0.21                                                        --------Pro forma earnings per common share                      $  0.42                                                        ========Weighted average number of common shares  used in per share computations (2):    Basic                                                6,396,000     8,037,000    7,742,000       7,261,000    7,432,000    Diluted                                              6,396,000     8,139,000    7,742,000       7,261,000    7,261,00015SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued)                                                (DOLLARS IN THOUSANDS)                                                      YEAR ENDED DECEMBER 31,                                                      -----------------------                                               1996      1997       1998       1999        2000                                               ----      ----       ----       ----        ----Operational data (as of end of year) (3): Facilities                                       30         45        50         50         50 Licensed beds                                 3,700      5,468     6,120      6,124      6,124Average occupancy rate (4)                      92.6%      92.3%      92.3%     90.9%      90.1%Patient days (5):Private and other                            335,363    394,151   503,234    489,074    455,491Medicare                                     108,229    138,023   196,222    219,924    238,574Medicaid                                     653,222    834,637 1,169,258  1,240,228  1,246,735                                          ----------  --------- ---------  ---------  ---------Total                                      1,096,814  1,366,811 1,868,714  1,949,226  1,940,800                                           =========  ========= =========  =========  =========Sources of total net revenues:Private and other (6)                          35.5%      34.1%     30.2%      28.9%      25.8%Medicare                                       26.3%      25.9%     27.7%      21.8%      25.0%Medicaid                                       38.2%      40.0%     42.1%      49.3%      49.2%Balance sheet data:Working capital                              $16,826   $ 22,621  $ 36,403  $  36,536  $  33,280Total assets                                 141,799    168,562   264,536    283,233    203,097Total debt                                    18,208     33,642   134,680    171,245    179,116Capital lease obligation                      57,277     56,285    55,531     54,700          -Stockholders' equity (deficit) (7)            44,880     51,783        83    (23,522)   (67,074)(1)  Financial  and  operating  data combine the  historical  results of various     legal   entities  (the   “Predecessor   Entities”)   that  became     subsidiaries of Harborside Healthcare Corporation (the “Company”)     through a  reorganization  (the  “Reorganization”)  that occurred     immediately prior to the Company’s initial public offering on June 14,     1996 (the  “IPO”).  Prior to the Reorganization,  the Predecessor     Entities  (primarily  partnerships and subchapter S corporations)  were not     directly  subject to Federal or state income  taxation.  A pro forma income     tax expense has been reflected for the period presented,  prior to the IPO,     as if the Company had always owned the Predecessor Entities.(2)  Through the IPO, the Company issued  3,600,000  shares of common stock. Pro     forma net income per for 1996 is based upon  4,400,000  shares  outstanding     for the entire year and the appropriate weighting for shares issued through     the IPO.(3)  Includes  two managed  facilities  with 178  licensed  beds in 1997 and one     managed facility with 106 licensed beds in 1998, 1999 and 2000.(4)  “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.(5)  “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.(6)  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.(7)  In accordance with  Securities and Exchange  Commission  requirements,  the     carrying  amount  of the  Company’s  Exchangeable  Preferred  Stock is     excluded  from total  stockholders’  equity.  As of December 31, 1998,     1999 and  2000,  the  carrying  amount of the  Company’s  Exchangeable     Preferred Stock was $42,293,000, $48,277,000 and $55,112,000, respectively.16
**ITEM 7.**MANAGEMENT'S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONSOVERVIEW
Harborside HealthcareCorporation, (“Harborside” or the “Company”) is a leadingprovider of high-quality long-term care and specialty medical services in theeastern United States. The Company has focused on establishing strong localmarket positions with high-quality facilities in four principal regions: theSoutheast (Florida), the Midwest (Ohio and Indiana), New England (Connecticut,Massachusetts, New Hampshire and Rhode Island) and the Mid-Atlantic (New Jerseyand Maryland). As of December 31, 2000, the Company operated 50 facilities (18owned, 31 leased and one managed) with a total of 6,124 licensed beds. Asdescribed in Note A to the audited consolidated financial statements of theCompany included elsewhere in this filing, the Company accounts for itsinvestment in one of its owned facilities using the equity method. The Companyprovides a broad continuum of medical services including: (i) traditionalskilled nursing care and (ii) specialty medical services, including a variety ofsubacute care programs such as orthopedic rehabilitation, CVA/stroke care,cardiac recovery, pulmonary rehabilitation and wound care, as well as distinctprograms for the provision of care to Alzheimer’s and hospice patients. Aspart of its subacute services, the Company provides physical, occupational andspeech rehabilitation 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. (See Note P to the Company’s consolidatedfinancial statements included elsewhere in this report.) 

The Company was created inMarch 1996, in anticipation of an initial public offering (the “IPO”),in order to combine under its control the operations of various long-term carefacilities and ancillary businesses (the “Predecessor Entities”) whichhad operated since 1988. The Company completed the IPO on June 14, 1996 andissued 3,600,000 shares of common stock at $11.75 per share. The owners of thePredecessor Entities contributed their interests in such Predecessor Entities tothe Company and received 4,400,000 shares of the Company’s common stock. 

The Company’sfinancial statements for periods prior to the IPO have been prepared bycombining the historical financial statements of the Predecessor Entities,similar to a pooling of interests presentation. The Company’s financialstatements prior to the date of the IPO do not include a provision for Federalor state income taxes because the Predecessor Entities (primarily partnershipsand subchapter S corporations) were not directly subject to Federal or stateincome taxation. The Company’s combined financial statements for periodsprior to the date of the IPO include a pro forma income tax expense for eachperiod presented, as if the Company had always owned the Predecessor Entities. 

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 (approximately $29 millionafter taxes) 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 financed through syntheticleases. 

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. (See Note P to the Company’s consolidated financialstatements included elsewhere in this report). The Company derives its netpatient service revenues primarily from private pay sources, the federalMedicare program for certain elderly and disabled patients and state Medicaidprograms for indigent patients. The Company’s total net revenues areinfluenced by a number of factors, including: (i) the licensed bed capacity ofits facilities; (ii) the occupancy rates; (iii) the payor mix of its facilitiesand the rates of reimbursement among payor categories (private and other,Medicare and Medicaid); and (iv) the extent to which subacute and otherspecialty medical and ancillary services are utilized by the patients and paidfor by the respective payment sources. Private net patient service revenues arerecorded at established per diem billing rates. Net patient service revenues tobe reimbursed under contracts with third-party payors, primarily the Medicareand Medicaid programs, are recorded at amounts estimated to be realized underthese contractual arrangements. The Company employs specialists to monitorreimbursement rules, policies and related developments in order to comply withall reporting requirements and to assist the Company in receivingreimbursements. 

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 inMedicaid revenues as a percentage of total net revenues during fiscal 1999 is
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primarily the result of a decrease in Medicare revenues as a result of theimplementation of the new Medicare Prospective Payment System (“PPS”)effective January 1, 1999, as well as a decrease in other revenues derived fromcontracts to provide rehabilitation therapy services to non-affiliated long-termcare facilities. Implementation of PPS was effective for all of theCompany’s facilities beginning January 1, 1999 and caused theCompany’s average Medicare Part A per diem rate to decrease from $397 perday in 1998 to $290 per day in 1999. During the third quarter of 1999, theCompany terminated its contracts to provide rehabilitation therapy services tonon-affiliated long-term care facilities. Primarily as a result of the effectsof the Balanced Budget Refinement Act of 1999, the Company’s averageMedicare Part A per diem rate increased from $290 per Medicare patient day in1999 to $322 per Medicare patient day in 2000. 
                               TOTAL NET REVENUES (1)                                    ----------------------                               1998              1999             2000                               ----              ----             ----Private and other........      30.2%              28.9%           25.8%Medicare.................      27.7               21.8            25.0Medicaid.................      42.1               49.3            49.2                             ------             ------           -----  Total..................     100.0%             100.0%          100.0%                             ======             ======           =====
(1) Total net revenuesexclude net revenues of the Larkin Chase Center which is owned by Bowie CenterLimited Partnership (“Bowie L.P.”). The Company owns a 75% partnershipinterest in Bowie L.P. but records its investment in Bowie L.P. using the equitymethod of accounting. See Note A to the Company’s consolidated financialstatements included elsewhere in this filing. 
 OPERATING EXPENSES
The Company’s facilityoperating expenses consist primarily of payroll and employee benefits related tonursing, housekeeping and dietary services provided to patients, as well asmaintenance and administration of the facilities. Other significant facilityoperating expenses include the cost of rehabilitation therapy services, medicaland pharmacy supplies, food, utilities, insurance and taxes. The Company’sgeneral and administrative expenses include all costs associated with itsregional and corporate operations. 
18MANAGEMENT'S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONSYear Ended December 31, 2000 Compared to Year Ended December 31, 1999
*Total Net Revenues*.Total net revenues increased by $22,057,000 or 7.3%, from $300,615,000 in 1999to $322,672,000 in 2000. The increase in total revenues from 1999 to 2000 wasprimarily the result of higher average revenues per patient day. The averageoccupancy rate at all of the Company’s facilities decreased from 90.9% forthe year ended December 31, 1999 to 90.1% for the year ended December 31, 2000.Average net patient service revenues per patient day at the Company’sfacilities increased from $152 for the year ended December 31, 1999 to $164 forthe year ended December 31, 2000. The Company’s average Medicare Part A perdiem rate increased from $290 per Medicare patient day for the year endedDecember 31, 1999 to $322 per Medicare patient day for the year ended December31, 2000, while the Company’s average per diem Medicaid rate increased from$120 for the year ended December 31, 1999 to $127 for the year ended December31, 2000. In accordance with provisions of the Balanced Budget Refinement Act of1999, the Company elected to have fourteen of its facilities waive theirremaining transition period available under Medicare’s current prospectivepayment reimbursement system. Effective January 1, 2000, these fourteenfacilities began to be reimbursed at the Federal per diem payment rate for paidMedicare days. Additionally, the Balanced Budget Refinement Act of 1999temporarily increased the Federal per diem rates by 20% for fifteen acuitycategories beginning on April 1, 2000. These increased rates were to stay ineffect until the date on which the Health Care Financing Administrationimplemented a revised PPS system that more accurately reimburses the costs ofcaring for medically complex patients. Primarily as the result of electing tomove fourteen facilities to the Federal per diem rate and the temporary Medicarerate increases implemented on April 1, 2000, the Company’s average MedicarePart A payment rate increased from $290 per Medicare patient day for the yearended December 31, 1999 to $322 per Medicare patient day for the year endedDecember 31, 2000. The Company’s quality mix of private, Medicare andinsurance revenues was 50.7% for the year ended December 31, 1999 as compared to50.8% for the year ended December 31, 2000. 

*Facility OperatingExpenses*. Facility operating expenses increased by $10,985,000, or 4.4%,from $248,795,000 in 1999 to $259,780,000 in 2000. The overall increase inoperating expenses in 2000 was primarily 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 $3,700,000 from 1999 to 2000. 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 $2,156,000, or 25.8% from the year ended December 31, 1999 to theyear ended December 31, 2000. 

Facility operating expensesfor the quarter and year ended December 31, 2000 include a non recurring chargein the amount of $575,000. The charge was incurred in connection with theCompany’s participation in a shared collateral arrangement designed todecrease the Company’s required letter of credit commitments for it’shigh deductible workers compensation insurance policy. The Company posted aletter of credit equal to approximately 15% of the estimated workerscompensation claim requirements as collateral for a bond in favor of theinsurance company that underwrote the high deductible policy. The program topurchase the bonds as a substitute for the letters of credit was created for aselect number of companies who agreed to jointly and severally share thepotential risk of loss. During the fourth quarter of 2000, the Company wasnotified that one of the participants in the shared collateral pool caused adefault under the shared collateral agreement in connection with a bankruptcyfiling,. The insurance carrier responded by drawing on all of the pledgedletters of credit. The Company has terminated its participation in the sharedcollateral program in connection with its workers compensation policy, andaccordingly, the Company will incur no additional charges in connection withthat program. 

*General andAdministrative; Service Charges Paid to Affiliate*. General andadministrative expenses increased by $185,000 or 1.0%, from $17,808,000 in 1999to $17,993,000 in 2000. The Company reimburses a former affiliate for dataprocessing services provided to the Company. During 1999, such reimbursementstotaled $1,173,000 compared to $1,083,000 in 2000. 

*Amortization of PrepaidManagement Fees.*Amortization of prepaid management fees (paid in connectionwith the Merger) was $1,200,000 in 1999 and 2000. (See Note O to theCompany’s consolidated financial statements included elsewhere in thisreport.) 

*Depreciation andAmortization*. Depreciation and amortization decreased slightly from$10,249,000 for the year ended December 31, 1999 to $10,210,000 for the yearended December 31, 2000. The effect of an increase in depreciation expense wasentirely offset by a decrease in amortization expense. The increase indepreciation expense was the result of assets placed in service during late 1999and 2000. The decrease in amortization expense was the result of deferredfinancing costs written-off in connection with a reduction in funds committedthrough the Company’s bank credit facility in 2000. (See Note H to theCompany’s consolidated financial statements included elsewhere in thisreport.) and goodwill written off in connection with the Company’srestructuring of its therapy services business during 1999. (See Note P to theCompany’s consolidated financial statements included elsewhere in thisreport.) 

*Facility Rent*.Facility rent expense increased by $1,881,000 from $22,394,000 in 1999 to$24,275,000 in 2000. Most of the increase in rent expense ($1,500,000) occurredas a result of the Company terminating capital leases for four facilities in theCleveland area in September 2000 and entering into four new operating leases forthese facilities. (See Note I to the Company’s consolidated financialstatements included elsewhere in this report.) 

*RestructuringCosts.* In connection with restructuring the Company’s therapy servicesbusiness, the Company incurred restructuring costs of $5,745,000 during thethird quarter of 1999. (See Note P to the Company’s consolidated financialstatements included elsewhere in this report.) 

*Loss on the terminationof capital lease.*In connection with the termination of a capital leaseduring the third quarter of 2000, the Company recorded a non-recurring charge of$8,900,000. The principal components of this charge included the write-off of
19
capital leased assets in excess of the related capital lease obligation($5,700,000) and the write-off of deferred financing costs ($1,800,000) relatedto the Company’s bank credit facility. (See Note I to the Company’sconsolidated financial statements included elsewhere in this report.) 

*Interest Expense,net*. Interest expense, net, increased from $20,895,000 in 1999 to$21,675,000 in 2000. This increase is the result of higher outstanding balancesin 2000 with respect to the Company’s 11% Senior Subordinated DiscountNotes (the “Discount Notes”). The Company issued $99.5 million ofDiscount Notes in August 1998. The interest associated with the Discount Notesaccretes until August 1, 2003 and then becomes payable in cash, semi-annually inarrears, beginning on February 1, 2004. As of December 31, 2000, the DiscountNotes had accreted to a balance of $128,941,000. Additionally, as of December31, 1999 and 2000, the Company had $32,750,000 outstanding on its revolvingcredit facility. The Company has not made additional borrowings on its revolvingcredit facility since July 7, 1999. 

*Income Tax Expense(Benefit).*As a result of the loss incurred in 1999, income tax benefit of$10,304,000 was recognized in that year. In 2000, deferred taxes wereeliminated, due to uncertainty regarding future realization of these assets,resulting in income tax expense of $14,322,000. 
  Net Loss.  Net loss was $17,601,000 in 1999 as compared to a loss of $36,706,000 in 2000.Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
*Total Net Revenues*.Total net revenues decreased by $10,429,000 or 3.4%, from $311,044,000 in 1998to $300,615,000 in 1999. The reduction in total revenues from 1998 to 1999 wasprimarily the result of lower occupancy and lower average revenues per patientday at the Company’s facilities and the termination of the Company’scontracts to provide rehabilitation therapy services to non-affiliated long-termcare facilities. These factors were partially offset by increased revenues fromfacilities acquired by the Company in 1998 and operated by the Company duringall of 1999. The Company’s revenues increased by $2,115,000 as a result ofthe acquisition of two North Toledo facilities (the “North ToledoFacilities”) on April 1, 1998; $4,738,000 from the acquisition of two RhodeIsland facilities (the “Rhode Island Facilities”) on May 8, 1998, and$7,571,000 from the acquisition of two Danbury, Connecticut facilities (the“Danbury Facilities”) on December 1, 1998. The average occupancy rateat all of the Company’s facilities decreased from 92.3% for the year endedDecember 31, 1998 to 90.9% for the year ended December 31, 1999. Average netpatient service revenues per patient day at “same store” facilitiesdecreased from $159.74 for the year ended December 31, 1998 to $153.08 for theyear ended December 31, 1999. This decrease in average net patient servicerevenues per patient day was a result of the implementation of the new MedicareProspective Payment System (“PPS”) which became effective at all ofthe Company’s facilities on January 1, 1999. Implementation of PPS causedthe Company’s average Medicare Part A per diem rate to decrease from $397per Medicare patient day for the year ended December 31, 1998 to $290 perMedicare patient day for the year ended December 31, 1999. For the year endedDecember 31, 1999, the Company also experienced reduced revenues generatedthrough the provision of Medicare Part B services to residents at itsfacilities. This reduction was due partially to lower productivity by Companytherapists during the first quarter as they adjusted to the newly implementedMedicare reimbursement system. Additionally, PPS established certain annual perpatient limitations on the amount of Part B therapy that is reimbursable throughthe Medicare program. Management believes that the introduction of these annuallimits resulted in reduced revenues for the year ended December 31, 1999 asaffected parties adapted to the new regulatory environment. Implementation ofPPS also caused a decrease in revenues generated by providing rehabilitationtherapy services to non-affiliated long-term care facilities. In response toreduced reimbursement from the Medicare program, non-affiliated facilitiesreduced the amount of therapy services provided at their facilities.Additionally, during the third quarter of 1999, the Company terminated itscontracts to provide rehabilitation therapy services at non-affiliatedfacilities. The Company’s quality mix of private, Medicare and insurancerevenues was 57.9% for the year ended December 31, 1998 as compared to 50.7%during the same period of 1999. This decrease in quality mix of revenues wasprimarily the result of the decrease in Medicare revenues caused by theimplementation of PPS. 

