**FC-GEN Acquisition, Inc. and Subsidiaries**

 

**Consolidated Financial Statements**

 

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**Index to Consolidated Financial Statements**

 

On July 13, 2007, FC-GEN Acquisition, Inc. (the Company), through its wholly-owned subsidiary GEN Acquisition, Corp., (MergerCorp) merged with and into Genesis HealthCare Corporation (the Predecessor Company or GHC), with GHC and its subsidiaries continuing as the surviving corporation and assuming all of the debt obligations of Merger Corp.  The term“Successor” refers to FC-GEN Acquisition, Inc. after giving effect to the consummation of the merger.  The term “Predecessor” refers to GHC prior to giving effect to the consummation of the merger.  See note1 – “General Information – The Merger”.

 
| ** **                                                                                                                                                                                                                                                                                                                                      | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                                                                                                                                                                                                                                                            |     |
| Independent Auditors’ Report                                                                                                                                                                                                                                                                                                               | 2        |
|                                                                                                                                                                                                                                                                                                                                            |     |
| Consolidated Balance Sheets as ofDecember 31, 2007 (Successor) and December 31, 2006 (Predecessor)                                                                                                                                                                                                                                    | 3        |
|                                                                                                                                                                                                                                                                                                                                            |     |
| Consolidated Statements of Operations for theperiod from July 14, 2007 through December 31, 2007 (Successor); the period January 1, 2007 through July 13, 2007, the three months ended December 31, 2006, and the year ended September 30, 2006 (Predecessor)                                                     | 4        |
|                                                                                                                                                                                                                                                                                                                                            |     |
| Consolidated Statements of Shareholders’Equity and Other Comprehensive Income (Loss) for the period from July 14, 2007 through December 31, 2007 (Successor); the period January 1, 2007 through July 13, 2007, the three months ended December 31, 2006, and the yearended September 30, 2006 (Predecessor) | 5        |
|                                                                                                                                                                                                                                                                                                                                            |     |
| Consolidated Statements of Cash Flows for theperiod from July 14, 2007 through December 31, 2007 (Successor); the period January 1, 2007 through July 13, 2007, the three months ended December 31, 2006, and the year ended September 30, 2006 (Predecessor)                                                     | 6        |
|                                                                                                                                                                                                                                                                                                                                            |     |
| Notes to Consolidated FinancialStatements                                                                                                                                                                                                                                                                                                       | 7        |

 

1

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**Independent Auditors’ Report**

 

The Board of Directors

FC-GENAcquisition, Inc.

 

We have audited theaccompanying consolidated balance sheets of FC-GEN Acquisition, Inc. and subsidiaries (Successor) as of December 31, 2007, and of Genesis HealthCare Corporation and subsidiaries (Predecessor) as of December 31, 2006, and the relatedconsolidated statements of operations, shareholders’ equity and other comprehensive income (loss), and cash flows for the period from July 14, 2007 to December 31, 2007 (Successor period), and from January 1, 2007 toJuly 13, 2007 (Predecessor period), for the three months ended December 31, 2006, and for the year ended September 30, 2006 (Predecessor periods).  These consolidated financial statements are the responsibility of theCompany’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the auditing standards generally accepted in the United States of America.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.  An audit includes consideration of the internal control over financial reporting as a basis for designingaudit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overallfinancial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the Successor consolidated financial statements referred to above present fairly, in all material respects, the financial position ofFC-GEN Acquisition, Inc. and subsidiaries as of December 31, 2007, and the results of their operations and their cash flows for the Successor period, in conformity with U.S. generally accepted accounting principles.  Further, in ouropinion, the aforementioned Predecessor consolidated financial statements present fairly, in all material respects, the financial position of Genesis HealthCare Corporation and its subsidiaries as of December 31, 2006, and the results of theiroperations and their cash flows for the Predecessor periods, in conformity with U.S. generally accepted accounting principles.

 

As discussed in Note 1 to the consolidated financial statements, effective July 14, 2007, FC-GEN Acquisition, Inc.  acquired all of theoutstanding stock of Genesis HealthCare Corporation in a business combination accounted for as a purchase (the “Merger”).  As a result of the Merger, the consolidated financial information for the periods after the Merger is presentedon a different cost basis than that for the periods before the Merger and, therefore, is not comparable.

 

As described in Note 1 to the consolidated financial statements, the Company adopted Emerging Issues Task Force Issue No. 04-5, *Determining Whether a General Partner, or the GeneralPartner of a Group, Controls a Limited Partnership or Similar Entity when the Limited Partnership has Certain Rights* as of October 1, 2006.  As discussed in Note 16, the Company adopted Financial Accounting Standards BoardInterpretation No. 47, *Accounting for Conditional Asset Retirement Obligations*, in 2006.