*Facility OperatingExpenses*. Facility operating expenses increased by $2,795,000, or 1.1%, from$246,000,000 in 1998 to $248,795,000 in 1999. Of this increase, $1,758,000 wasdue to the operations of the North Toledo Facilities, $4,300,000 was due to theoperations of the Rhode Island Facilities, and $6,242,000 was due to theoperations of the Danbury Facilities. These increases in operating expenses weresubstantially offset by reductions in expenses at “same store”facilities in 1999, which were initiated by management in response to therevenue decline noted above. Expense reductions included wage and staffingreductions related to the delivery of rehabilitative therapy services, reducedindirect nursing support and the renegotiation of vendor contracts. The Companyexperienced an increased reliance on outside nurse agency personnel in 1999,which offset the effects of some of these savings. Outside nurse agencypersonnel are more costly than the Company’s employees; however, their useis necessary to maintain adequate staffing levels in the Company’sfacilities when the Company cannot recruit or retain sufficient employees.Strong economic conditions in the Company’s markets in 1999 made itdifficult to maintain or expand the Company’s employee base. 

*General andAdministrative; Service Charges Paid to Affiliate*. General andadministrative expenses increased by $2,386,000 or 15.5%, from $15,422,000 in1998 to $17,808,000 in 1999. As a percentage of total net revenues, general andadministrative expenses increased from 5.0% in 1998 to 5.9% in 1999. Thisincrease resulted from an increase in salaries, consulting and other relatedexpenses associated with the development of the Company’s data processingcapabilities, efforts to streamline the Company’s business processes,training initiatives supporting facility-based personnel, and increased legalexpenses. The Company reimburses a former affiliate for certain data processingand administrative services provided to the Company. During 1998, suchreimbursements totaled $1,291,000 as compared to $1,173,000 in 1999. 

*Amortization of PrepaidManagement Fees.* Amortization of prepaid management fees (paid inconnection with the Merger) was $500,000 in 1998 as compared to $1,200,000 in1999. (See Note O to the Company’s consolidated financial statementsincluded elsewhere in this report). 

*Depreciation andAmortization*. Depreciation and amortization increased by $3,899,000 from$6,350,000 in 1998 to $10,249,000 in 1999 primarily due to the amortization ofcosts related to the leveraged recapitalization and the exercise of purchaseoptions for seven facilities which were financed through synthetic leases priorto the leveraged recapitalization. The exercise of these purchase options wasfunded through financing arranged in connection with the leveragedrecapitalization. 
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*Facility Rent*.Facility rent expense decreased by $18,000 from $22,412,000 in 1998 to$22,394,000 in 1999. The decrease in rent expense is the result of a reductionin rent expense related to the exercise of purchase options on previously leasedfacilities partially offset by the acquisition of the Danbury Facilities bymeans of a synthetic lease. 

*RestructuringCosts.* In connection with restructuring the Company’s therapy servicesbusiness, the Company incurred restructuring costs of $5,745,000 during thethird quarter of 1999. (See Note P to the Company’s consolidated financialstatements included elsewhere in this report). 

*Interest Expense,net*. Interest expense, net, increased from $11,271,000 in 1998 to$20,895,000 in 1999. This net increase is primarily due to the issuance of$99,500,000 of 11% Senior Subordinated Discount Notes (the “DiscountNotes”) during the third quarter of 1998 in connection with the leveragedrecapitalization, as well as increased utilization of the Company’srevolving credit facility in 1999. The interest associated with the DiscountNotes accretes until August 1, 2003 and then becomes payable in cash,semi-annually in arrears, beginning on February 1, 2004. 

*Income Taxes (Benefit).*As a result of the losses incurred in 1998 and 1999, income tax benefits of$5,020,000 and $10,304,000, respectively, were recognized for those years. 
  Net Loss.  Net loss was $17,601,000 in 1999 as compared to a loss of $24,187,000 in 1998.LIQUIDITY ANDCAPITAL 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, from a real estate investmenttrust which has purchased the facilities from the owner, or through syntheticlease borrowings. The Company’s existing facility leases generally requireit to make monthly lease payments and pay all property operating costs. TheCompany generally negotiates leases which provide for extensions beyond theinitial lease term and an option to purchase the leased facility. In some cases,the option to purchase the leased facility is at a price based on the fairmarket value of the facility at the time the option is exercised. In othercases, the lease for the facility sets forth a fixed purchase option price whichthe Company believes is equal to the fair market value of the facility at theinception date of such lease, thus allowing the Company to realize the valueappreciation of the facility while maintaining financial 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 Notesaccretes at 11% per annum until August 1, 2003 and then becomes payable in cash,semi-annually in arrears, beginning on February 1, 2004. Dividends on thePreferred Stock are payable, at the option of the Company, in additional sharesof the Preferred Stock until August 1, 2003. After that date dividends may onlybe paid in cash. The Company does not expect to pay any cash dividends on thePreferred Stock prior to August 1, 2003. In August 1998, the Company alsoentered into a new $250 million collateralized credit facility (the “NewCredit Facility”). The terms of the New Credit Facility originally providedup to $75 million on a revolving credit basis plus an additional $175 millioninitially funded on a revolving basis that converts to a term loan on an annualbasis on each anniversary of the closing. During the first four years of thefacility, any or all of the full $250 million of availability under the facilitycould be used for synthetic lease financings. Proceeds of loans under thefacility may be used for acquisitions, working capital purposes, capitalexpenditures and general corporate purposes. Interest is based on either LIBORor prime rates of interest (plus applicable margins determined by theCompany’s leverage ratio) at the election of the Company. The New CreditFacility contains various financial and other restrictive covenants and limitsaggregate borrowings under the New Credit Facility to a predetermined multipleof earnings 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 New 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 itsadmission 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),renegotiation of vendor contracts and ongoing efforts to reduce theCompany’s reliance on outside nurse agency personnel. All of the staffingreductions were implemented, on or prior to, April 1, 1999. Effective March 30,1999, the Company obtained an amendment (the “First Amendment”) to theNew Credit Facility which limited borrowings under the New 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. Beginningwith the first quarter of 1999, the First Amendment replaced the originalfinancial covenants with one new financial covenant, a minimum cumulative amountof EBITDA. The original financial covenants provided maximum ratios of totalindebtedness to EBITDA and senior indebtedness to EBITDA, and a minimum debtservice coverage ratio. The First Amendment required minimum amounts of EBITDA,measured quarterly, but calculated on a rolling twelve-month basis, throughDecember 31, 2000. As long as the Company met or exceeded the required minimumcumulative amounts of EBITDA, the Company could access the New Credit Facilityfor general corporate 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 a
21
specified 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. (See Note P to the Company’s condensed consolidated financialstatements included elsewhere in this report.) As a result of this restructuringcharge, the Company’s consolidated net worth as of September 30, 1999 (ascalculated for purposes of this requirement) had fallen below the requiredlevel. The Company anticipated that its net worth would continue to be below therequired level at December 31, 1999, which would have resulted in an event ofdefault under each of these leases with the Company potentially facing the lossof these operations. Such default could also have triggered cross-defaults underthe Company’s other lease and debt obligations. In December 1999, theCompany paid $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 and on September 27, 2000, the Company terminated the ClevelandFacilities capital leases and assigned its purchase rights for these facilitiesto an investment entity organized by Investcorp S.A. for $5.0 million, whichacquired the Cleveland Facilities on September 27, 2000. On that date, theCompany entered into new operating leases for each of the Cleveland Facilitieswith combined annual rent expense of approximately $5.9 million. The Companyalso repaid the $5.0 million loan 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 the related capital leaseobligation ($5.7 million) and the write-off of deferred financing costs ($1.8million) originally incurred in obtaining the Company’s New CreditFacility. In order to complete the Cleveland Facility leasing transaction, theCompany was required to obtain the release of certain collateral held by thebank group which provides the New Credit Facility. The Company obtained therelease of the collateral as part of an amendment (the “SecondAmendment”) to the New Credit Facility, which also resulted in a permanentreduction of the Company’s maximum borrowings under the credit facilityfrom $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 March 28, 2001, theCompany obtained an additional amendment (the “Third Amendment”) tothe New Credit Facility. The Third Amendment resulted in a permanent reductionof the Company’s maximum borrowings under the New Credit Facility from $150million to $60 million, revised certain financial covenants, changed thematurity date of the New Credit Facility to March 31, 2004 and increased theCompany’s borrowing rate. The Third Amendment also requires the Company torepay, on an annual basis, the greater of $5.0 million or 50% of theCompany’s excess cash flow (as defined). As a result of the permanentreduction in funds available through the New Credit Facility, the Company willbe required to write off approximately $2.6 million of deferred financing costsincurred when the New Credit Facility was obtained. 

As of December 31, 2000,total borrowings under the New Credit Facility were $52,019,000 and consisted of$32,750,000 of revolver loans, $13,700,000 of synthetic lease obligations and$5,569,000 of undrawn letters of credit. As of December 31, 2000, the Companyhad approximately $7,981,000 of funding available under the New Credit Facility(as amended by the Third Amendment) and was not in default of the financialcovenants of the New Credit Facility as amended by the Third Amendment. 

The Company’soperating activities in 1999 provided net cash of $752,000 as compared toproviding net cash of $26,366,000 in 2000, an improvement of $25,614,000. Cashflows from operations in 2000 increased primarily as the result of a reductionin the Company’s pre-tax operating loss and a decrease in accountsreceivable and prepaid expenses and other, partially offset by an increase indeferred income taxes. During 2000, the Company received approximately $3.5million in federal and state income tax refunds. 

Net cash used by investingactivities was $20,762,000 during 1999 as compared to $8,702,000 used in 2000.The primary use of cash for investing purposes during 1999 was to fund additionsto property and equipment associated with the maintenance of the Company’sexisting facilities and the development of its data processing capabilities. Asdiscussed above, the Company also paid $5,000,000 to the landlord of theCleveland Facilities in order to obtain the New Option. The primary use of cashfor investing purposes during 2000 was to fund additions of property andequipment associated with the maintenance of the Company’s nursingfacilities. 

Net cash provided byfinancing activities decreased from net cash provided of $20,500,000 in 1999 tonet cash used of $8,326,000 in 2000. This decrease was due to the fact thatduring 1999 the Company borrowed $20,000,000 under the New Credit Facility ascompared to no new borrowings during 2000. The Company has not drawn on itsrevolving credit facility since July 7, 1999. During 2000, the Company alsorepaid a $5,000,000 note payable to an affiliate of Investcorp S.A. 

In addition to the DiscountNotes, as of December 31, 2000, the Company had two mortgage loans outstandingtotaling $17,424,000 and $32,750,000 in advances on its New Credit Facility. Onemortgage loan had an outstanding principal balance of $15,904,000 of which$15,140,000 is due at maturity in 2004. This loan bears interest at an annualrate of 10.65% plus additional interest equal to 0.3% of the difference betweenthe annual operating revenues of the four mortgaged facilities and actualrevenues during the twelve-month base period. The Company’s other mortgageloan, which encumbers a single facility, had an outstanding principal balance of$1,520,000 at December 31, 2000, of which $1,338,000 is due in 2010. 

Harborside expects that itscapital expenditures for 2001, excluding acquisitions of new long-term carefacilities, will aggregate approximately $6,500,000. 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 financed withborrowings under the New Credit Facility, direct operating leases or assumeddebt. Harborside may be required to obtain additional equity financing tofinance any significant acquisitions in the future. 

In December 2000, theMedicare, Medicaid, and State Child Health Insurance Program BenefitsImprovement and Protection Act of 2000 (“BIPA”) was enacted. BIPA willincrease the existing nursing rate component of the Federal per diem rate, for
22
each RUG category, by 16.66% from April 1, 2001 through September 30, 2002. Inaddition, BIPA will eliminate the 20% add-on for three of the fifteenrehabilitation services RUG categories and substitute a 6.7% add-on for allfifteen rehabilitation services RUG categories. BIPA also extended themoratorium on the annual limitation on Part B therapy charges of $1,500 perbeneficiary through calendar year 2002 and repealed the BBA requirement toimplement consolidated billing for Part B services. The Company believes thatthe primary effect of the BIPA on the Company will be to increase theCompany’s Medicare Part A per diem rate from $322 in 2000 to $340 in 2001. 

The Company’s currentgeneral and professional liability insurance policy expires on September 1,2001. The Company is currently in discussions with its insurance advisors toreview various replacement options. At this time, the Company estimates that itsannual cost for professional and general liability insurance will increase from$2,500,000 to $6,000,000 effective September 1, 2001. There can be no assurance,however, that the coverage limits of the Company’s insurance policy will beadequate or that insurance will continue to be available to the Company oncommercially reasonable terms in the future. 

The Health InsurancePortability and Accountability Act of 1997 (“HIPAA”) became effectiveon January 1, 1997 and mandated the adoption of regulations designed to (a)standardize transaction formats and billing codes for documenting medicalservices and processing medical claims; and (b) protect the privacy and securityof individually identifiable health information. Final HIPAA regulations werepublished during the fourth quarter 2000. The Company is currently working inconjunction 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 ofHIPAA compliance. There can be no assurances that compliance with HIPAAregulations will not have an adverse effect on the Company’s results ofoperations, cash flows or its financial position. (See “GovernmentRegulation”.) 

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. 

PROPOSED RESTRUCTURING OF DISCOUNT NOTES AND PREFERRED STOCK

In March 2001, the Company entered into an agreement (the"Restructuring Agreement") with Investcorp S.A. and the holders of more than amajority in interest of the Company's Discount Notes and Preferred Stock forpurposes of implementing a restructuring of the Discount Notes and PreferredStock. The Restructuring Agreement contemplates that the Company will offer toexchange for each $1,000 amount at maturity of outstanding Discount Notes acombination of the following: (1) 0.5899118 of a new 12% Senior SubordinatedDiscount Note due 2007 (the "New Notes") each having a principal amount atmaturity equal to $1,000 and an original issue price of $685.01 (assuming theNew Notes are issued on May 1, 2001), (2) $88.235 in cash and (3) common stockpurchase warrants for approximately 10.9 shares of its Class A Common Stock. TheCompany will also offer to exchange common stock purchase warrants forapproximately 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 will solicit consents from holders of outstanding DiscountNotes and Preferred Stock to amendments to the Indenture governing the DiscountNotes and to the Certificate of Designation governing the Preferred Stock thatwould eliminate or modify certain restrictive covenants and other provisionscontained in the Indenture and the Certificate of Designation and wouldsubstantially eliminate the preferences of the Preferred Stock, including thereduction of the liquidation preference from $1,000 to $0.01 per share and theelimination of the right of holders to be paid dividends on shares of PreferredStock. Also, the Company will issue to Investcorp S.A. (or one or more of itsaffiliates or designees) up to 15,000 shares of a new series of 13% convertibleexchangeable preferred stock (which will be mandatorily redeemable in 2008) and1,854,422 common stock purchase warrants for a total purchase price of up to$15,000,000. 

Assuming the tender and exchange of all outstandingDiscount Notes and Preferred Stock in the exchange offer: (1) the Company willhave an aggregate principal amount at maturity of $100,285,000 of New Notesoutstanding and an aggregate liquidation preference of $15,000,000 of newpreferred stock outstanding, (2) the warrants to be issued to holders ofDiscount Notes, to holders of Preferred Stock, and to Investcorp S.A. wouldrepresent the right to purchase an aggregate of 15%, 5% and 15%, respectively,of the total number of shares of all classes of the Company's common stock on afully diluted basis as of the closing of the transactions contemplated by theRestructuring Agreement (excluding shares issuable upon conversion of the newpreferred stock to be issued to Investcorp, each share of which will initiallybe convertible into 150 shares of Class A Common Stock, and (3) the aggregateamount of cash to be paid by the Company as partial consideration for tenderedDiscount Notes would be $15,000,000. 

Upon the completion of the reduction in the liquidationpreference of the Preferred Stock from $55,112,000 to $551, as contemplated bythe Restructuring Agreement, the carrying amount of the Preferred Stock will bereduced from $55,112,000 to $551 and the amount of the reduction, net of anyunamortized deferred financing costs related to the issuance of the PreferredStock (approximately $1,062,000 as of December 31, 2000), will be directlytransferred to the Company's Accumulated Deficit account. Upon the completion ofthe exchange of the New Notes for the Discount Notes (the "Note Exchange"), asdescribed in the Restructuring Agreement, the carrying value of the accretedprincipal of the Discount Notes would be reduced to $66,072,000, assuming theNote Exchange took place on December 31, 2000, and the amount of the reduction,net of the expected aggregate cash payment of $15,000,000, would be directlytransferred to the Company's Long-term Accrued Interest account. In the future,
23
the carrying amount of the New Notes will increase as the result of accretionand will result in a corresponding decrease in the carrying amount of Long-termAccrued Interest. Interest expense on the New Notes will be recognized such thata constant effective interest rate will be 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. The Company will notrecognize a gain or loss for accounting purposes in connection with the Note Exchangeexcept for the write-off of unamortized deferred financing costs related to theissuance of the Discount Notes (approximately $3,592,000 as of December 31,2000) and the recognition of various investment advisory and legal feesassociated with the arrangement of the Restructuring Agreement and estimated tobe approximately $3,000,000. 

Holders owning approximately 75% of the aggregateprincipal amount at maturity of Discount Notes and approximately 90% of thePreferred Stock have agreed to accept the restructuring proposal (includingconsenting to the amendments to the Indenture and the Certificate ofDesignation). 

The restructuring proposal will be made to holders ofoutstanding Discount Notes and Preferred Stock only by an exchange offer to bemailed to such holders during the week of April 2, 2001. The restructuring issubject to certain conditions, including, among other things, the absence of amaterial adverse change in the business of the Company, acceptance of therestructuring proposal by the holders of at least 95% of the Discount Notes, andconsummation of the restructuring by June 15, 2001. 

In the unlikely event that the transactions contemplatedby the Restructuring Agreement are not completed by June 30, 2001, the Companywould likely not be in compliance with certain financial covenants required byits New Credit Facility as of that date. In such event, the Company would needto obtain a further modification of its covenants in order to avoid a defaultunder the New Credit Facility. 

**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 New CreditFacility are sensitive to changes in interest rates. Under the New CreditFacility, interest is based on either LIBOR or prime rates of interest (plusapplicable margins), at the Company’s election. As the prime and LIBORrates of interest increase, interest expense associated with the Company’sborrowings under the New Credit Facility would also increase. An increase of 1%in the applicable rate would have increased the Company’s annual interestcost by approximately $328,000. 

The Company did notexperience significant changes in interest rates during the year ended December31, 2000. 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. By entering into an interest rate swap, the Companycan effectively transform variable rate debt into fixed rate debt. The Companydid not have any interest rate swap arrangements outstanding during the yearsending December 31, 1999 or December 31, 2000. 
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**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**
INDEX TO FINANCIAL STATEMENTSHARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES:Report of Independent Accountants......................................................................26Consolidated Balance Sheets as of December 31, 1999 and 2000...........................................27Consolidated Statements of Operations for the years ended December 31, 1998, 1999 and 2000...................................................................................28Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended December 31, 1998, 1999 and 2000......................................................................29Consolidated Statements of Cash Flows for the years ended December 31,1998, 1999 and 2000....................................................................................30Notes to Consolidated Financial Statements.............................................................3125                                          REPORT OF INDEPENDENT ACCOUNTANTSTo the Stockholders and Board of Directors ofHarborside Healthcare Corporation     In our  opinion,  the  accompanying  consolidated  balance  sheets  and therelated  consolidated  statements of operations,  changes in  stockholders’equity (deficit),  and cash flows present fairly, in all material respects,  thefinancial  position of Harborside  Healthcare  Corporation and its  subsidiaries(the  “Company”)  at December  31,  2000 and 1999,  and the results oftheir  operations  and  their  cash  flows  for the three  years  then  ended inconformity with accounting principles generally accepted in the United States ofAmerica. These financial statements are the responsibility of the Company’smanagement;  our  responsibility  is to express  an  opinion on these  financialstatements  based on our audits.  We conducted our audits of these statements inaccordance with auditing  standards  generally  accepted in the United States ofAmerica,  which require that we plan and perform the audit to obtain  reasonableassurance   about  whether  the  financial   statements  are  free  of  materialmisstatement.  An audit includes examining, on a test basis, evidence supportingthe  amounts  and  disclosures  in  the  financial  statements,   assessing  theaccounting  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, MassachusettsFebruary 16, 2001, except as tothe information contained in Notes H and S,as to which the date is March 28, 200126                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                             CONSOLIDATED BALANCE SHEETS                              (dollars in thousands, except share and per share amounts)                                                       AS OF DECEMBER 31,                                                                            1999           2000                                                                       ---------      ---------        ASSETSCurrent assets:  Cash and cash equivalents ......................................     $   1,386      $  10,724  Accounts receivable, net of allowances for doubtful     accounts of $3,098 and $2,272 respectively ..................        50,168         48,659  Prepaid expenses and other .....................................        19,940         13,180  Prepaid income taxes ...........................................         2,608           --  Deferred income taxes (Note K) .................................         2,400           --                                                                       ---------      ---------    Total current assets .........................................        76,502         72,563Restricted cash (Note C) .........................................         2,420          4,805Property and equipment, net (Note D) .............................       166,326        105,089Deferred financing and other non-current assets, net (Note E) ....        15,546         11,253Other assets, net (Note O) .......................................         3,100          1,900Note receivable (Note F) .........................................         7,487          7,487Deferred income taxes (Note K) ...................................        11,852           --                                                                       ---------      ---------    Total assets .................................................     $ 283,233      $ 203,097                                                                       =========      =========        LIABILITIESCurrent liabilities:  Current maturities of long-term debt (Note H) ..................     $     227      $   5,250  Current portion of capital lease obligation (Note I) ...........         4,633           --  Note payable to affiliate (Note O) .............................         5,000           --  Accounts payable ...............................................         9,328         10,883  Employee compensation and benefits .............................        14,021         15,865  Other accrued liabilities ......................................         5,508          6,301  Accrued interest ...............................................           572            470  Current portion of deferred income .............................           677            514                                                                       ---------      ---------    Total current liabilities ....................................        39,966         39,283Long-term portion of deferred income (Note G) ....................         2,427          1,910Long-term debt (Note H) ..........................................       166,018        173,866Long-term portion of capital lease obligation (Note I) ...........        50,067           --                                                                       ---------      ---------    Total liabilities ............................................       258,478        215,059                                                                       ---------      ---------Commitments and contingencies (Notes G and M)Exchangeable preferred stock, redeemable, $.01 par value  with a liquidation value of $1,000 per share;  500,000 shares authorized; 48,277 and  55,112 issued and outstanding, respectively (Note L) ...........        48,277         55,112                                                                       ---------      ---------        STOCKHOLDERS' DEFICIT (Note L)Common stock, $.01 par value, 19,000,000 shares authorized, 14,611,164 and 15,275,664 shares issued, respectively           146            153Additional paid-in capital .......................................       198,603        191,750Less common stock in treasury, at cost, 7,349,832 shares .........      (183,746)      (183,746)Accumulated deficit ..............................................       (38,525)       (75,231)                                                                       ---------      ---------    Total stockholders' deficit ..................................       (23,522)       (67,074)                                                                       ---------      --------- Total liabilities and stockholders' deficit .....................     $ 283,233      $ 203,097                                                                       =========      =========The accompanying notes are an integral part of the condensed consolidated financial statements.27                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                        CONSOLIDATED STATEMENTS OF OPERATIONS                                   (dollars in thousands, except per share amounts)                                           FOR THE YEARS ENDED DECEMBER 31,                                                           1998           1999         2000                                                        ---------      ---------      ---------Total net revenues ................................     $ 311,044      $ 300,615      $ 322,672                                                        ---------      ---------      ---------Expenses:  Facility operating ..............................       246,000        248,795        259,780  General and administrative ......................        15,422         17,808         17,993  Service charges paid to former affiliate (Note O)         1,291          1,173          1,083  Amortization of prepaid management fee (Note O) .           500          1,200          1,200  Depreciation and amortization ...................         6,350         10,249         10,210  Facility rent ...................................        22,412         22,394         24,275  Merger costs (Note B) ...........................        37,172           --             --  Restructuring costs (Note P) ....................          --            5,745           --  Loss on termination of capital lease (Note I) ...          --             --            8,914                                                         ---------      ---------       -------   Total expenses .................................       329,147        307,364        323,455                                                         ---------      ---------       ------- Loss from operations .............................       (18,103)        (6,749)          (783)Other:Interest expense, net .............................        11,271         20,895         21,675  Other expense (income) ..........................          (167)           261            (74)                                                         ---------      ---------       -------Loss before income taxes ..........................       (29,207)       (27,905)       (22,384)Income tax expense (benefit) (Note K) .............        (5,020)       (10,304)        14,322                                                         --------      ---------        -------Net loss ..........................................       (24,187)       (17,601)       (36,706)Preferred stock dividends .........................        (2,296)        (6,004)        (6,853)                                                        ---------      ---------       --------Loss available for common shares ..................     $ (26,483)     $ (23,605)      $(43,559)                                                        =========      =========       ========Loss per common share (Note L):         Basic and Diluted ........................     $   (3.42)     $   (3.25)      $  (6.00)                                                        =========      =========       ========The accompanying notes are an integral part of the condensed consolidated financial statements.28                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                         CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)                                                (dollars in thousands)                                 FOR THE YEARS ENDED DECEMBER 31, 1998, 1999 and 2000                                                                                                          Retained                                                                             Additional                    Earnings                                                                 Common      Paid-in        Treasury     (Accumulated                                                                 Stock       Capital          Stock         Deficit)          Total                                                               ---------     ---------      ---------      ---------      ---------Stockholders' equity, December 31, 1997 ...................    $      80     $  48,440           --       $   3,263         $51,783Net loss for the year ended December 31, 1998 .............         --            --             --          (24,187)       (24,187)Exercise of stock options .................................         --              29           --             --               29Issuance of common stock, net (6,600,000 shares) ..........           66       158,434           --             --          158,500Purchase of treasury stock (7,349,832 shares) .............         --            --        $(183,746)          --         (183,746)Preferred stock dividends .................................         --          (2,296)          --             --           (2,296)                                                               ---------     ---------      --------       ---------      ---------Stockholders' equity, December 31, 1998 ...................          146       204,607       (183,746)       (20,924)            83Net loss for the year ended December 31, 1999 .............         --            --             --          (17,601)       (17,601)Preferred stock dividends .................................         --          (6,004)          --             --           (6,004)                                                               ---------     ---------      --------       ---------      ---------Stockholders' deficit, December 31, 1999 ..................          146       198,603       (183,746)       (38,525)       (23,522)Net loss for the year ended December 31, 2000 .............         --            --             --          (36,706)       (36,706)Issuance of restricted shares (664,500 shares) ............            7          --             --             --                7Preferred stock dividends .................................         --          (6,853)          --             --           (6,853)                                                               ---------     ---------      ---------      ---------      ---------Stockholders' deficit, December 31, 2000 ..................    $     153     $ 191,750      $(183,746)     $ (75,231)     $ (67,074)                                                               =========     =========      =========      =========      =========The accompanying notes are an integral part of the condensed consolidated financial statements.29                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                        CONSOLIDATED STATEMENTS OF CASH FLOWS                                                (dollars in thousands)                                           FOR THE YEARS ENDED DECEMBER 31,                                                                     1998           1999           2000                                                                  ---------      ---------      ---------Operating activities:Net loss ......................................................   $ (24,187)     $ (17,601)     $ (36,706)Adjustments to reconcile net loss to net  cash provided (used) by operating activities:Depreciation of property and equipment ........................       4,973          7,173          7,776Amortization of deferred financing and other non-current assets ...........................................       1,377          3,076          2,434             Amortization of prepaid management fee ...........         500          1,200          1,200Amortization of deferred income ...............................        (550)          (677)          (680)Prepayment of management fees .................................      (6,000)          --             --Accretion of senior subordinated discount notes ...............       4,583         11,771         13,095Amortization of loan costs  and fees (included in rental and interest expense) ..........          56            156            143Accretion of interest on capital lease obligation .............       3,185          3,443          2,753Noncash restructuring charge ..................................        --            1,852           --Noncash lease termination costs ...............................        --             --            7,542Noncash issuance of restricted shares .........................        --             --                7Merger costs not requiring cash ...............................        (350)          --             --                                                                  ---------       ---------      ---------                                                                    (16,413)        10,393         (2,436)Changes in operating assets and liabilities: (Increase) decrease in accounts receivable ...................     (17,530)          (222)         1,509 (Increase) decrease in prepaid expenses and other ............      (3,202)        (4,006)         6,343 (Increase) decrease in deferred income taxes .................      (4,092)        (7,939)        14,252 Increase in accounts payable .................................         126          1,927          1,555 Increase in employee compensation and benefits ...............       2,479            801          1,844 Increase (decrease) in accrued interest ......................        (189)           510           (102) Increase (decrease) in other accrued liabilities .............       3,068         (1,977)           793 Increase (decrease) in income taxes payable ..................      (3,694)         1,265          2,608                                                                   ---------      ---------      ---------  Net cash provided (used) by operating activities ............     (39,447)           752         26,366                                                                   ---------      ---------      ---------Investing activities: Additions to property and equipment ..........................     (68,605)       (13,197)        (6,199) Additions to deferred financing and other  non-current assets ..........................................     (13,494)        (2,255)          (118) Transfers (to) from restricted cash, net .....................       3,435           (310)        (2,385) Payment of purchase deposit ..................................        --           (5,000)          --                                                                   ---------      ---------      ---------Net cash used by investing activities .........................     (78,664)       (20,762)        (8,702)                                                                   ---------      ---------      ---------Financing activities: Borrowings under revolving line of credit ....................      17,150         20,000           -- Issuance of note payable to affiliate ........................        --            5,000           -- Payment of note payable to affiliate .........................        --             --           (5,000) Repaid on revolving line of credit ...........................     (20,000)          --             -- Payment of long-term debt ....................................        (191)          (206)          (224) Proceeds from issuance of senior subordinated discount notes..      99,493          --             -- Proceeds from issuance of exchangeable preferred stock .......      40,000           --             -- Purchase of treasury stock ...................................    (183,746)          --             -- Proceeds from sale of common stock ...........................     158,500           --             -- Principal payments of capital lease obligation ...............      (3,939)        (4,274)        (3,084) Receipt of cash in connection with lease .....................       2,964           --             -- Dividends paid on exchangeable preferred stock ...............        --              (20)           (18) Exercise of stock options ....................................          29           --             --                                                                  ---------      ---------      ---------  Net cash provided (used) by financing activities ............     110,260         20,500         (8,326)                                                                  ---------      ---------      ---------Net increase (decrease) in cash and cash equivalents ..........      (7,851)           490          9,338Cash and cash equivalents, beginning of year ..................       8,747            896          1,386                                                                  ---------      ---------      ---------Cash and cash equivalents, end of year ........................   $     896      $   1,386      $  10,724                                                                  =========      =========      =========Supplemental Disclosure:  Interest paid ...............................................   $   3,636      $   5,911      $   7,129  Income taxes paid ...........................................   $   3,047      $     243      $     130  Accretion of preferred dividends ............................   $   2,293      $   5,984      $   6,835The accompanying notes are an integral part of the condensed consolidated financial statements.30HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSA. NATURE OF BUSINESS
Harborside Healthcare Corporation and its subsidiaries (the “Company”) operate long-termcare facilities and, until September 1999, provided rehabilitation therapyservices to non-affiliated long-term care facilities (See Note P). As ofDecember 31, 2000, the Company owned eighteen facilities, operated thirty-oneadditional facilities under various leases and managed one facility. The Companyaccounts for its investment in one 75% owned facility using the equity method ofaccounting. 
B. BASIS OF PRESENTATION

The Company wasincorporated as a Delaware corporation on March 19, 1996, and was formed as aholding company, in anticipation of an initial public offering (the“IPO”), to combine under the control of a single corporation theoperations of various business entities (the “Predecessor Entities”)which were all under the majority control of several related stockholders. 