 

 

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 30, 2008

 

2

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**FC-GEN ACQUISITION, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)**

 
| ** **                                                                                                                            | ** ** | **Successor**                   | ** ** | ** ** | ** **                      | **Predecessor** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|------------|---------------------------------|-----------------|------------|
| ** **                                                                                                                            | ** ** | **December 31, 2007** | ** ** | ** ** | **December 31, 2006** | ** **      |
| **Assets:**                                                                                                                           |       |                            |       |       |                            |            |
| Current assets:                                                                                                                       |       |                            |       |       |                            |            |
| Cash andequivalents                                                                                                                   |       | $                               | 53,419     |       |                            | $               | 66,270     |   |
| Current portion of restricted cash andinvestments in marketable securities                                                            |       | 23,538                          |       |       | 32,403                          |            |
| Accountsreceivable, net of allowances for doubtful accounts of $30,924 and $28,171, at December 31, 2007 and 2006, respectively  |       | 249,710                         |       |       | 244,515                         |            |
| Prepaid expenses and other currentassets                                                                                              |       | 90,652                          |       |       | 49,746                          |            |
| Current portion of deferred income taxes                                                                                              |       | 40,243                          |       |       | 46,226                          |            |
| Total current assets                                                                                                                  |       | 457,562                         |       |       | 439,160                         |            |
| Property and equipment, net of accumulated depreciation of $36,892 and $257,322, at December 31, 2007 and 2006, respectively     |       | 1,767,455                       |       |       | 931,992                         |            |
| Assets held for sale                                                                                                                  |       | —                          |       |       | 3,911                           |            |
| Restrictedcash and investments in marketable securities                                                                               |       | 82,457                          |       |       | 65,820                          |            |
| Other long-term assets                                                                                                                |       | 85,989                          |       |       | 91,472                          |            |
| Deferredincome taxes                                                                                                                  |       | —                          |       |       | 6,461                           |            |
| Identifiable intangible assets, net ofaccumulated amortization of $4,672 and $6,132, at December 31, 2007 and 2006, respectively |       | 114,267                         |       |       | 4,165                           |            |
| Goodwill                                                                                                                              |       | 265,678                         |       |       | 10,758                          |            |
| Total assets                                                                                                                          |       | $                               | 2,773,408  |       |                            | $               | 1,553,739  |   |
| **Liabilities andShareholders’ Equity:**                                                                                         |       |                            |       |       |                            |            |
| Current liabilities:                                                                                                                  |       |                            |       |       |                            |            |
| Currentinstallments of long-term debt                                                                                                 |       | $                               | 10,664     |       |                            | $               | 14,178     |   |
| Accounts payable                                                                                                                      |       | 49,601                          |       |       | 51,914                          |            |
| Accruedexpenses                                                                                                                       |       | 32,967                          |       |       | 41,085                          |            |
| Accrued compensation                                                                                                                  |       | 90,194                          |       |       | 77,972                          |            |
| Accruedinterest                                                                                                                       |       | 12,485                          |       |       | 6,154                           |            |
| Current portion of self-insurance liabilityreserves                                                                                   |       | 33,907                          |       |       | 38,079                          |            |
| Income taxes payable                                                                                                                  |       | —                          |       |       | 10,136                          |            |
| Total current liabilities                                                                                                             |       | 229,818                         |       |       | 239,518                         |            |
|                                                                                                                                  |       |                            |       |       |                            |            |
| Long-termdebt                                                                                                                         |       | 1,799,494                       |       |       | 457,538                         |            |
| Deferred income taxes                                                                                                                 |       | 307,457                         |       |       | —                          |            |
| Self-insurance liability reserves                                                                                                     |       | 90,913                          |       |       | 72,175                          |            |
| Other long-term liabilities                                                                                                           |       | 86,146                          |       |       | 67,734                          |            |
| Commitmentsand contingencies                                                                                                          |       |                            |       |       |                            |            |
| Shareholders’ equity:                                                                                                            |       |                            |       |       |                            |            |
| **Successor:**                                                                                                                        |       |                            |       |       |                            |            |
| Capitalstock, no par value, 1,500 shares authorized, 1,500 shares issued and outstanding                                              |       | —                          |       |       | —                          |            |
| **Predecessor:**                                                                                                                      |       |                            |       |       |                            |            |
| Common stock - par $0.01, 45,000,000 sharesauthorized, 20,808,867 shares issued                                                       |       | —                          |       |       | 208                             |            |
| Treasurystock at cost, 1,075,745 shares                                                                                               |       | —                          |       |       | (42,787                         | )               |
| Common stock held in deferred compensation planat cost, 261,066 shares                                                                |       | —                          |       |       | (11,003                         | )               |
| Deferredcompensation liability                                                                                                        |       | —                          |       |       | 6,388                           |            |
| Additional paid-in capital                                                                                                            |       | 294,574                         |       |       | 649,355                         |            |
| (Accumulateddeficit) retained earnings                                                                                                |       | (35,601                         | )          |       | 114,743                         |            |
| Accumulated other comprehensive income (loss)                                                                                         |       | 607                             |       |       | (130                            | )               |
| Total shareholders’ equity                                                                                                       |       | 259,580                         |       |       | 716,774                         |            |
| Total liabilities and shareholders’ equity                                                                                       |       | $                               | 2,773,408  |       |                            | $               | 1,553,739  |   |