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 Agreement, the New Investors acquired approximately 91%of the post-merger common stock of the Company. The remaining 9% of the commonstock was retained by existing shareholders, including management. As a resultof the Merger, 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’ equity. 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 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 $37 million ($29 million after taxes) for direct andother costs related to the Merger transaction. In connection with the Merger andthe related refinancings, the Company exercised purchase options for sevenfacilities which had been previously financed through synthetic 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 servicerevenues payable by patients at the Company’s facilities are recorded atestablished billing rates. Net patient service revenues to be reimbursed bycontracts with third-party payors, primarily the Medicare and Medicaid programs,are recorded at the amount estimated to be realized under these contractualarrangements. Revenues from Medicare and Medicaid are generally based onreimbursement of the reasonable direct and indirect costs of providing servicesto program participants or a prospective payment system. The Company separatelyestimates revenues due from each third-party with which it has a contractualarrangement and records anticipated settlements with these parties in thecontractual period during which services were rendered. The amounts actuallyreimbursable under Medicare and Medicaid are determined by filing cost reportswhich are then audited and generally retroactively adjusted by the payor.Legislative changes to state or Federal reimbursement systems may alsoretroactively affect recorded revenues. Changes in estimated revenues due inconnection with Medicare and Medicaid may be recorded by the Company subsequentto the year of origination and prior to final settlement based on improvedestimates. Such adjustments and final settlements with third-party payors, whichcould materially and adversely affect the Company, are reflected in operationsat the time of the adjustment or settlement. Beginning on January 1, 1999, allof the Company’s facilities which participate in the Medicare program beganto be reimbursed in accordance with the provisions of the Balanced Budget Act of1997 (the “Balanced Budget Act”). The Balanced Budget Act provides forthe reimbursement of Medicare funded skilled nursing facility services through aProspective Payment System which when fully implemented will reimburse theCompany’s facilities based upon a per diem rate adjusted for the acuity of
31
each patient and the geographic location of each facility. Accounts receivable,net, at December 31, 1999 and 2000 includes $12,838,000 and $11,451,000,respectively, of estimated settlements due from third-party payors and$4,465,000 and $2,268,000, 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 70%, 71%, and 74% of theCompany’s net revenues in the years ended December 31, 1998, 1999 and 2000,respectively, are from the Company’s participation in the Medicare andMedicaid programs. As of December 31, 1999 and 2000, $29,774,000 and$25,601,000, 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, housekeeping and dietary services provided to patients, aswell as maintenance and administration of the facilities. Other significantfacility operating expenses include: the cost of rehabilitation therapies,medical 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.(See Note P to the Company’s consolidated financial statements includedelsewhere in this report). 

Provision for Doubtful Accounts

Provisions foruncollectible accounts receivable of $1,418,000, $1,655,000 and $3,610,000 areincluded in facility operating expenses for the years ended December 31, 1998,1999 and 2000, 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 generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements and revenues and expensesduring the period reported. Actual results could differ from those estimates.Estimates are used when accounting for the collectibility of receivables,depreciation and amortization, employee benefit plans, taxes and contingencies. 

Property and Equipment

Property and equipment arestated at cost. Expenditures that extend the lives of affected assets arecapitalized, while maintenance and repairs are charged to expense as incurred.Upon the retirement or sale of an asset, the cost of the asset and any relatedaccumulated depreciation are removed from the balance sheet, and any resultinggain or loss is included in net income (loss). 

Depreciation expenseincludes the amortization of capital assets and is estimated using thestraight-line method. These estimates are calculated using the followingestimated useful lives: 
     Buildings and improvements                        31.5 to 40 years     Furniture and equipment                           5 to 10 years     Leasehold improvements                            over the life of the lease     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). 

In connection with each ofits acquisitions, the Company reviewed the assets of the acquired facility andassessed its relative fair value in comparison to the purchase price. Covenantsnot-to-compete are being amortized using the straight-line method over theperiod 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. Goodwill is amortized using the straight-linemethod over a 15 to 40 year period. 

Assessment of Long-Lived Assets

The Company periodicallyreviews the carrying value of its long-lived assets (primarily property andequipment 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. The Company has not recognizedany adjustments as a result of these assessments except for those noted withregard to the termination of the Company’s contract therapy business (SeeNote P). 
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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 set aside in escrow accounts as required by several of the Company’sleases and other financing arrangements. 

Income Taxes

The Company determinesdeferred taxes in accordance with Statement of Accounting Financial StandardsNo. 109, “Accounting for Income Taxes” (“SFAS No. 109”),which requires that deferred tax assets and liabilities be computed based on thedifference between the financial statement and income tax bases of assets andliabilities using the enacted marginal tax rate. Deferred income tax expenses orcredits are based on the changes in the assets or liabilities from period toperiod. A valuation allowance reduces deferred tax assets when it is more likelythan not that some portion or all of the deferred tax assets will not berecognized (See Note K). 

New Accounting Pronouncements

In June 1998, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsNo. 133, “*Accounting for Derivative Instruments and HedgingActivities*” (“SFAS 133”). In June 1999, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsNo. 137, which amended SFAS 133, delaying its effective date to fiscal yearsbeginning after June 15, 2000. The Company adopted this accounting standard asrequired effective October 1, 2000 and it did not have any impact on the Company'sconsolidated financial position or results of operations. 

In  December  1999,  the  Securities  and  ExchangeCommission  issued Staff Accounting  Bulletin No. 101,  "Revenue  Recognition inFinancial  Statements." The adoption of this new  pronouncement did not have anyimpact on the Company's consolidated financial position or results of operations.

D. PROPERTY AND EQUIPMENT

The Company’s propertyand equipment are stated at cost and consist of the following as of December 31: 
                                                1999                    2000                                                ----                    ----Land                                      $   7,238,000            $   7,238,000Land improvements                             3,625,000                3,643,000Buildings and improvements                   88,780,000               91,393,000Leasehold improvements                        4,520,000                4,520,000Equipment, furnishings and fixtures          26,997,000               28,720,000Assets under capital lease                   63,481,000                  187,000                                           ------------             ------------                                            194,641,000              135,701,000Less accumulated depreciation                28,315,000               30,612,000                                           ------------             ------------                                           $166,326,000             $105,089,000                                           ============             ============
E. DEFERRED FINANCING AND OTHER NON-CURRENT ASSETS

Deferred financing andother non-current assets are stated at cost and consist of the following as ofDecember 31: 
                                                1999                    2000                                                ----                    ----Deferred financing costs                    $18,760,000              $16,095,000Covenant not-to-compete                       1,200,000                1,200,000Goodwill                                        569,000                  569,000Other                                           256,000                  256,000                                            -----------              -----------                                             20,785,000               18,120,000Less accumulated amortization                 5,239,000                6,867,000                                            -----------              -----------                                            $15,546,000              $11,253,000                                            ===========              ===========
F. NOTE RECEIVABLE

In connection with theacquisition of five Connecticut facilities on December 1, 1997 (See Note G), theCompany received a note receivable from the owners in the amount of $7,487,000.Interest is earned at the rate of 9% per annum, and payments are due monthly, inarrears, commencing January 1, 1998 and continuing until November 30, 2010, atwhich time the entire principal balance is due. The proceeds of the note wereused by the owner to repay certain indebtedness. The note is collateralized byvarious mortgage interests and other collateral. 
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G. OPERATING LEASES

In March 1993, a subsidiaryof the Company entered into an agreement with a non-affiliated entity to leasetwo long-term care facilities in Ohio with 289 beds for a period of ten years.The lease agreement, which became effective in June 1993, provides for fixedannual rental payments of $900,000. At the end of the ten-year period, theCompany has the option to acquire the facilities for $8,500,000, or to pay a$500,000 termination fee and relinquish the operation of the facilities to thelessor. On the effective date of the lease, the subsidiary paid $1,200,000 tothe lessor for a covenant not-to-compete which remains in force through June2003. 

Effective October 1, 1994,a subsidiary of the Company entered into an agreement with a related party tolease a 100 bed long-term care facility in Florida for a period of ten years.The lease agreement provides for annual rental payments of $551,250 in theinitial twelve-month period and annual increases of 2% thereafter. The Companyhas the option to exercise two consecutive five-year lease renewals. The Companyalso has the right to purchase the facility at fair market value at any timeafter the fifth anniversary of the commencement of the lease. The leaseagreement also required the Company to escrow funds equal to three months’base rent. 

Effective April 1, 1995, asubsidiary of the Company entered into an agreement with Meditrust to lease a100-bed long-term care facility in Ohio for a period of ten years. The leaseagreement provides for annual rental payments of $698,400 in the initialtwelve-month period. The Company is also required to make additional rentalpayments beginning April 1, 1996 in an amount equal to 5.0% of the differencebetween the facility’s operating revenues in each applicable year and theoperating revenues in the twelve-month base period which commenced on April 1,1995. The annual additional rent payment will not exceed $14,650. At the end ofthe initial lease period, the Company has the option to exercise two consecutivefive-year lease renewals. The Company’s obligations under the lease arecollateralized by, among other things, an interest in any property improvementsmade by the Company and by a second position on the facility’s accountsreceivable. The Company also has the right to purchase the facility at its fairmarket value on the eighth and tenth anniversary dates of the commencement ofthe lease and at the conclusion of each lease renewal. 

Effective January 1, 1996,a subsidiary of the Company entered into an agreement with Meditrust to leaseseven facilities with a total of 820 beds. The lease agreement provides forannual rental payments of $4,582,500 in the initial twelve-month period andannual increases based on changes in the consumer price index thereafter. Thelease has an initial term of ten years with two consecutive five-year renewalterms exercisable at the Company’s option. The Company’s obligationsunder the lease are collateralized by, among other things, an interest in anyproperty improvements made by the Company and by a second position on therelated facilities’ accounts receivable. In conjunction with the lease, theCompany was granted a right of first refusal and an option to purchase thefacilities as a group, which option is exercisable at the end of the eighth yearof the initial term and at the conclusion of each renewal term. The purchaseoption is exercisable at the greater of the fair market value of the facilitiesat the time of exercise or Meditrust’s original investment. 

Effective January 1, 1996,a subsidiary of the Company entered into an agreement with Meditrust to leasesix long-term care facilities with a total of 537 licensed beds in NewHampshire. The lease agreement provides for annual rental payments of $2,324,000in the initial twelve-month period and annual rental increases based on changesin the consumer price index thereafter. The lease has an initial term of tenyears with two consecutive five-year renewal terms exercisable at theCompany’s option. The Company’s obligations under the lease arecollateralized by, among other things, an interest in any property improvementsmade by the Company and by a second position on the related facilities’accounts receivable. In conjunction with the lease, the Company was granted aright of first refusal and an option to purchase the facilities as a group,which is exercisable at the end of the eighth year of the initial term and atthe conclusion of each renewal term. The purchase option is exercisable at thegreater of 90% of the fair market value of the facilities at the time ofexercise or Meditrust’s original investment. In connection with this lease,the Company received a cash payment of $3,685,000 from Meditrust which wasrecorded as deferred income and is being amortized over the ten-year initiallease term as a reduction of rental expense. 

The Meditrust leasescontain cross-default and cross-collateralization provisions. A default by theCompany under one of these leases could adversely affect a significant number ofthe Company’s properties and result in a loss to the Company of suchproperties. In addition, the leases permit Meditrust to require the Company topurchase the facilities upon the occurrence of a default. 

Effective March 1, 1997,the Company entered into an agreement with a non-affiliated party to lease onelong-term care facility with 163 beds in Baltimore, Maryland for a period of tenyears. The lease agreement provides for fixed annual rental payments of $900,000for the first three years and annual increases based on changes in the consumerprice index thereafter. From July 1, 1999 through August 28, 2000, the Companyhas the option to acquire the facility for $10,000,000. After August 28, 2000,the purchase price escalates in accordance with a schedule. On the effectivedate of the lease, the Company paid $1,000,000 to the lessor in exchange for thepurchase option. This option payment is being amortized over the life of thelease. 

As of August 1, 1997, theCompany acquired four long-term care facilities with 401 beds in Massachusetts.The Company financed this acquisition through an operating lease with a realestate investment trust (the “REIT”). The lease provides for annualrental payments of $1,576,000 in the initial twelve-month period and annualincreases based on changes in the consumer price index thereafter. The lease hasan initial term of ten years with, at the Company’s option, eightconsecutive five-year renewal terms. In conjunction with the lease, the Companywas granted a right of first refusal and an option to purchase the facilities asa group, which option is exercisable at the end of the initial lease term and atthe conclusion of each renewal term. The purchase option is exercisable at thefair market value of the facilities at the time of exercise. 

On August 28, 1997, theCompany obtained a five-year synthetic leasing facility (the “LeasingFacility”) from the same group of banks that provided the “CreditFacility” (See Note H). The Company used $23,600,000 of the funds availablethrough the Leasing Facility to acquire three long-term care facilities with 341beds in Dayton, Ohio in September 1997. Acquisitions made through the LeasingFacility were accounted for financial reporting purposes as operating leaseswith an initial lease term which would have expired at the expiration date ofthe leasing facility. Annual rent for properties acquired through the LeasingFacility was determined based on the purchase price of the facilities acquired
34
and an interest rate factor which varied with the Company’s leverage ratio(as defined) and which was based on LIBOR, or at the Company’s option, theagent bank’s prime rate. 

As of December 1, 1997, theCompany acquired five long-term care facilities with 684 beds in Connecticut.The Company financed this acquisition through an operating lease from theseller. The lease provides for an initial annual rental payment of $7,491,000and, beginning in the third lease year, certain annual rent increases based onchanges in the consumer price index, but not to exceed $30,000 per year. Thelease has an initial term of ten years with, at the Company’s option, threeone-year extensions. In conjunction with the lease, the Company was granted anoption to purchase the facilities as a group at predetermined purchase pricesbetween eight and thirteen years post the lease commencement. 

On April 1, 1998, theCompany acquired two facilities with 248 beds in Ohio through the LeasingFacility, and on May 8, 1998 the Company acquired two facilities with 267 bedsin Rhode Island through the Leasing Facility. The Company used a total of$35,650,000 of funds available through the Leasing Facility to acquire thesefour facilities. 

In connection with theMerger on August 11, 1998, the Company exercised its rights to purchase allseven of the facilities it had acquired through the Leasing Facility for anaggregate amount equal to $59,250,000. 

On September 27, 2000, theCompany entered into an agreement with an affiliate of Investcorp S.A. to leasefour facilities with a total of 692 beds. The Company acquired these facilitiesin 1996 and operated these facilities under capital leases until September 27,2000 (See Note I). The new lease agreement provides for fixed annual rentalpayments of $5,850,000 in the initial twelve month-period and annual rentalincreases based on changes in the consumer price index thereafter. The lease hasan initial term of fifteen years with two consecutive five-year renewal termsexercisable at the Company’s option. In conjunction with the lease, theCompany was granted an option to purchase the facilities as a group, which isexercisable within the last nine months of the initial fifteen-year lease term.The purchase option is exercisable at the fair market value of the facilities atthe time of exercise. 

Under the terms of each ofthe facility leases described above, the Company is responsible for the paymentof all real estate and personal property taxes, as well as other reasonablecosts required to operate, maintain, insure and repair the facilities. 

Future minimum rentcommitments under the Company’s non-cancelable operating leases as ofDecember 31, 2000 are as follows: 
                                                 Real Estate         Equipment         Total                                                 -----------         ---------         -----                  2001                          $ 27,766,000       $1,403,000    $   29,169,000                  2002                            28,059,000          505,000        28,564,000                  2003                            27,911,000          167,000        28,078,000                  2004                            27,239,000                -        27,239,000                  2005                            25,797,000                -        25,797,000                  Thereafter                      75,404,000                -        75,404,000                                                ------------       ----------     -------------                                                $212,176,000       $2,075,000      $214,251,000                                                ============       ==========      ============
H. LONG-TERM DEBT

The Company has a mortgagepayable to Meditrust in the amount of $15,904,000 at December 31, 2000. TheMeditrust debt is cross-collateralized by the assets of four of theCompany’s facilities (the “Four Facilities”). The Meditrust debtbears interest at the annual rate of 10.65%. Additional interest payments arealso required 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 loan agreement with Meditrust places certainrestrictions on the Four Facilities; among them, the agreement restricts theirability to incur additional debt or to make significant dispositions of assets.The Four Facilities are also required to maintain a debt service coverage ratioof at least 1.2 to 1.0 (as defined in the loan agreement) and a current ratio ofat least 1.0 to 1.0. The Meditrust Loan agreement contains a prepayment penaltycalculated in accordance with a formula. 

A subsidiary of the Companyassumed a first mortgage note (the “Note”) with a remaining balance of$1,775,000 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. 

In April of 1997, theCompany obtained a three-year $25,000,000 revolving credit facility (the“Credit Facility”) from a commercial bank. On August 28, 1997, theCompany amended the Credit Facility to add additional banks as parties to theCredit Facility, extended the maturity to five years and made certain additionalamendments to the terms of the agreement. Borrowings under this facility werecollateralized by patient accounts receivable and certain real estate. Theassets which collateralized the Credit Facility also collateralized theCompany’s obligation under the Leasing Facility. The facility was scheduledto mature in September 2002 and provided for prime and LIBOR interest rateoptions which varied with the Company’s leverage ratio (as defined). 