 

See accompanying notes to the consolidatedfinancial statements.

 

3

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**FC-GEN ACQUISITION INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(IN THOUSANDS)**

 
| ** **                                                                                                                  | ** ** | **Successor**                                                                         |       |       |                                                                           |       | **Predecessor**                                    | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **Period from July 14, 2007 through December 31, 2007** | ** ** | ** ** | **Period from January 1, 2007 through July 13, 2007** | ** ** | **Three months ended December 31, 2006** | ** ** | **Year Ended September 30, 2006** | ** ** |
| ** **                                                                                                                  | ** ** | ** **                                                                            | ** ** | ** ** | ** **                                                                     | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Net revenues                                                                                                                |       | $                                                                                     | 958,261    |       |                                                                           | $          | 1,071,215                                          |       | $ | 475,268 |   | $ | 1,762,610 |   |
| Salaries, wages and benefits                                                                                                |       | 589,599                                                                               |       |       | 646,204                                                                        |       | 287,673                                            |       | 1,085,883 |   |
| Otheroperating expenses                                                                                                     |       | 201,999                                                                               |       |       | 230,531                                                                        |       | 100,334                                            |       | 385,407 |   |
| General and administrative costs                                                                                            |       | 50,814                                                                                |       |       | 69,416                                                                         |       | 30,743                                             |       | 112,705 |   |
| Provision forlosses on accounts receivable and notes receivable                                                             |       | 8,552                                                                                 |       |       | 9,225                                                                          |       | 5,090                                              |       | 12,385 |   |
| Merger related costs                                                                                                        |       | —                                                                                |       |       | 57,567                                                                         |       | 2,789                                              |       | — |   |
| Lease expense                                                                                                               |       | 13,920                                                                                |       |       | 12,053                                                                         |       | 5,464                                              |       | 22,225 |   |
| Depreciation and amortization expense                                                                                       |       | 37,586                                                                                |       |       | 39,237                                                                         |       | 17,114                                             |       | 62,107 |   |
| Accretionexpense                                                                                                            |       | 113                                                                                   |       |       | 149                                                                            |       | 69                                                 |       | — |   |
| Interest expense                                                                                                            |       | 121,864                                                                               |       |       | 16,639                                                                         |       | 7,013                                              |       | 24,964 |   |
| Investmentincome                                                                                                            |       | (4,172                                                                                | )          |       | (6,132                                                                         | )          | (3,169                                             | )          | (9,283 | ) |
| Other income                                                                                                                |       | —                                                                                |       |       | (2,974                                                                         | )          | —                                             |       | — |   |
| (Loss) income before income tax (benefit) expense, equity in net income of unconsolidated affiliates and minority interests |       | (62,014                                                                               | )          |       | (700                                                                           | )          | 22,148                                             |       | 66,217 |   |
| Income tax (benefit) expense                                                                                                |       | (25,570                                                                               | )          |       | 6,484                                                                          |       | 8,835                                              |       | 27,026 |   |
| (Loss) income before equity in net income of unconsolidated affiliates and minority interests                               |       | (36,444                                                                               | )          |       | (7,184                                                                         | )          | 13,313                                             |       | 39,191 |   |
| Equity in net income of unconsolidatedaffiliates                                                                            |       | 479                                                                                   |       |       | 403                                                                            |       | 236                                                |       | 1,977 |   |
| Minority interests                                                                                                          |       | (614                                                                                  | )          |       | (955                                                                           | )          | (447                                               | )          | (1,490 | ) |
| (Loss) income from continuingoperations                                                                                     |       | (36,579                                                                               | )          |       | (7,736                                                                         | )          | 13,102                                             |       | 39,678 |   |
| Income (loss)from discontinued operations, net of taxes                                                                     |       | 978                                                                                   |       |       | (252                                                                           | )          | 95                                                 |       | (2,262 | ) |
| Cumulative effect of an accounting change, net of taxes                                                                     |       | —                                                                                |       |       | —                                                                         |       | —                                             |       | (1,539 | ) |
| Net (loss) income                                                                                                           |       | $                                                                                     | (35,601    | )          |                                                                           | $          | (7,988                                             | )          | $ | 13,197 |   | $ | 35,877 |   |