On August 11, 1998, inconnection with the Merger, the Company entered into a new, six year$250,000,000 collateralized credit facility (the “New CreditFacility”). During the first four years of the New Credit Facility, up to$250,000,000 could be used in connection with synthetic lease financing.Proceeds of the loans could be used for working capital, capital expenditures,acquisitions and general corporate purposes. The New Credit Facility iscollateralized by substantially all of the Company’s patient accountsreceivable, certain real estate and a first or second priority interest in thecapital stock of certain of the Company’s subsidiaries. Interest is basedon either LIBOR or prime rates of interest (plus applicable margins), at theelection of the Company, and was 9.65% - 10.01% at December 31, 2000. The NewCredit Facility requires that the Company maintain an interest/rent coverageratio which varies by year, and limits aggregate borrowings under the New Credit
35
Facility to a predetermined multiple of EBITDA. The New Credit Facility containsa number of restrictive covenants that, among other things, restrict theCompany’s ability to incur additional indebtedness, prohibit thedisposition of certain assets, limit the Company’s ability to make capitalexpenditures in excess of pre-determined levels and limits the ability of theCompany to declare and pay certain dividends. 

During the first quarter of1999, the Company determined that it’s anticipated financial results forthat quarter would cause the Company to be out of compliance with certainfinancial covenants of the New Credit Facility. Accordingly, the Companyobtained an amendment (the “First Amendment”) to the New CreditFacility effective March 30, 1999 which limited borrowings under the New CreditFacility to an aggregate of $58,500,000 (exclusive of undrawn letters of creditoutstanding as of March 30, 1999) and which modified certain financialcovenants. In order to complete the Cleveland Facility leasing transaction (SeeNote I), the Company was required to obtain the release of certain collateralheld by the bank group which provides the New Credit Facility. The Companyobtained the release of the collateral as part of an amendment (the “SecondAmendment”) to the New Credit Facility, which also resulted in a permanentreduction of the Company’s maximum borrowings under the New Credit Facilityfrom $250 million to $150 million and an increase in the Company’sborrowing rate. As a result of the permanent reduction in funds availablethrough the New Credit Facility, the Company was required to write off aproportionate amount of the deferred financing costs incurred when the NewCredit Facility was obtained. 

On March 28, 2001, theCompany obtained an additional amendment (the “Third Amendment”) tothe New Credit Facility. The Third Amendment resulted in a permanent reductionof the Company’s maximum borrowings under the New Credit Facility from $150million to $60 million, revised certain financial covenants, changed thematurity date of the New Credit Facility to March 31, 2004 and increased theCompany’s borrowing rate. The Third Amendment also requires the Company torepay, on an annual basis, the greater of $5,000,000 or 50% of theCompany’s excess cash flow (as defined). As a result of the permanentreduction in funds available through the New Credit Facility, the Company willbe required to write off approximately $2.6 million of the deferred financingcosts incurred when the New Credit Facility was obtained. 

As of December 31, 2000,the Company had outstanding $32,750,000 in revolving loans and $13,700,000 insynthetic lease financings, and had $8,787,000 of remaining availability underthe New Credit Facility. 

In connection with theMerger on August 11, 1998, the Company issued $170,000,000 principal amount atmaturity (approximately $99,500,000 gross proceeds) of 11% Senior SubordinatedDiscount Notes Due 2008 (the “Discount Notes”). Each Discount Note wasissued with a principal amount at maturity of $1,000 and an original issue priceof $585.25. Interest on the Discount Notes accretes in accordance with apredetermined formula on a semi-annual basis on February 1, and August 1, ofeach year. Cash interest will not accrue on the Discount Notes until August 1,2003. Thereafter, interest on the Discount Notes will be paid semi-annually inarrears in cash on February 1 and August 1, of each year commencing February 1,2004. The Discount Notes will be redeemable in whole or in part, at the optionof the Company on or after August 1, 2003 based on a predetermined redemptionschedule which begins on August 1, 2003 at 105.5% and which declinesincrementally to 100% on August 1, 2006. In addition, the Company may redeem upto 35% of the aggregate outstanding accreted value of the Discount Notes at aredemption price of 111% of accreted value at any time prior to August 1, 2001with the proceeds of a public offering of common stock, provided that theredemption occurs within 60 days of the closing of the public offering and thatat least 65% of the aggregate principal amount of the Discount Notes remainsoutstanding immediately after such redemption. At any time on or prior to August1, 2003, the Discount Notes may be redeemed in whole but not in part at theoption of the Company upon the occurrence of a Change of Control (as defined) inaccordance with the prescribed procedures and the payment of any ApplicablePremium (as defined). The Discount Notes must be redeemed in whole on August 1,2008.(See Note S. Proposed Restructuring of Discount Notes and Preferred Stock.)

Upon any voluntary orinvoluntary liquidation of the Company, holders of the Discount 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 debt evidenced by the Discount Notes is unsecured, subordinate toexisting and future senior debt of the Company, but senior in right with allexisting and future subordinated debt of the Company. Certain of thesubsidiaries of the Company have jointly and severally guaranteed theCompany’s payment obligations (subject to maximum amounts per subsidiary)under the Discount Notes (See Note Q). Each Discount Note guaranteed by suchsubsidiary is subordinated to any Senior Debt of such guarantor. The Companyderives substantially all of its income from operations through its subsidiariesand consequently, the Discount Notes are effectively subordinated to thepotential claims of creditors of all of the subsidiaries of the Companyirrespective of subsidiary guarantees. The Discount Notes also contain certainrestrictive covenants which limit the ability of the Company to incur debt,issue preferred stock, merge or dispose of substantially all of its assets. 

In March 2001, the Companyentered into an agreement with Investcorp S.A. and, the holders of more than amajority in interest of the Company’s Discount Notes and Preferred Stockfor purposes of implementing a restructuring of the Discount Notes and thePreferred Stock. (See Note S.) 

Interest expense charged tooperations for the years ended December 31, 1998, 1999 and 2000 was $12,447,000,$21,678,000 and $23,007,000, respectively. 

As of December 31, 1999 and 2000, the Company's long-term debt, excluding the current portion, consisted of thefollowing:
                                                 1999           2000Senior subordinated discount notes           $ 115,847,000  $ 128,942,000Mortgages payable                               17,421,000     17,174,000Credit facility                                 32,750,000     27,750,000                                             -------------  -------------                                             $ 166,018,000  $ 173,866,000                                             =============  =============36
As of December 31, 2000,future long-term debt maturities associated with the Company’s debt are asfollows: 
           2001             $  5,250,000           2002                5,272,000           2003                5,303,000           2004               32,910,000           2005                   20,000           Thereafter        130,361,000                            ------------                            $179,116,000                            ============
Substantially all of theCompany’s assets are subject to liens under long-term debt or operatinglease agreements. 

I.  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 (SeeNote P), the Company’s consolidated net worth as of September 30, 1999 (ascalculated for purposes of this requirement) had fallen below the requiredlevel. The Company anticipated that its net worth would continue to be below therequired level at December 31, 1999, which would have resulted in an event ofdefault under each of these leases with the Company potentially facing the lossof these operations. Such default could also have triggered cross-defaults underthe Company’s other lease and debt obligations. In December 1999, theCompany paid $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 bank 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. The Company obtained therelease of the collateral as part of an amendment to the Company’s 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 borrowings 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 

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 of continuous service areeligible to participate in the plan. The plan is subject to the provisions ofthe Employee Retirement Income Security Act of 1974. Employee contributions tothis plan may be matched at the discretion of the Company. The Companycontributed $475,000 and $298,000 to the plan in 1998 and 2000. There were nocontributions made to the plan in 1999. 

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. 

K. INCOME TAXES

As required by SFAS No.109, the Company annually evaluates the positive and negative evidence bearingupon the realizability of its deferred tax assets. The Company has consideredthe recent and historical results of operations and concluded, in accordancewith the applicable accounting methods that it is more likely than not that acertain portion of the deferred tax assets will not be realizable. To the extentthat an asset will not be realizable, a valuation allowance is established. Thetax effects of temporary differences giving rise to deferred tax assets as ofDecember 31, 1999 and 2000 are as follows: 
                                                           1999            2000                                                                ----            ----Deferred tax assets:     Reserves                                               $ 2,288,000    $    725,000     Rental payments                                            770,000         752,000     Interest payments                                        6,007,000      12,076,000     Net operating loss carryforwards                         5,778,000      10,404,000     Other                                                       23,000         118,000     Valuation allowance                                       (614,000)    (24,075,000)                                                            -----------    ------------     Total deferred tax assets                              $14,252,000    $          -                                                            ===========    ============37
Significant components of the provision (benefit) for income taxes for the years ended December 31, 1998, 1999 and2000 are as follows:
                                                 1998           1999            2000                                                 ----           ----            ----Current:     Federal                             $   (781,000)   $  (2,784,000)               -     State                                   (146,000)         418,000     $     70,000                                         ------------    -------------     ------------Total current                                (927,000)      (2,366,000)          70,000                                         ------------    -------------     ------------Deferred:     Federal                               (3,447,000)      (6,277,000)      11,596,000     State                                   (646,000)      (1,661,000)       2,656,000                                         -------------   -------------     ------------Total deferred                             (4,093,000)      (7,938,000)      14,252,000                                         -------------   -------------     ------------Total income tax expense (benefit)       $ (5,020,000)   $ (10,304,000)    $ 14,322,000                                         =============   =============     ============
The reconciliation of income tax computed at statutory rates to income tax (benefit) for the years ended December31, 1998, 1999 and 2000 are as follows:
                                                   1998                       1999                 2000                                                   ----                       ----                 ----Statutory rate                             $(10,222,000) (35.0)%  $  (9,767,000) (35.0)% $  (7,834,000) (35.0)%State income tax, net of federal benefit       (515,000)  (1.8)        (808,000)  (2.9)     (1,765,000)  (7.9)Permanent differences                            59,000    0.2           41,000    0.2         198,000    0.9Change in valuation allowance                         -      -               -      -       23,461,000  104.8Net operating loss - rate differential        5,658,000   19.4          230,000    0.8          90,000    0.4Other                                                 -      -               -      -          172,000    0.8                                           ------------  ------    ------------  ------   ------------- -------                                           $ (5,020,000) (17.2)%   $(10,304,000) (36.9)%  $  14,322,000  64.0%                                           ============  =======   ============  =======  ============= =======
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 (the “PreferredStock”) and 19,000,000 shares (comprised of five classes) of common stock,each with a par value of $.01 per share, consisting of Harborside Class A CommonStock, Harborside Class B Common Stock, Harborside Class C Common Stock,Harborside Class D Common Stock and Common Stock (collectively “HarborsideCommon Stock”). 

The numbers of shares ofHarborside Common Stock authorized and outstanding as of December 31, 1999 and2000 are as follows: 
                                     1999 and 2000             1999                 2000Title                              Authorized Shares    Outstanding Shares   Outstanding Shares---------                          -----------------    ------------------   ------------------Harborside Class A Common Stock        1,200,000              661,332             661,332Harborside Class B Common Stock        6,700,000            5,940,000           5,940,000Harborside Class C Common Stock        1,580,000              640,000           1,304,500Harborside Class D Common Stock           20,000               20,000              20,000Common Stock                           9,500,000                    -                  -                                      ----------           ----------          ----------Total                                 19,000,000            7,261,332           7,925,832                                      ==========           ==========          ==========
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.This number of votes per share results in holders of Harborside Class D CommonStock, as of December 31, 2000, being entitled in the aggregate to a number ofvotes equal to the total number of outstanding shares of Harborside Class BCommon Stock, Harborside Class C Common Stock and Harborside Class D CommonStock as of December 31, 2000. Holders of Harborside Class B Common Stock orHarborside Class C Common Stock will not have any voting rights, except that theholders of the Harborside Class B Common Stock and Harborside Class C CommonStock will have the right to vote as a class to the extent required under thelaws of the State of Delaware. 

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. 
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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, 2000, 73,167 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 13.5%Exchangeable Preferred Stock (the “Preferred Stock”). The holders ofthe Preferred Stock are entitled to receive quarterly dividend payments inarrears beginning November 1, 1998. Dividends are payable in cash or inadditional shares of Preferred Stock, at the option of the Company, until August1, 2003. After August 1, 2003, dividends may be paid only in cash. During theyears ended December 31, 1999 and 2000, all dividends except for fractionalshares amounting to $20,000 and $18,000, respectively, were paid in additionalshares. The Preferred Stock may be redeemed for cash by the Company, in whole orin part, at the option of the Company, in accordance with a predeterminedredemption premium schedule which begins on August 1, 2003 at 106.75% of theliquidation preference of the Preferred Stock at the date of redemption andwhich declines to 100% on August 1, 2006. In addition, at any time prior toAugust 1, 2001 the Company may redeem up to 35% of the Preferred Stock at aredemption price equal to 113.5% of the liquidation preference of the PreferredStock at the date of redemption with the proceeds of a public offering of commonstock, provided that the redemption occurs within 60 days of the closing of suchoffering. At any time prior to August 1, 2003, the Preferred Stock may beredeemed by the Company, in whole but not in part, upon the occurrence of achange in control (as defined) and in accordance with prescribed procedures andthe payment of a premium based upon a formula. The Preferred Stock isexchangeable in whole but not in part, on any dividend date, at the option ofthe Company, into 13.5% Exchange Debentures due in 2010 subject to such exchangebeing permitted by (1) the terms of the Indenture and (2) the terms of theCompany’s Credit Facility. The Company is required to redeem the PreferredStock in whole on August 1, 2010. 

Upon any voluntary orinvoluntary liquidation of the Company, holders of the Preferred Stock will beentitled 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 Preferred Stock have no voting rights except thoseprovided by law and as set forth in the Certificate of Designation (the“Certificate”). The Certificate provides that if the Company fails tomeet certain obligations associated with the Preferred Stock, then the Board ofDirectors shall be adjusted to allow the holders of a majority of the thenoutstanding Preferred Stock, voting separately as a class, to elect twodirectors. Voting rights associated with the failure to meet Preferred Stockobligations will continue until either the obligation is satisfied or a majorityof the holders of the then outstanding Preferred Stock waive the satisfaction ofthe obligation. The Certificate also contains certain restrictive covenants thatlimit the Company’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. 

As of December 31, 2000,Preferred Stock dividends accrete based on the following schedule: 
     2001       $ 7,825,000     2002         8,936,000     2003         5,778,000                -----------                $22,539,000                ===========
In March 2001, the Companyentered into an agreement with Investcorp S.A. and, the holders of more than amajority in interest of the Company’s Discount Notes and Preferred Stockfor purposes of implementing a restructuring of the Discount Notes and thePreferred Stock. (See Note S.) 

Loss per Common Share Computation

Basic loss per common shareis computed by dividing net loss less Preferred Stock dividends by the weightedaverage number of common shares outstanding. The computation of diluted loss pershare is similar to that of basic 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. 
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The following table setsforth the computation of basic and diluted earnings (loss) per common share forthe years ended December 31, 1998, 1999 and 2000: 
                                                                1998            1999             2000                                                                ----            ----             ----Numerator:     Net loss                                            $  (24,187,000)   $ (17,601,000)    $ (36,706,000)     Preferred Stock dividends                               (2,296,000)      (6,004,000)       (6,853,000)                                                         --------------    -------------     -------------     Loss available for common shares                    $  (26,483,000)   $ (23,605,000)    $ (43,559,000)                                                         ==============    =============     =============Denominator:Weighted average shares outstanding                           7,742,000        7,261,000         7,432,000     Adjustment for nonvested Restricted Shares                       -                -          (171,000)                                                           ------------     ------------       -----------     Denominator for basic and diluted     loss per common share - Adjusted weighted     - average shares and assumed conversions                 7,742,000        7,261,000         7,261,000                                                             ==========       ==========        ==========     Basic and diluted loss per common share                $    (3.42)       $   (3.25)         $  (6.00)
At December 31, 1999,options to purchase 637,226 shares of common stock were not included in thecomputation of diluted loss per share because to do so would have beenantidilutive. At December 31, 2000, options to purchase 109,944 shares of commonstock and 664,500 Restricted Shares were not included in the computation ofdiluted loss per share because to do so would have been antidilutive. 

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-employeedirectors 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. The Company recognized a compensation charge of $8,011,066 inconnection with the exercise of these options into cash. This charge wasincluded as part of the Merger Costs recorded by the Company in 1998 (See NoteB). 

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. Options will expire on the date determinedby the Board of Directors, which will not be later than 30 days after theseventh anniversary of the grant date. Optionees will have certain rights to putto the Company, and the Company will have certain rights to call from theoptionee, vested stock options upon termination of the optionee’semployment with the Company prior to an initial public offering. All optionsgranted under the Stock Option Plan during 1998 were granted with an exerciseprice equal to $25.00, equal to the fair market value of the stock on the dateof grant. Options granted under the Stock Option Plan during 1998 were to vestat the 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. A maximum of 806,815shares have been reserved for issuance 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, 1998         675,499      $   8.15 - $25.00          $23.06---------------------------------------------------------------------------------------Cancelled                            (38,273)     $  25.00                   $25.00Balance at December 31, 1999         637,226      $   8.15 - $25.00          $22.94---------------------------------------------------------------------------------------Cancelled                           (527,232)     $  25.00                   $25.00=======================================================================================Balance at December 31, 2000         109,994      $   8.15 - $21.69          $13.07=======================================================================================
As of December 31, 1998,1999 and 2000, there were 109,994 exercisable options at a weighted-averageexercise price of $13.07. 
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In 1996, the Companyadopted SFAS No. 123, “Accounting for Stock-Based Compensation.” SFASNo. 123 requires that companies either recognize compensation expense for grantsof stock, 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 No. 123, and has applied Accounting Principles Board Opinion No. 25 andrelated interpretations in accounting for its plans. Accordingly, nocompensation cost has been recognized for its stock option plans. Hadcompensation cost for the Company’s stock-based compensation plans beendetermined based on the fair value at the grant dates as calculated inaccordance with SFAS No. 123, the Company’s unaudited pro forma net incomeand pro forma net income per share for the years ended December 31, 1997, 1998and 1999 would have been reduced to the amounts indicated below: 
                       1998            1998            1999           1999            2000           2000                       ----            ----            ----           ----            ----           ----                                   Loss                            Loss                             Loss                   Loss            Available      Loss             Available       Loss             Available                   Available for   Per Common     Available for    Per Common      Available for    Per Common                   Common Shares   Share Diluted  Common Shares    Share Diluted   Common Shares    Share Diluted                   -------------   -------------  -------------    -------------   -------------    -------------      AsReported            $(26,483,000)    $   (3.42)     $(23,605,000)    $(3.25)       $(43,559,000)    $(6.00)     Pro   Forma            $(29,300,000)    $   (3.78)     $(24,027,000)    $(3.31)       $(43,559,000)    $(6.00)
The weighted average fairvalue of options granted was $6.28 during 1998. 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 5.4% for 1998 .Expected volatility of 0% (except for 109,994 in options held by seniormanagement; such options have an assumed volatility of 40%) was assumed for theyear ended December 31, 1998. 

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 but not reported at the end of each year. 

The Company self-insuresfor most workers’ compensation claims. The Company maintains stop-lossinsurance such that the Company’s liability for losses is limited. TheCompany accrues for estimated workers’ compensation claims incurred but notreported at the end of each year. 

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 $6,400,000 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 Partnership agreement states thateach partner will contribute an amount in respect of any liability incurred by apartner in connection with a guarantee of the partnership’s debt, so thatpartners each bear their proportionate share of any liability based on theirpercentage 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, 1999 and 2000, 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, 2000, thefair market value of the Company’s Senior Subordinated Debt wasapproximately $35,700,000. The book value of the Company’s SeniorSubordinated Debt was $128,941,000. The Company estimates that the fair value ofits remaining fixed rate debt approximates its carrying amount. 
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O. RELATED PARTY TRANSACTIONS

Until December 31, 1998, aformer affiliate of the Company provided office space, legal, tax, dataprocessing and other administrative services to the Company in return for amonthly fee. Total service charges under this arrangement were $1,291,000, forthe year ended December 31, 1998. During 1999, the former affiliate providedonly data processing and tax services to the Company. During 2000, the formeraffiliate provided only data processing services to the Company. Total servicecharges under this arrangement were $1,291,000, $1,173,000 and $1,083,000, forthe years ended December 31, 1998, 1999 and 2000, 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 31,1998, 1999 and 2000 was $500,000, $1,200,000 and $1,200,000, respectively. As ofDecember 31, 2000, $1,200,000 of the unamortized fee is classified in“Prepaid and other expenses” while $1,900,000 is classified as“Other assets, net”. 

In December 1999, anaffiliate of Investcorp S.A., provided the Company with $5,000,000 in financingunder a credit agreement. The funds were provided for purposes of making anacquisition deposit on certain facilities currently financed through a capitallease (See Note I). The loan was repaid during the third quarter of 2000. 

As of December 31, 1999 and 2000, the net receivable due from Bowie, L.P. was approximately $2.6 million and $0.2million, respectively.

P. RESTRUCTURING COSTS

During the third quarter of1999, the Company terminated its contracts to provide rehabilitation therapyservices to non-affiliated long-term care facilities. The Company, through awholly-owned subsidiary, had provided physical, speech and occupational servicesto non-affiliated skilled nursing facilities since 1995. Significant changes inthe contract therapy business, primarily related to reductions in Medicarereimbursement for therapy services caused by the Balanced Budget Act of 1997 ledto this decision. The Company continues to provide rehabilitation therapyservices to nursing facilities which it owns. 

The Company’s therapyservices restructuring plan required the termination of approximately sixtyrehabilitation therapy services employees and the closure of two regionaloffices. During the third quarter of 1999, the Company recorded restructuringcharges of approximately $5.7 million under this plan, most of which werenon-cash in nature. The restructuring charge consisted of approximately $2.5million of uncollectible accounts receivable, $1.5 million of unamortizedgoodwill, $0.7 million of employee costs and $1.0 million due to the write-offof other assets. As of December 31, 2000, the Company’s restructuringreserve was fully utilized. 

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 ToledoLimited Partnership, Harborside Connecticut Limited Partnership, Harborside ofFlorida Limited Partnership, Harborside of Ohio Limited Partnership, HarborsideHealthcare Baltimore Limited Partnership, Harborside of Cleveland LimitedPartnership, Harborside of Dayton Limited Partnership, Harborside MassachusettsLimited Partnership, Harborside of Rhode Island Limited Partnership, HarborsideNorth Toledo Limited Partnership, Harborside Healthcare Advisors LimitedPartnership, Harborside Toledo Corp., KHI Corporation, Harborside DanburyLimited Partnership, Harborside Acquisition Limited Partnership V, HarborsideAcquisition Limited Partnership VI, Harborside Acquisition Limited PartnershipVII, Harborside Acquisition Limited Partnership VIII, Harborside AcquisitionLimited Partnership IX, Harborside Acquisition Limited Partnership X, Sailors,Inc., New Jersey Harborside Corp., Bridgewater Assisted Living LimitedPartnership, Maryland Harborside Corp., Harborside Homecare Limited Partnership,Harborside Rehabilitation Limited Partnership, Harborside Healthcare NetworkLimited Partnership and Harborside Health I Corporation. 

The information whichfollows presents the condensed consolidating financial position as of December31, 1999 and 2000; the condensed consolidating results of operations for theyears ended December 31, 1998, 1999 and 2000; and the condensed consolidatingcash flows for the years ended December 31, 1998, 1999 and 2000 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. 
42 Q. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                        Condensed Consolidating Balance Sheet                                                As of December 31,1999                                                (dollars in thousands)                                                     Parent      Guarantors   Non-Guarantors   Elimination    Consolidated                                                   ---------      ---------      ---------      ---------      ---------ASSETSCurrent assets:   Cash and cash equivalents ...................   $     --       $      355      $   1,031     $     --       $    1,386   Accounts receivable, net of allowance .......         --           34,423         15,745           --           50,168   Intercompany receivable .....................      150,195           --             --         (150,195)          --   Prepaid expenses and other ..................        3,590         14,096          2,254           --           19,940   Prepaid income taxes ........................        2,608           --             --             --            2,608   Deferred income taxes .......................        2,150            250           --             --            2,400                                                   ----------      ---------      ---------      ---------      ---------Total current assets ...........................      158,543         49,124         19,030       (150,195)        76,502Restricted cash ................................         --            1,826            594           --            2,420Investments in limited partnerships ............       15,584           --            4,044        (19,628)          --Property and equipment, net ....................         --          146,976         19,350           --          166,326Deferred financing and other non-current assets, net .......................       10,749          3,416          1,381           --           15,546Other assets, net ..............................        3,100           --             --             --            3,100Note receivable ................................         --            7,487           --             --            7,487Deferred income taxes ..........................           71         11,781           --             --           11,852                                                    ---------      ---------      ---------      ---------      ---------Total assets ...................................    $ 188,047      $ 220,610      $  44,399      $(169,823)     $ 283,233                                                    =========      =========      =========      =========      =========LIABILITIESCurrent liabilities:   Current maturities of long-term debt.........    $    --        $      22      $     205      $    --        $     227   Current portion of capital lease     obligation ................................         --            4,633           --             --            4,633   Note payable to affiliate ...................        5,000           --             --             --            5,000   Accounts payable ............................         --            6,879          2,449           --            9,328   Intercompany payable ........................         --          122,092         11,766       (133,858)          --   Employee compensation and benefits ..........         --           10,687          3,334           --           14,021   Other accrued liabilities ...................         --            4,663            845           --            5,508   Accrued interest ............................          572           --             --             --              572   Current portion of deferred income ..........         --             --             --              677            677                                                    ---------      ---------      ---------      ---------      ---------Total current liabilities ......................        5,572        148,976         18,599       (133,181)        39,966Long-term portion of deferred income ...........         --              893          2,211           (677)         2,427Long-term debt .................................      148,594          1,520         15,904           --          166,018Long-term  portion of capital lease obligation .         --           50,067           --             --           50,067                                                    ---------      ---------      ---------      ---------      ---------Total liabilities ..............................      154,166        201,456         36,714       (133,858)       258,478                                                    ---------      ---------      ---------      ---------      ---------Exchangeable preferred stock, redeemable, $.01 par value with a liquidation value of $1,000 per share; 500,000 shares authorized; 48,277 issued and outstanding .................       48,277           --             --             --           48,277                                                    ---------      ---------      ---------      ---------      ---------STOCKHOLDERS' EQUITY (DEFICIT)Common stock, $.01 par value, 19,000,000  shares authorized, 14,611,164 shares issued...          146          2,569          3,885         (6,454)           146Additional paid-in capital .....................      198,377           --             --              226        198,603Less common stock in treasury,at cost, 7,349,832..............................     (183,746)          --             --             --         (183,746)Retained earnings (accumulated deficit).........      (29,173)        (8,170)        (3,274)         2,092        (38,525)Partners' equity ...............................         --           24,755          7,074        (31,829)          --                                                    ---------      ---------      ---------      ---------      ---------Total stockholders' equity (deficit) ...........      (14,396)        19,154          7,685        (35,965)       (23,522)                                                    ---------      ---------      ---------      ---------      ---------Total liabilities and stockholders'equity (deficit) ...............................    $ 188,047      $ 220,610      $  44,399      $(169,823)     $ 283,233                                                    =========      =========      =========      =========      =========43 Q. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                        Condensed Consolidating Balance Sheet                                               As of December 31, 2000                                                (dollars in thousands)                                                       Parent      Guarantors    Non-Guarantors    Elimination  Consolidated                                                     ---------      ---------    ---------------   ---------    ------------ASSETSCurrent assets:   Cash and cash equivalents ...................    $     --       $    9,317     $    1,407       $   --        $  10,724   Accounts receivable, net of allowance .......          --           33,111         15,548           --           48,659   Intercompany receivable .....................       146,953           --             --         (146,953)          --   Prepaid expenses and other ..................         3,128          8,403          1,649           --           13,180                                                    ----------     ----------     ----------       --------      ---------Total current assets ...........................       150,081         50,831         18,604       (146,953)        72,563Restricted cash ................................          --            4,116            689           --            4,805Investments in limited partnerships ............        15,584           --            4,044        (19,628)          --Property and equipment, net ....................          --           85,719         19,370           --          105,089Deferred financing and other non-current assets, net .......................         7,109          3,001          1,143           --           11,253Other assets, net ..............................         1,900           --             --             --            1,900Note receivable ................................          --            7,487           --             --            7,487                                                    ----------      ---------      ---------      ---------      ---------Total assets ...................................    $  174,674      $ 151,154      $  43,850      $(166,581)     $ 203,097                                                    ==========      =========      =========      =========      =========LIABILITIESCurrent liabilities:   Current maturities of long-term debt ........    $    5,000      $      22      $     228      $    --        $   5,250   Accounts payable ............................          --            8,331          2,552           --           10,883   Intercompany payable ........................          --          119,147         11,543       (130,690)          --   Employee compensation and benefits ..........          --           12,293          3,572           --           15,865   Other accrued liabilities ...................          --            5,364            937           --            6,301   Accrued interest ............................           470           --             --             --              470   Current portion of deferred income ..........          --             --             --              514            514                                                    ----------       --------       --------       ---------      ---------Total current liabilities ......................         5,470        145,157         18,832       (130,176)        39,283Long-term portion of deferred income ...........          --              582          1,842           (514)         1,910Long-term debt .................................       156,692          1,498         15,676           --          173,866                                                    ----------       --------       --------       ---------      --------Total liabilities ..............................       162,162        147,237         36,350       (130,690)       215,059                                                    ----------       --------       --------       ---------      --------Exchangeable preferred stock, redeemable, $.01 par value with a liquidation value of $1,000 per share; 500,000 shares authorized; 55,112 issued and outstanding .................        55,112           --             --             --           55,112                                                    ----------       --------       --------       --------        -------STOCKHOLDERS' EQUITY (DEFICIT)Common stock, $.01 par value, 19,000,000shares authorized, 15,275,664 shares issued.....           153          2,569          3,885         (6,454)           153Additional paid-in capital .....................       191,524           --             --              226        191,750Less common stock in treasury,at cost, 7,349,832 shares.......................      (183,746)          --             --             --         (183,746)Retained earnings (accumulated deficit).........       (50,531)       (23,407)        (3,459)         2,166        (75,231)Partners' equity ...............................          --           24,755          7,074        (31,829)          --                                                     ---------      ---------       --------       --------      ---------Total stockholders' equity (deficit) ...........       (42,600)         3,917          7,500        (35,891)       (67,074)                                                     ---------      ---------       --------       --------      ---------Total liabilities and stockholders'equity (deficit) ...............................     $ 174,674      $ 151,154      $  43,850      $(166,581)     $ 203,097                                                     =========      =========      =========      =========      =========44Q. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                   Condensed Consolidating Statement of Operations                                         For the year ended December 31, 1998                                                (dollars in thousands)                                                           Parent     Guarantors   Non-Guarantors   Elimination    Consolidated                                                         ---------      ---------      ---------     ---------      ---------Total net revenues .................................     $    --        $ 234,672      $ 104,280     $ (27,908)     $ 311,044                                                         ---------      ---------      ---------     ---------      ---------Expenses:   Facility operating ..............................          --          187,849         86,059       (27,908)       246,000   General and administrative ......................           150         15,272           --            --           15,422   Service charges paid to former affiliate ........          --            1,291           --            --            1,291   Amortization of prepaid management fee ..........           500           --             --            --              500   Depreciation and amortization ...................           624          4,150          1,576          --            6,350   Facility rent ...................................          --           14,110          8,302          --           22,412   Merger costs ....................................        27,047          9,874            251          --           37,172   Management fees paid to affiliates ..............          --           (6,203)         6,203          --             --                                                         ---------      ---------      ---------     ---------      ---------Total expenses .....................................        28,321        226,343        102,391       (27,908)       329,147                                                         ---------      ---------      ---------     ---------      ---------Income (loss) from  operations .....................       (28,321)         8,329          1,889          --          (18,103)Other:   Interest expense, net ...........................         2,015          7,687          1,569          --           11,271   Other income ....................................          --             --             --            (167)          (167)                                                         ---------      ---------      ---------     ---------      ---------Income (loss) before income taxes ..................       (30,336)           642            320           167        (29,207)Income tax expense (benefit) .......................        (5,101)           250            223          (392)        (5,020)                                                         ---------      ---------      ---------     ---------      ---------Net income (loss) ..................................     $ (25,235)     $     392      $      97     $     559      $ (24,187)                                                         =========      =========      =========     =========      =========                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                   Condensed Consolidating Statement of Operations                                         For the year ended December 31, 1999                                                (dollars in thousands)                                                           Parent      Guarantors     Non-Guarantors Elimination    Consolidated                                                         ---------      ---------      ---------      ---------      ---------Total net revenues .................................     $      24      $ 217,818      $  96,498      $ (13,725)     $ 300,615                                                         ---------      ---------      ---------      ---------      ---------Expenses:   Facility operating ..............................          --          181,995         80,525        (13,725)       248,795   General and administrative ......................            65         17,743           --             --           17,808   Service charges paid to former affiliate ........          --            1,173           --             --            1,173   Amortization of prepaid management fee ..........         1,200           --             --             --            1,200   Depreciation and amortization ...................         1,718          6,720          1,811           --           10,249   Facility rent ...................................          --           13,890          8,504           --           22,394   Restructuring costs .............................          --            5,745           --             --            5,745   Management fees paid to affiliates ..............          --           (5,757)         5,757           --             --                                                         ---------      ---------      ---------      ---------      ---------Total expenses .....................................         2,983        221,509         96,597        (13,725)       307,364                                                         ---------      ---------      ---------      ---------      ---------Loss from  operations ..............................        (2,959)        (3,691)           (99)          --           (6,749)Other:   Interest expense, net ...........................         2,945         16,241          1,709           --           20,895   Other expense ...................................          --             --             --              261            261                                                         ---------      ---------      ---------      ---------      ---------Loss before income taxes ...........................        (5,904)       (19,932)        (1,808)          (261)       (27,905)Income tax benefit .................................        (2,303)        (7,195)          (704)          (102)       (10,304)                                                         ---------      ---------      ---------      ---------      ---------Net loss ...........................................     $  (3,601)     $ (12,737)     $  (1,104)     $    (159)     $ (17,601)                                                         =========      =========      =========      =========      =========45Q. 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           --           21,675   Other 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)                                                         =========      =========      =========      =========      =========46Q. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                   Condensed Consolidating Statement of Cash Flows                                         For the year ended December 31, 1998                                                (dollars in thousands)                                                             Parent      Guarantors   Non-Guarantors   Elimination    Consolidated                                                           ---------     -----------     ---------      ---------      ---------Operating activities:Net cash provided (used) by operating activities ......  $ (110,038)     $  77,121      $  (3,033)     $  (3,497)     $ (39,447)                                                         ----------      ---------      ---------      ---------      ---------Investing activities:     Additions to property and equipment ..............      --            (68,817)        (2,591)         2,803        (68,605)     Additions to deferred financing and      other non-current assets ........................      (4,885)        (8,613)             4            --         (13,494)     Transfers to restricted cash, net ................      --                212          2,529            694          3,435                                                          ---------      ---------      ---------       --------      ---------Net cash  provided (used) by investing activities .....      (4,885)       (77,218)           (58)         3,497        (78,664)                                                          ---------      ---------      ---------       --------      ---------Financing activities:         Borrowings under the revolving line of             credit ...................................         --          17,150           --             --           17,150         Repaid on revolving line of credit ...........         --         (20,000)          --             --          (20,000)     Payment of long-term debt ........................         --            (357)           166           --             (191)     Proceeds from issuance of senior      subordinated discount notes .....................      99,493           --             --             --           99,493         Proceeds from issuance of exchangeable          preferred stock .............................      40,000           --             --             --           40,000     Purchase of treasury stock .......................    (183,746)          --             --             --         (183,746)     Proceeds from sale of common stock ...............     158,500           --             --             --          158,500     Principal payments of capital lease obligation ...         --          (3,939)          --             --           (3,939)     Receipt of cash in connection with lease .........         --           2,964           --             --            2,964     Exercise of stock options ........................          29           --             --             --               29                                                          ---------       ---------      --------       ---------      --------Net cash provided (used) by financing activities ......     114,276         (4,182)           166           --          110,260                                                          ---------       ---------      --------       ---------      --------Net decrease in cash and cash equivalents .............        (647)        (4,279)        (2,925)          --           (7,851)Cash and cash equivalents, beginning of year ..........         698          4,378          3,671           --            8,747                                                          ---------       ---------      --------       ---------      --------Cash and cash equivalents, end of year ................   $      51       $     99       $    746       $   --         $    896                                                          =========       =========      ========       =========      ========Supplemental Disclosure:Interest paid .........................................   $     650       $   2,480      $    506       $    --        $  3,636                                                          =========       =========      =========      =========      ========Income taxes paid .....................................   $   3,047       $     --       $    --        $     -        $  3,047                                                          =========       =========      =========      =========      ========Accretion of preferred dividends ......................   $   2,293       $     --       $    --        $     --       $  2,293                                                          =========       =========      =========      =========      ========47Q. CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)                                  HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES                                   Condensed Consolidating Statement of Cash Flows                                         For the year ended December 31, 1999                                                (dollars in thousands)                                                           Parent        Guarantors   Non-Guarantors   Elimination   Consolidated                                                          --------        --------    --------------   -----------   ------------Operating activities:Net cash provided (used) by operating activities .......  $(23,096)       $ 19,958      $  2,892       $    998        $    752                                                          ---------       --------      --------       --------        --------Investing activities:Additions to property and equipment ....................      --           (10,435)       (2,288)          (474)       (13,197)Additions to deferred financing and      other non-current assets .........................    (1,935)           (308)          (12)           --          (2,255)Payment of purchase deposit ............................      --            (5,000)         --              --          (5,000)     Transfers to (from) restricted cash, net ..........      --               336          (122)          (524)          (310)                                                          ---------       --------      --------       --------        --------Net cash  used by investing activities .................    (1,935)        (15,407)       (2,422)          (998)       (20,762)                                                          ---------       --------      --------       --------        --------Financing activities:Borrowings under the revolving line ofcredit .................................................    20,000            --            --             --           20,000Issuance of note payable to affiliate ..................     5,000            --            --             --            5,000Payment of long-term debt ..............................      --              (21)         (185)           --             (206)Principal payments of capital lease obligation .........      --           (4,274)          --             --           (4,274)Dividends paid on exchangeable preferred stock .........      (20)            --            --             --              --                                                          ---------       -------       -------        --------        -------Net cash provided (used) by financing activities .......    24,980         (4,295)         (185)           --           20,500                                                          ---------       -------       -------        --------        -------Net increase (decrease) in cash and cash equivalents ...       (51)           256           285            --              490Cash and cash equivalents, beginning of year ...........        51             99           746            --              896                                                          --------        -------      --------        --------        -------Cash and cash equivalents, end of year .................  $    --         $   355      $  1,031        $    --         $ 1,386                                                          =========       =======      ========        ========        =======Supplemental Disclosure:Interest paid ..........................................  $    834       $  4,594      $    483        $    --         $ 5,911                                                          =========      ========      ========        ========        =======Income taxes paid ......................................  $    243       $   --        $   --          $    --         $   243                                                          =========      ========      ========        ========        =======Accretion of preferred dividends .......................  $  5,984       $   --        $   --          $    --         $ 5,984                                                          =========      ========      ========        ========        =======48Q. 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                                                         ========        ========      =========      ========      ========49 R.  SUMMARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED)The Company's unaudited quarterly financial information follows:                                             Year Ended December 31, 1998                                             ----------------------------                                     First              Second              Third            Fourth                                    Quarter             Quarter            Quarter          Quarter         Total                                    -------             -------            -------          --------        -----Total net revenues            $   72,454,000      $   76,186,000       $  78,697,000    $  83,707,000  $ 311,044,000Income (loss) from operations      4,754,000           4,869,000        (32,786,000)        5,060,000    (18,103,000)Income (loss) before income taxes                      3,073,000           3,276,000        (36,360,000)          804,000    (29,207,000)Income taxes (benefit)             1,198,000           1,278,000         (7,460,000)         (36,000)     (5,020,000)Net income (loss)                  1,875,000           1,998,000        (28,900,000)          840,000    (24,187,000)Preferred stock dividends                  -                   -           (915,000)      (1,381,000)     (2,296,000)Earnings (loss) available forcommon shares                      1,875,000           1,998,000        (29,815,000)        (541,000)    (26,483,000)Earnings (loss) per common share:   Basic                       $        0.23       $       0.25         $     (3.93)     $     (0.07)  $       (3.42)   Diluted                     $        0.23       $       0.24         $     (3.93)     $     (0.07)  $       (3.42)                                             Year Ended December 31, 1999                                             ----------------------------                                     First              Second              Third            Fourth                                    Quarter             Quarter            Quarter          Quarter         Total                                    -------             -------            -------          -------         -----Total net revenues            $   71,704,000      $   75,016,000      $   77,590,000  $    76,305,000   $300,615,000Income (loss) from operations    (4,541,000)             347,000         (3,972,000)        1,417,000     (6,749,000)Loss before income taxes                    (9,404,000)         (4,976,000)         (9,241,000)      (4,284,000)    (27,905,000)Income tax benefit               (3,668,000)         (1,940,000)         (3,604,000)      (1,092,000)    (10,304,000)Net loss                         (5,736,000)         (3,036,000)         (5,637,000)      (3,192,000)    (17,601,000)Preferred stock dividends        (1,427,000)         (1,475,000)         (1,525,000)      (1,577,000)     (6,004,000)Loss available forcommon shares                    (7,163,000)         (4,511,000)         (7,162,000)      (4,769,000)    (23,605,000)Loss per common share:   Basic and Diluted          $       (0.99)      $       (0.62)      $       (0.99)  $        (0.58)   $      (3.25)                                             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               (1,540,000)         (1,297,000)         (4,658,000)       21,817,000      14,322,000Net 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 available forcommon 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)50
PROPOSED RESTRUCTURING OF DISCOUNT NOTES AND PREFERRED STOCK