 

See accompanying notes to the consolidated financial statements.

 

4

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**FC-GEN ACQUISITION, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’EQUITY AND OTHER COMPREHENSIVE INCOME (LOSS)**

**(IN THOUSANDS)**

 
| ** **                                                               | ** ** | **Capital Stock** | ** ** | **Common stock** | ** ** | **Additional paid-in capital** | ** ** | **(Accumulated deficit) retained earnings** | ** ** | **Accumulated other comprehensive income (loss)** | ** ** | **Treasury stock** | ** ** | **Common stock held in deferred compensation plan** | ** ** | **Deferred compensation liability** | ** ** | **Total shareholders’ equity** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|--------------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------|------------|--------------------|------------|---------------------------------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| ** **                                                               | ** ** | ** **        | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **                                  | ** ** | ** **                                             | ** ** | ** **         | ** ** | ** **                                                    | ** ** | ** **                          | ** ** | ** **                          | ** ** |
| **Predecessor:**                                                         |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Balance at September 30, 2005 (Predecessor)                         |       | $                 | —     |             | $          | 204                            |       | $                                           | 623,326    |                                                   | $          | 65,669             |       | $                                                             | (562       | )                                   | $          | (32,096                             | )          | $ | (5,728 | ) | $ | — |   | $ | 650,813 |   |
| Comprehensive income                                                     |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Net income                                                               |       | —            |       | —           |       | —                         |       | 35,877                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Net unrealized gain on marketable securities,net of tax                  |       | —            |       | —           |       | —                         |       | —                                      |       | 357                                                    |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Netdecrease to minimum pension liability, net of tax                     |       | —            |       | —           |       | —                         |       | —                                      |       | 46                                                     |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Unrealized gain on VIE interest rateswap                                 |       | —            |       | —           |       | —                         |       | —                                      |       | 94                                                     |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Totalcomprehensive income                                                |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       | 36,374                              |       |
| Utilization of tax benefits under SOP 90-7                               |       | —            |       | —           |       | 7,572                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 7,572                               |       |
| Issuance ofcommon stock under stock option plan and stock incentive plan |       | —            |       | 3                |       | 8,867                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 8,870                               |       |
| Stock-based compensation expense for stockoptions                        |       | —            |       | —           |       | 4,523                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 4,523                               |       |
| Purchasesof common stock for treasury                                    |       | —            |       | —           |       | —                         |       | —                                      |       | —                                                 |       | (10,691            | )          | —                                                        |       | —                              |       | (10,691                             | )          |
| Purchases and sales, net, of common stock indeferred compensation plan   |       | —            |       | —           |       | 990                            |       | —                                      |       | —                                                 |       | —             |       | (3,986                                                        | )          | 6,009                               |       | 3,013                               |       |
|                                                                     |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Balance at September 30, 2006 (Predecessor)                         |       | $                 | —     |             | $          | 207                            |       | $                                           | 645,278    |                                                   | $          | 101,546            |       | $                                                             | (65        | )                                   | $          | (42,787                             | )          | $ | (9,714 | ) | $ | 6,009 |   | $ | 700,474 |   |
| Comprehensive income                                                     |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Net income                                                               |       | —            |       | —           |       | —                         |       | 13,197                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Net unrealized loss on marketable securities,net of tax                  |       | —            |       | —           |       | —                         |       | —                                      |       | (65                                                    | )          | —             |       | —                                                        |       | —                              |       |                                |       |
| Totalcomprehensive income                                                |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       | 13,132                              |       |
| Utilization of tax benefits under SOP 90-7                               |       | —            |       | —           |       | 1,389                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 1,389                               |       |
| Issuance ofcommon stock under stock option plan and stock incentive plan |       | —            |       | 1                |       | 1,704                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 1,705                               |       |
| Stock-based compensation expense for stockoptions                        |       | —            |       | —           |       | 881                            |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 881                                 |       |
| Purchases and sales, net, of common stock in deferred compensation plan  |       | —            |       | —           |       | 103                            |       | —                                      |       | —                                                 |       | —             |       | (1,289                                                        | )          | 379                                 |       | (807                                | )          |
| Balance at December 31, 2006 (Predecessor)                          |       | $                 | —     |             | $          | 208                            |       | $                                           | 649,355    |                                                   | $          | 114,743            |       | $                                                             | (130       | )                                   | $          | (42,787                             | )          | $ | (11,003 | ) | $ | 6,388 |   | $ | 716,774 |   |
|                                                                     |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Comprehensive loss                                                       |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Net loss                                                                 |       | —            |       | —           |       | —                         |       | (7,988                                      | )          | —                                                 |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Netunrealized gain on marketable securities, net of tax                  |       | —            |       | —           |       | —                         |       | —                                      |       | 426                                                    |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Net decrease to minimum pension liability, netof tax                     |       | —            |       | —           |       | —                         |       | —                                      |       | (84                                                    | )          | —             |       | —                                                        |       | —                              |       |                                |       |
| Unrealizedgain on VIE interest rate swap                                 |       | —            |       | —           |       | —                         |       | —                                      |       | 36                                                     |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Total comprehensive loss                                                 |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       | (7,610                              | )          |
| Utilizationof tax benefits under SOP 90-7                                |       | —            |       | —           |       | 3,542                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 3,542                               |       |
| Issuance of common stock under stock optionplan and stock incentive plan |       | —            |       | 2                |       | 4,680                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 4,682                               |       |
| Stock-basedcompensation expense for stock options                        |       | —            |       | —           |       | 1,786                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 1,786                               |       |
| Purchases and sales, net, of common stock in deferred compensation plan  |       | —            |       | —           |       | 127                            |       | —                                      |       | —                                                 |       | —             |       | (5,790                                                        | )          | 2,477                               |       | (3,186                              | )          |
| Balance at July 13, 2007 (Predecessor)                              |       | $                 | —     |             | $          | 210                            |       | $                                           | 659,490    |                                                   | $          | 106,755            |       | $                                                             | 248        |                                | $          | (42,787                             | )          | $ | (16,793 | ) | $ | 8,865 |   | $ | 715,988 |   |
|                                                                     |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| **Successor:**                                                           |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Balance at July 14, 2007(Successor)                                 |       | $                 | —     |             | $          | —                         |       | $                                           | —     |                                                   | $          | —             |       | $                                                             | —     |                                | $          | —                              |       | $ | — |   | $ | — |   | $ | — |   |
| Capitalcontributed by parent                                             |       | —            |       | —           |       | 300,000                        |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 300,000                             |       |
| Comprehensive loss                                                       |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       |                                |       |
| Net loss                                                                 |       | —            |       | —           |       | —                         |       | (35,601                                     | )          | —                                                 |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Net unrealized gain on marketable securities,net of tax                  |       | —            |       | —           |       | —                         |       | —                                      |       | 652                                                    |       | —             |       | —                                                        |       | —                              |       |                                |       |
| Unrealizedloss on VIE interest rate swap                                 |       | —            |       | —           |       | —                         |       | —                                      |       | (45                                                    | )          | —             |       | —                                                        |       | —                              |       |                                |       |
| Total comprehensive loss                                                 |       |              |       |             |       |                           |       |                                        |       |                                                   |       |               |       |                                                          |       |                                |       | (34,994                             | )          |
| Utilizationof tax benefits under SOP 90-7                                |       | —            |       | —           |       | 2,574                          |       | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | 2,574                               |       |
| Distributions to parent                                                  |       | —            |       | —           |       | (8,000                         | )          | —                                      |       | —                                                 |       | —             |       | —                                                        |       | —                              |       | (8,000                              | )          |
| Balance at December 31, 2007 (Successor)                            |       | $                 | —     |             | $          | —                         |       | $                                           | 294,574    |                                                   | $          | (35,601            | )          | $                                                             | 607        |                                | $          | —                              |       | $ | — |   | $ | — |   | $ | 259,580 |   |

 

See accompanying notes to the consolidated financial statements.