In March 2001, the Company entered into an agreement (the"Restructuring Agreement") with Investcorp S.A. and the holders of more than amajority in interest of the Company's Discount Notes and Preferred Stock forpurposes of implementing a restructuring of the Discount Notes and PreferredStock. The Restructuring Agreement contemplates that the Company will offer toexchange for each $1,000 amount at maturity of outstanding Discount Notes acombination of the following: (1) 0.5899118 of a new 12% Senior SubordinatedDiscount Note due 2007 (the "New Notes") each having a principal amount atmaturity equal to $1,000 and an original issue price of $685.01 (assuming theNew Notes are issued on May 1, 2001), (2) $88.235 in cash and (3) common stockpurchase warrants for approximately 10.9 shares of its Class A Common Stock. TheCompany will also offer to exchange common stock purchase warrants forapproximately 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 will solicit consents from holders of outstanding DiscountNotes and Preferred Stock to amendments to the Indenture governing the DiscountNotes and to the Certificate of Designation governing the Preferred Stock thatwould eliminate or modify certain restrictive covenants and other provisionscontained in the Indenture and the Certificate of Designation and wouldsubstantially eliminate the preferences of the Preferred Stock, including thereduction of the liquidation preference from $1,000 to $0.01 per share and theelimination of the right of holders to be paid dividends on shares of PreferredStock. Also, the Company will issue to Investcorp S.A. (or one or more of itsaffiliates or designees) up to 15,000 shares of a new series of 13% convertibleexchangeable preferred stock (which will be mandatorily redeemable in 2008) and1,854,422 common stock purchase warrants for a total purchase price of up to$15,000,000. 

Assuming the tender and exchange of all outstandingDiscount Notes and Preferred Stock in the exchange offer: (1) the Company willhave an aggregate principal amount at maturity of $100,285,000 of New Notesoutstanding and an aggregate liquidation preference of $15,000,000 of newpreferred stock outstanding, (2) the warrants to be issued to holders ofDiscount Notes, to holders of Preferred Stock, and to Investcorp S.A. wouldrepresent the right to purchase an aggregate of 15%, 5% and 15%, respectively,of the total number of shares of all classes of the Company's common stock on afully diluted basis as of the closing of the transactions contemplated by theRestructuring Agreement (excluding shares issuable upon conversion of the newpreferred stock to be issued to Investcorp, each share of which will initiallybe convertible into 150 shares of Class A Common Stock, and (3) the aggregateamount of cash to be paid by the Company as partial consideration for tenderedDiscount Notes would be $15,000,000. 

Upon the completion of the reduction in the liquidationpreference of the Preferred Stock from $55,112,000 to $551, as contemplated bythe Restructuring Agreement, the carrying amount of the Preferred Stock will bereduced from $55,112,000 to $551 and the amount of the reduction, net of anyunamortized deferred financing costs related to the issuance of the PreferredStock (approximately $1,062,000 as of December 31, 2000), will be directlytransferred to the Company's Accumulated Deficit account. Upon the completion ofthe exchange of the New Notes for the Discount Notes (the "Note Exchange"), asdescribed in the Restructuring Agreement, the carrying value of the accretedprincipal of the Discount Notes would be reduced to $66,072,000, assuming theNote Exchange took place on December 31, 2000, and the amount of the reduction,net of the expected aggregate cash payment of $15,000,000, would be directlytransferred to the Company's Long-term Accrued Interest account. In the future,the carrying amount of the New Notes will increase as the result of accretionand will result in a corresponding decrease in the carrying amount of Long-termAccrued Interest. Interest expense on the New Notes will be recognized such thata constant effective interest rate will be 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. The Company will notrecognize a gain or loss for accounting purposes in connection with the Note Exchangeexcept for the write-off of unamortized deferred financing costs related to theissuance of the Discount Notes (approximately $3,592,000 as of December 31,2000) and the recognition of various investment advisory and legal feesassociated with the arrangement of the Restructuring Agreement and estimated tobe approximately $3,000,000. 

Holders owning approximately 75% of the aggregateprincipal amount at maturity of Discount Notes and approximately 90% of thePreferred Stock have agreed to accept the restructuring proposal (includingconsenting to the amendments to the Indenture and the Certificate ofDesignation). 

The restructuring proposal will be made to holders ofoutstanding Discount Notes and Preferred Stock only by an exchange offer to bemailed to such holders during the week of April 2, 2001. The restructuring issubject to certain conditions, including, among other things, the absence of amaterial adverse change in the business of the Company, acceptance of therestructuring proposal by the holders of at least 95% of the Discount Notes, andconsummation of the restructuring by June 15, 2001. 

In the unlikely event that the transactions contemplatedby the Restructuring Agreement are not completed by June 30, 2001, the Companywould likely not be in compliance with certain financial covenants required byits New Credit Facility as of that date. In such event, the Company would needto obtain a further modification of its covenants in order to avoid a defaultunder the New Credit Facility. 
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**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 noremuneration to its employees or to executives of Investcorp 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      51    President, Chief Executive Officer and DirectorDamian N. Dell'Anno      41    Executive Vice President, Chief Operating Officer                               and DirectorWilliam H. Stephan       44    Senior Vice President, Chief Financial Officer                               and DirectorChristopher J. O'Brien   42    DirectorLars  C. Haegg           35    DirectorJames O. Egan            52    DirectorWilliam C. McCollum      29    Director
Stephen L. Guillard hasserved as President and Chief Executive Officer of the Company since March 21,1996 and of the predecessors of the Company since May 1988 and as a Director andChairman of the Board of the Company since its incorporation. Mr. Guillardpreviously served as Chairman, President and Chief Executive Officer ofDiversified Health Services (“DHS”), a long-term care company whichMr. Guillard co-founded in 1982. DHS operated approximately 7,500 long-term careand assisted living beds in five states. Mr. Guillard has a total of 27 years ofexperience in the long-term care industry and is a licensed Nursing HomeAdministrator. 

Damian N. Dell’Annohas served as Executive Vice President of Operations of the Company since March21, 1996 and its predecessors since 1994. From 1993 to 1994, he served as thehead of the specialty services group for the predecessors of the Company and wasinstrumental in developing the Company’s rehabilitation therapy business.From 1989 to 1993, Mr. Dell’Anno was Vice President of Reimbursement forthe predecessors of the Company. From 1988 to 1989, Mr. Dell’Anno served asDirector of Budget, Reimbursement and Cash Management for The Mediplex Group,Inc. (“Mediplex”), a long-term care company. Mr. Dell’Anno has atotal of 17 years of experience in the long-term care industry. 

William H. Stephan hasserved as Senior Vice President and Chief Financial Officer since March 21, 1996and its predecessors since joining the Company in 1994. From 1986 to 1994, Mr.Stephan was a Manager in the health care practice of Coopers & Lybrand LLP.His clients there included long-term care facilities, continuing care retirementcenters, physician practices and acute care hospitals. Mr. Stephan is aCertified Public Accountant and a member of the Healthcare Financial ManagementAssociation. 

Christopher J. O'Brien has been an executive of Investcorpsince December 1993. Prior to joining Investcorp,  he was a Managing Director ofMancuso & Company,  a private New York-based  merchant bank. He is a director ofCSK Auto  Corporation  , The William  Carter  Company,  NationsRent,  Inc.,  IWOHoldings,  Inc. (Independent  Wireless One Corporation) and SIND Holdings,  Inc.(SI Corporation).

Lars C. Haegg has been anexecutive of Investcorp since 1998. Prior to joining Investcorp, Mr. Haeggworked with McKinsey & Company where he was responsible for leadingconsulting teams for media, retail and electronics clients. Mr. Haegg previouslyworked with Strategic Planning Associates (now Mercer Management Consulting) inthe telecommunications and consumer goods sectors. 

James O. Egan has been anexecutive of Investcorp since January 1999. Prior to joining Investcorp, he wasemployed by KPMG, an accounting firm, as a Partner; Riverwood International, apaperboard, packaging and machinery company, as Senior Vice President and ChiefFinancial Officer; and Coopers & Lybrand LLP, an accounting firm, as aPartner. He is a director of CSK Auto Corporation, Werner Holding Co. (DE),Inc., Stratus Computer System International, IWO Holdings, Inc. (IndependentWireless One Corporation) and SIND Holdings, Inc. (SI Corporation). 

William  C. McCollum has been an executive of Investcorpsince May 1996.  Prior to  joining  Investcorp,  Mr.  McCollum  was a  financialAnalyst  with Chase  Securities  Inc.  He is a director  of the  William  CarterCompany.
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EXECUTIVE OFFICERS

The following table setsforth certain information with respect to the executive officers of the Company: 
NAME                     AGE   POSITION----                     ---   --------Stephen L. Guillard      51    President, Chief Executive Officer and DirectorDamian N. Dell'Anno      41    Executive Vice President, Chief Operating Officer                               and DirectorWilliam H. Stephan       44    Senior Vice President, Chief Financial Officer                               and DirectorBruce J. Beardsley       37    Senior Vice President of AcquisitionsSteven Raso              36    Senior Vice President of OperationsInformation 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 has servedas Senior Vice President of Operations since 1998. From 1994 to 1998, he servedas Vice President of Reimbursement for the Company and he served as Director ofReimbursement and Budgets from 1989 to 1994. In these capacities, Mr. Raso hasbeen responsible for various aspects of Company Operations, including theMedicare and Medicaid reimbursement cost reporting functions, including audits,appeals, licensing and rate determinations. Mr. Raso also oversees thebudgeting, accounts receivable and compliance departments within the Company. 