 

5

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**FC-GEN ACQUISITION, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

 
| ** **                                                                                                       | ** ** | **Successor**                                                                         | ** ** | ** ** | ** **                                                                     | ** ** | **Predecessor**                                         | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **Period from July 14, 2007 through December 31, 2007** | ** ** | ** ** | **Period from January 1, 2007 through July 13, 2007** | ** ** | **Three months ended December 31, 2006** | ** ** | **Year Ended September 30, 2006** | ** ** |
|                                                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Cash flows from operating activities:                                                                            |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Net (loss)income                                                                                                 |       | $                                                                                     | (35,601    | )          |                                                                           | $          | (7,988                                                  | )          | $ | 13,197 |   | $ | 35,877 |   |
| Adjustments to reconcile net income (loss) tonet cash provided by operating activities:

Merger related expenses |       | —                                                                                |       |       | 57,567                                                                         |       | 2,789                                                   |       | — |   |
| Non-cashinterest expenses                                                                                        |       | 48,216                                                                                |       |       | 946                                                                            |       | 460                                                     |       | — |   |
| Non-cash compensation expenses                                                                                   |       | —                                                                                |       |       | 8,086                                                                          |       | 2,836                                                   |       | 11,093 |   |
| Loss onimpairment of assets and other non-cash charges                                                           |       | —                                                                                |       |       | 312                                                                            |       | 766                                                     |       | 6,646 |   |
| Depreciation and amortization                                                                                    |       | 37,586                                                                                |       |       | 39,237                                                                         |       | 17,181                                                  |       | 62,519 |   |
| Provision forlosses on accounts receivable and notes receivable                                                  |       | 8,552                                                                                 |       |       | 9,225                                                                          |       | 5,074                                                   |       | 14,590 |   |
| Equity in net income of unconsolidatedaffiliates and minority interests                                          |       | 135                                                                                   |       |       | 552                                                                            |       | 253                                                     |       | (376 | ) |
| Provision fordeferred taxes                                                                                      |       | (20,566                                                                               | )          |       | 13,317                                                                         |       | (227                                                    | )          | 14,944 |   |
| Excess tax benefits from share-based paymentarrangements                                                         |       | —                                                                                |       |       | (477                                                                           | )          | (108                                                    | )          | (1,267 | ) |
| Amortizationof deferred rents                                                                                    |       | 4,385                                                                                 |       |       | 1,441                                                                          |       | 407                                                     |       | 1,742 |   |
| Cumulative effect of an accountingchange                                                                         |       | —                                                                                |       |       | —                                                                         |       | —                                                  |       | 2,965 |   |
| Changes in assets and liabilities:                                                                               |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Accounts receivable                                                                                              |       | (7,033                                                                                | )          |       | (16,410                                                                        | )          | (21,479                                                 | )          | (47,210 | ) |
| Accountspayable, accrued expenses and other                                                                      |       | (19,246                                                                               | )          |       | 2,791                                                                          |       | 21,339                                                  |       | (20,195 | ) |
|                                                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Total adjustments                                                                                                |       | 52,029                                                                                |       |       | 116,587                                                                        |       | 29,291                                                  |       | 45,451 |   |
| Net cash provided by operating activities                                                                        |       | 16,428                                                                                |       |       | 108,599                                                                        |       | 42,488                                                  |       | 81,328 |   |
| Cash flows from investingactivities:                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Capitalexpenditures                                                                                              |       | (51,260                                                                               | )          |       | (56,888                                                                        | )          | (27,095                                                 | )          | (102,066 | ) |
| Purchases of restricted marketable securities                                                                    |       | (23,152                                                                               | )          |       | (23,596                                                                        | )          | (4,500                                                  | )          | (92,081 | ) |
| Proceeds onmaturity or sale of restricted marketable securities                                                  |       | 33,233                                                                                |       |       | 27,846                                                                         |       | 13,301                                                  |       | 93,299 |   |
| Net change in restricted cash and equivalents                                                                    |       | (12,282                                                                               | )          |       | (9,089                                                                         | )          | (7,109                                                  | )          | 2,673 |   |
| Purchases ofeldercare centers and lease amendments                                                               |       | —                                                                                |       |       | (22,138                                                                        | )          | (49,619                                                 | )          | (4,728 | ) |
| Investment in joint venture                                                                                      |       | —                                                                                |       |       | —                                                                         |       | —                                                  |       | (2,109 | ) |
| Proceeds fromsale of eldercare assets                                                                            |       | 11,509                                                                                |       |       | —                                                                         |       | —                                                  |       | — |   |
| Purchase of GHC common stock, net of cashacquired                                                                |       | (1,388,496                                                                            | )          |       | —                                                                         |       | —                                                  |       | — |   |
| Consolidationof partnerships                                                                                     |       | —                                                                                |       |       | —                                                                         |       | 2,324                                                   |       | — |   |
| Other, net                                                                                                       |       | 5,083                                                                                 |       |       | 1,808                                                                          |       | (643                                                    | )          | 6,909 |   |
|                                                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Net cash used in investing activities                                                                            |       | (1,425,365                                                                            | )          |       | (82,057                                                                        | )          | (73,341                                                 | )          | (98,103 | ) |
| Cash flows from financingactivities:                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Borrowings under revolving creditfacility                                                                        |       | —                                                                                |       |       | —                                                                         |       | 33,000                                                  |       | 6,000 |   |
| Repaymentsunder revolving credit facility                                                                        |       | (6,000                                                                                | )          |       | (33,000                                                                        | )          | —                                                  |       | — |   |
| Proceeds from issuance of long-termdebt                                                                          |       | 1,679,140                                                                             |       |       | —                                                                         |       | —                                                  |       | — |   |
| Repayment oflong-term debt                                                                                       |       | (344,529                                                                              | )          |       | (10,808                                                                        | )          | (10,510                                                 | )          | (15,452 | ) |
| Merger financing and other fees                                                                                  |       | (158,255                                                                              | )          |       | —                                                                         |       | (383                                                    | )          | (534 | ) |
| Purchase ofcommon stock for treasury                                                                             |       | —                                                                                |       |       | —                                                                         |       | —                                                  |       | (10,691 | ) |
| Proceeds from exercise of stockoptions                                                                           |       | —                                                                                |       |       | 917                                                                            |       | 88                                                      |       | 3,654 |   |
| Capitalcontributed by parent                                                                                     |       | 300,000                                                                               |       |       | —                                                                         |       | —                                                  |       | — |   |
| Distributions to parent                                                                                          |       | (8,000                                                                                | )          |       | —                                                                         |       | —                                                  |       | — |   |
| Excess taxbenefits from share-based payment arrangements                                                         |       | —                                                                                |       |       | 477                                                                            |       | 109                                                     |       | 1,267 |   |
|                                                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Net cash provided by (used in) financing activities                                                              |       | 1,462,356                                                                             |       |       | (42,414                                                                        | )          | 22,304                                                  |       | (15,756 | ) |
|                                                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |   |   |   |   |
| Net increase(decrease) in cash and equivalents                                                                   |       | $                                                                                     | 53,419     |       |                                                                           | $          | (15,872                                                 | )          | $ | (8,549 | ) | $ | (32,531 | ) |
| Cash and equivalents:                                                                                            |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Beginning of period                                                                                              |       | —                                                                                |       |       | 66,270                                                                         |       | 74,819                                                  |       | 107,350 |   |
|                                                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
|                                                                                                             |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| End of period                                                                                                    |       | $                                                                                     | 53,419     |       |                                                                           | $          | 50,398                                                  |       | $ | 66,270 |   | $ | 74,819 |   |
| Supplemental disclosure of cashflow information:                                                                 |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Interest paid                                                                                                    |       | $                                                                                     | 68,258     |       |                                                                           | $          | 15,677                                                  |       | $ | 8,237 |   | $ | 25,354 |   |
| Taxes paid                                                                                                       |       | 21                                                                                    |       |       | 1,667                                                                          |       | 1,816                                                   |       | 9,104 |   |
| Non-cash financing activities:                                                                                   |       |                                                                                  |       |       |                                                                           |       |                                                    |       |   |   |
| Capital leases                                                                                                   |       | $                                                                                     | 13,822     |       |                                                                           | $          | 40,013                                                  |       | $ | — |   | $ | — |   |
| Assumption oflong-term debt                                                                                      |       | —                                                                                |       |       | —                                                                         |       | 4,375                                                   |       | 3,190 |   |