**ITEM 11. EXECUTIVE COMPENSATION**
SUMMARY COMPENSATION TABLE
The following table setsforth the cash and non-cash compensation for 2000, 1999 and 1998 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                            Salary  Bonus     Compen-       Stock             Options/      Compen-Principal Position         Year        ($)  ($)       sation ($)(1) Award(s)($)(2)    SARs #        sation($)(3)(4)------------------         ----     ------  --------  ------------- --------------    ------        -------Stephen L. Guillard        2000    397,523    86,250           0           1,550            0       28,280President and Chief        1999    345,000         0           0               0            0       14,440Executive Officer          1998    348,579   300,000   1,854,500               0      184,904      761,419Damian N. Dell'Anno        2000    281,259    45,000           0           1,010            0       13,750Executive Vice             1999    225,000         0           0               0            0        9,000President of               1998    225,344   100,000     916,643               0      117,666      349,150OperationsWilliam H. Stephan         2000    227,692    38,000           0             700            0       11,295Senior Vice                1999    190,000         0           0               0            0        9,500President and              1998    186,230    40,000     432,505               0       80,641      199,007Chief FinancialOfficerBruce J. Beardsley         2000    226,249    40,000           0             700            0       11,000Senior Vice                1999    200,000         0           0               0            0       10,000President of               1998    195,227    40,000     435,370               0       80,641      210,195AcquisitionsSteven V. Raso             2000    177,499    28,000           0             490            0        8,750Senior Vice                1999    140,000         0           0               0            0        7,000President of               1998    138,462   220,000     278,780               0       55,771      147,442Operations53(1)  Includes stock options  exercised on August 11, 1998 in connection with the     Merger.
(2) On September 29, 2000,the Company granted 155,000, 101,000, 70,000, 70,000 and 49,000 shares ofRestricted Stock to Messrs. Guillard, Dell’Anno, Stephan, Beardsley andRaso, respectively. As part of this stock issuance, options granted on August11, 1998 to purchase shares of the Company’s Class C common stock at $25.00per share in the amounts of 160,904, 104,666, 72,641, 72,641, and 50,771 sharesfor Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso, respectively,were cancelled. One-third of the shares of restricted stock vest annuallybeginning on December 31, 2001. As of December 31, 2000, the aggregaterestricted stock holdings for each of the Named Executive Officers consisted ofthe 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, 70,000shares with a value of $700; and Mr. Raso, 49,000 shares with a value of$490. 
(3)  Includes matching  contributions made by the Company under its Supplemental     Executive Retirement Plan and 401(k) Plan.(4)  Includes "Change in Control" payments made and forgiveness of loans used to     purchase stock, as provided in the Employment Agreements referred to below.OPTION/SAR GRANTS IN LAST FISCAL YEAR
The Company did not grantany stock options or stock appreciation rights during 2000. 
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEARAND FISCAL YEAR END OPTION/SAR VALUES
The following table setsforth information concerning the aggregate number of exercisable andunexercisable stock options and stock appreciation rights held as of the end of2000. No stock options were exercised by the Named Executive Officers during2000. 
                           NUMBER OF                           SECURITIES       VALUE OF                           UNDERLYING       UNEXERCISED                           UNEXERCISED      IN-THE MONEY                           OPTIONS/SARS AT  OPTIONS/SARS AT                           FISCAL YEAR END  FISCAL YEAR END ($)                           EXERCISABLE/     EXERCISABLE/       NAME                UNEXERCISABLE    UNEXERCISABLE (1)       ----                -------------    -----------------Stephen L. Guillard                  0/0                     0Damian N. Dell'Anno        10,560/10,560                     0William H. Stephan         38,332/38,332                     0Bruce J. Beardsley         39,162/39,162                     0Steven V. Raso             21,940/21,940                     0
(1) Underlying shares arenot publicly traded and are subject to repurchase by the Company under certaincircumstances at the employee’s cost or at the then current value of theunderlying share, as determined by the Company’s Board of Directors uponthe termination of the employee’s employment with the Company. None ofthese options are classified as in-the-money for purposes of this table. TheCompany 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 President andChief Executive Officer of the Company, Mr. Dell’Anno serves as ExecutiveVice President and Chief Operating Officer of the Company, Mr. Stephan serves asSenior Vice President and Chief Financial Officer of the Company, Mr. Beardsleyserves as Senior Vice President of Acquisitions of the Company and Mr. Rasoserves as Senior Vice President of Operations of the Company. Through March 31,1999, Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Raso receivedminimum annual base 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. ThroughDecember 31, 1999, Messrs. Guillard, Dell’Anno, Stephan, Beardsley and Rasoelected to forgo the scheduled compensation adjustments. In January 2000, theamounts of compensation due to these individuals as a result of these electivedeferrals were paid by the Company, and as of January 1, 2000, the salaries ofMessrs. 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. Under the terms ofthese Employment Agreements, the salaries of each officer will be subject tofurther adjustment at the discretion of the Compensation Committee of the Boardof 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 base
54
salary 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 EmploymentAgreements 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, if theapplicable performance targets are met, (ii) the ability to exercise vestedstock options for the period ending on the earlier of the date that is 180 daysfrom the date his employment is terminated or the specific expiration datestated in the options, and (iii) in the case of Mr. Guillard, for the periodending 24 months after termination, and in the cases of Messrs. Dell’Anno,Stephan, Beardsley and Raso, for the period ending 12 months after termination,payment of the officer’s compensation at the rate most recently in effect;subject to such officer’s compliance with noncompetition andnonsolicitation covenants for such 12 or 24 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. Harborside matches50% of amounts contributed until 10% of base salary has been contributed.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

Immediately following 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 Effective Time, determined after giving effect to theexercise of the options issued or issuable under the Stock Option Plan. Optionsto purchase approximately 7.7% of such shares (determined on such basis) weregranted to members of the Company’s management upon consummation of theMerger. Options for the remaining approximately 2.3% of the shares of capitalstock of the Company (determined on such basis) were reserved for grant tocurrent or future officers and employees of the Company. 

The Stock Option Plan isadministered by the Company’s Board of Directors. The Board designateswhich employees of the Company are eligible to receive awards under the StockOption Plan, and the amount, timing and other terms and conditions applicable tosuch awards. Future options will be exercisable in accordance with the termsestablished by the Board and will expire on the date determined by the Board,which will not be later than 30 days after the seventh anniversary of the grantdate. An optionee will have certain rights to put to the Company, and theCompany will have certain rights to call from the optionee, vested stock optionsissued to the optionee under the Stock Option Plan upon termination of theoptionee’s employment with the Company prior to an initial public offering. 

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

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, 2001, 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 the
55
outstanding 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, 2001. 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. 
                        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        3.2Christopher J. O'Brien                  --        --               --         --Lars C. Haegg                           --        --               --         --James O. Egan                           --        --               --         --William C. McCollum                     --        --               --         --All directors and executive officers asa group (9 persons)                225,651   109,994          335,645       43.5                        HARBORSIDE 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 eachperson listed in the table as a holder of Harborside Class A Common Stock is c/oHarborside Healthcare Corporation, One Beacon Street, Boston, Massachusetts02108. 

(2) As used in the tableabove, a beneficial owner of a security includes any person who, directly orindirectly, through contract, arrangement, understanding, relationship, orotherwise has or shares (i) the power to vote, or direct the voting of, suchsecurity or (ii) investment power which includes the power to dispose, or todirect the disposition of, such security. 

(3) Includes shares ofstock that are subject to options exercisable within 60 days of March 1, 2001.The options granted upon consummation of the Merger pursuant to the CompanyStock Option Plan are not included in this table because they are notexercisable within 60 days of March 1, 2001. 

(4) Reflects the percentagesuch shares and options represent of the number of outstanding shares of suchclass of the Company’s common stock after giving effect to the exercise ofoptions owned by such person or persons. 

(5) The shares beneficiallyowned by George Krupp are owned of record by The George Krupp 1994 Family Trust(“GKFT”). The shares beneficially owned by Douglas Krupp are owned ofrecord by The Douglas Krupp 1994 Family Trust (“DKFT”). The trusteesof both GKFT and DKFT are Lawrence I. Silverstein, Paul Krupp and M. GordonEhrlich (the “Trustees”). The Trustees share control over the power todispose of the assets of GKFT and DKFT and thus each may be deemed tobeneficially own the shares held by GKFT and DKFT; however, each of the Trusteesdisclaims beneficial ownership of all of such shares. 

(6) Investcorp does notdirectly own any stock in the Company. The number of shares shown as owned byInvestcorp includes all of the shares owned by INVESTCORP Investment EquityLimited (See note (7) below). Investcorp owns no stock in Ballet Limited, Denary
56
Limited, Gleam Limited, Highlands Limited, Noble Limited, Outrigger Limited,Quill Limited, Radial Limited, Shoreline Limited, Zinnia Limited, or in thebeneficial owners of these entities (See note (10) below). Investcorp may bedeemed to share beneficial ownership of the shares of voting stock held by theseentities because the entities have entered into revocable management services orsimilar agreements with an affiliate of Investcorp, pursuant to which each suchentities has granted such affiliate the authority to direct the voting anddisposition of the Company voting stock owned by such entity for so long as suchagreement is in effect. Investcorp is a Luxembourg corporation with its addressat 37 rue Notre-Dame, Luxembourg. 

(7)  INVESTCORP  Investment  Equity  Limited is a CaymanIslands  corporation,  and a  wholly-owned  subsidiary of  Investcorp,  with itsaddress at P.O. Box 1111, West Wind Building,  George Town, Grand Cayman, CaymanIslands.

(8) SIPCO Limited may bedeemed to control Investcorp through its ownership of a majority of acompany’s stock that indirectly owns a majority of Investcorp’sshares. 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 than0.1% of the stock in each of Ballet Limited, Denary Limited, Gleam Limited,Highlands Limited, Noble Limited, Outrigger Limited, Quill Limited, RadialLimited, Shoreline Limited and Zinnia Limited (See note (10) below). CIP may bedeemed to share beneficial ownership of the shares of voting stock of theCompany held by such entities because CIP acts as a director of such entitiesand the ultimate beneficial stockholders of each of those entities have grantedto CIP revocable proxies in companies that own those entities’ stock. Noneof the ultimate beneficial owners of such entities beneficially ownsindividually 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 ZinniaLimited is a Cayman Islands corporation with its address at P.O. Box 2197, WestWind Building, GeorgeTown, Grand Cayman, Cayman Islands. 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In December of 1999, theCompany borrowed $5 million from an affiliate of Investcorp S.A. to fund apayment of $5 million to the landlord of four facilities in Ohio. In return forthe payment, the Company received an option to acquire the four facilities.Interest on this loan was payable quarterly in arrears and was based on aninety-day LIBOR rate plus 275 basis points. The Company exercised its option toacquire the four facilities on June 30, 2000. On September 27, 2000, the Companyassigned its purchase rights for the four facilities to an investment entityorganized by Investcorp, for $5.0 million, which simultaneously acquired thefour facilities. Also on that date, the Company entered into new operatingleases for each of the four facilities with combined annual rent ofapproximately $5.9 million. The Company used the proceeds of the purchase rightsassignment to repay the $5.0 million note payable from an affiliate ofInvestcorp S.A. 
57PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)         1.       Financial Statements:                  See Index to Consolidated Financial 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 by reference herein or are filed as partof this annual report.        Exhibit        Number           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      3.2(a)****         Certificate of Incorporation of Sailors, Inc.      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 registrants58      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)     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.59     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.     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)60     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)     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 Partnership61     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     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.62      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                         LEASE dated September 26, 2000, by and between, HHC BROADVIEW, INC. as LANDLORD AND     10.31               HARBORSIDE OF CLEVELAND LIMITED PARTNERSHIP as TENANT                         LEASE dated September 26, 2000, by and between, HHC WESTBAY, INC.     10.32                        as LANDLORD AND HARBORSIDE OF CLEVELAND LIMITED PARTNERSHIP                         as TENANT     21.1                Subsidiaries of the Registrant      *                  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 Registrant’s Quarterly Report on Form 10-Q                         for the quarter ended September 30, 1997 (File No. 01-14538)   ****                  Incorporated by reference to the Registrant's Registration Statement on Form S-4                         (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:                         None63SIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant hasduly caused this report to signed on its behalf by the undersigned, thereunto duly authorized, on the 30st day ofMarch, 2001.                                             HARBORSIDE HEALTHCARE CORPORATION                                             By   /s/ Stephen L. Guillard                                                  -----------------------                                                  President, Chief Executive                                                  Officer and DirectorPursuant to the requirements of the Securities and Exchange Act of 1934, this reporthas been signed below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated/s/ Stephen L. Guillard        President, Chief Executive Officer and Director-----------------------        (Principal Executive Officer)/s/ Damian N. Dell'Anno        Executive Vice President of Operations and Director-----------------------/s/ William H. Stephan         Senior Vice President, Chief Financial Officer and Director----------------------         (Principal Financial and Accounting Officer)/s/ Christopher J. O'Brien     Director--------------------------/s/ Lars C. Haegg              Director-----------------/s/ James O. Egan              Director-----------------/s/ W. Christian McCollum      Director-------------------------64                                          Harborside Healthcare Corporation                                                  One Beacon Street                                                   Boston, MA 02210March 30, 2001Securities and Exchange Commission450 Fifth Avenue, N.W.Washington, D.C.  20549Ladies and Gentlemen:In accordance with Item 601(b)(4)(iii) of Regulation S-K, Harborside HealthcareCorporation (the“Company”) has not filed herewith any instrument withrespect to long term debt not being registered where the total number of securitiesauthorized thereunder does not exceed ten percent (10%) of the total assets of theCompany and 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 Officer65Exhibit 21.1Subsidiaries of Harborside Healthcare Corporation as of December 31, 2000:                                                 Jurisdiction of                                                 Incorporation or                           Name                  Organization              Doing Business As                          -----                  ------------              -----------------1.    Bay Tree Nursing Center Corporation        Massachusetts             Harborside Healthcare -Palm Harbor2.    Belmont Nursing Center Corporation         Massachusetts             Harborside Healthcare -Toledo3.    Bowie Center Limited Partnership           Maryland                  Larkin Chase Nursing and      Restoration      Center4.    Countryside Care Center Corporation        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.    Harborside of Florida Limited Partnership  Florida                   Harborside Healthcare - Brevard7.    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       Partnership14.  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 Center6615.  Harborside Rehabilitation Limited           Massachusetts             Theracor Rehabilitation Services       Partnership16.  Harborside Toledo Corporation               Massachusetts17.  Harborside Toledo Limited Partnership       Massachusetts             Harborside Healthcare - Swanton18.  HHCI Limited Partnership                    Massachusetts             Harborside Healthcare - Naples                                                                           Harborside Healthcare - Sarasota                                                                           Harborside Healthcare - Pinebrook                                                                           Harborside Healthcare - New Haven                                                                           Harborside Healthcare - Woods Edge                                                                           Harborside Healthcare - Indianapolis                                                                           Harborside Healthcare - Troy19.  KHI Corporation                             Delaware                  KHI Corporation20.  Maryland Harborside Corporation             Massachusetts             Maryland HarborsideCorp.21.  Oakhurst Manor Nursing Center               Massachusetts             Harborside Healthcare - Ocala       Corporation22.  Orchard Ridge Nursing Center                Massachusetts             Harborside Healthcare - Gulf Coast       Corporation23.  Riverside Retirement Limited Partnership    Massachusetts             Harborside Healthcare - Decatur24.  Sunset Point Nursing Center Corporation     Massachusetts             Harborside Healthcare - Clearwater25.  West Bay Nursing Center Corporation         Massachusetts             Harborside Healthcare - Tampa Bay26.  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 - Dayton29.  Harborside Connecticut          Limited Partnership                    Massachusetts             Harborside Healthcare - Arden House                                                                           Harborside Healthcare - Governor's                                                                           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 Healthcare - Glen Crest6733.  Harborside Acquisition       Limited Partnership V                     Massachusetts             Harborside Acquisition Limited PartnershipV34.  Harborside Acquistion       Limited Partnership VI                    Massachusetts             Harborside Acquisition Limited PartnershipVI35.  Harborside Acquisition       Limited Partnership VII                   Massachusetts             Harborside Acquisition Limited PartnershipVII36.  Harborside Acquisition       Limited Partnership VIII                  Massachusetts             Harborside Acquisition Limited PartnershipVIII37.      Harborside Acquisition       Limited Partnership IX                    Massachusetts             Harborside Acquisition Limited PartnershipIX38.      Harborside Acquisition       Limited Partnership X                     Massachusetts             Harborside Acquisition Limited PartnershipX39.  Sailors, Inc.                               Delaware                  Sailors, Inc.40.  New Jersey Harborside Corp.                 Massachusetts             New Jersey Harborside Corp.41.      Bridgewater Assisted Living       Limited Partnership                       New Jersey                Bridgewater Assisted Living LimitedPartnership68