 

See accompanying notes to the consolidated financialstatements.

 

6

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**FC-GEN Acquisition, Inc. andSubsidiaries Notes to Consolidated Financial Statements**

 

**(1)****  ****General Information**

 

***The Merger***

 

OnJuly 13, 2007, FC-GEN Acquisition, Inc. (the Company), through its wholly-owned subsidiary GEN Acquisition, Corp., (Merger Corp) merged with and into Genesis HealthCare Corporation (GHC or the Predecessor Company), with GHC and itssubsidiaries continuing as the surviving corporation and assuming all of the debt obligations of Merger Corp (the Merger).  Private equity funds managed by affiliates of Formation Capital, LLC and JER Partners (collectively the“Sponsors”) wholly own the Company’s parent, FC-GEN Investment, LLC (Parent).  The Company was incorporated in January 2007 for the purpose of acquiring GHC and did not have any operations prior to July 13, 2007other than in connection with the Merger.  Unless the context otherwise requires references in this report to the “Company” refers to the operations of GHC prior to the Merger and FC-GEN Acquisition, Inc. subsequent to theMerger.

 

The Mergertransaction, including the redemption of previous debt and the payment of related fees and expenses, was financed by equity contributions of $300 million, the issuance of $1.3 billion of aggregate principal amount of a variable rate senior term loandue 2009 and the issuance of $379 million of aggregate principal amount of a variable rate unsecured senior subordinated mezzanine term loan due 2012.

 

The transaction was treated as a purchase and thus the assets and liabilities were recordedat their respective fair value at July 14, 2007.  This resulted in a significant increase to the value of the Company’s property and equipment, identifiable intangible assets, deferred tax liabilities and goodwill.

 

***Description of Business***

 

The Company provides inpatient services through skilled nursing and assisted living centers primarily located in the eastern UnitedStates.  The Company has 214 owned, leased, managed and jointly owned eldercare centers with 25,891 beds as of December 31, 2007.  Revenues of the Company’s owned, leased and otherwise consolidated centers constituteapproximately 90% of its revenues.

 

The Company provides a range of rehabilitation therapy services, including speech pathology, physical therapy and occupational therapy.  These services are provided by rehabilitation therapists and assistants employedor contracted at substantially all of the centers operated by the Company, as well as by contract to healthcare facilities operated by others.  After the elimination of intercompany revenues, the rehabilitation therapy services businessconstitutes approximately 8% of the Company’s revenues.

 

The Company provides an array of other specialty medical services, including respiratory health services, management services, physician services, hospitality services, staffing services andother healthcare related services.

 

7

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***Basis of Presentation***

 

The Company’s financial position at December 31, 2007 includes the impact of the Merger as well as the application ofpurchase accounting.  The Merger has been reflected as of July 14, 2007 and the consolidated financial statements reflecting the financial position of the Company at December 31, 2007 and the results of operations and cash flows forthe period from July 14, 2007 to December 31, 2007 (after giving effect to the Merger) are designated as “Successor” financial statements.  The consolidated financial statements reflecting the results of operations and cashflows of the Company through the close of business on July 13, 2007 (prior to giving effect to the Merger) are designated “Predecessor” financial statements.

 

The accompanying consolidated financial statements have been prepared inaccordance with U.S. generally accepted accounting principles.  In the opinion of management, the consolidated financial statements include all necessary adjustments for a fair presentation of the financial position and results of operationsfor the periods presented.

 

***Factors Affecting Comparability of Financial Information***

 

The Successor has a December fiscal year end, while the Predeccesor had a September fiscal year end.  As a resultof the change in fiscal year end and as a result of the Merger, the consolidated financial statements for the periods after the Merger are presented on a different cost basis than that for periods before the Merger, and therefore, are notcomparable.  The Company believes the Merger has effected the consolidated statements of operations of the Successor as compared to the Predecessor primarily in interest expense, accretion expense, lease expense and depreciation andamortization expense.  This lack of comparability is due to differing capital structures and the application of purchase accounting resulting in a differing cost basis.  The Company believes the Merger has affected the consolidated balancesheet of the Successor as compared to the Predecessor primarily in cash and equivalents, property and equipment, identifiable intangible assets, goodwill, deferred tax liabilities, long-term debt and shareholders’ equity.  This lack ofcomparability is also due to differing capital structures and the application of purchase accounting resulting in a differing cost basis.

 

***Adjustments and Reclassifications***

 

The Predecessorresults for the three months ended December 31, 2006 were favorably affected by a $2.5 million ($1.5 million after-tax) adjustment to self-insurance reserves and the settlement of certain other long-term liabilities.  The self-insurancereserves for certain prior periods were increased $1.2 million as a result of a review of the Company’s accounting for workers’ compensation policies.  Other long-term liabilities were reduced $3.7 million to recognize the favorableprior year settlement of certain obligations related to Predecessor’s 2000-2001 Chapter 11 Bankruptcy proceedings.  The Company believes that the effect of the above adjustments are not material to its consolidated financial position,result of operations or liquidity for any prior period.

 

Certain prior year amounts have been reclassified to conform with current period presentation, the effect of which was not material.

 

***Principles of Consolidation and Variable Interest Entities***

 

The accompanying consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, itsconsolidated variable interest entities (VIEs) and certain other partnerships.  All significant intercompany accounts and transactions have been eliminated in consolidation for all periods presented.

 

The Company’sinvestments in VIEs in which it is the primary beneficiary are consolidated, while the investment in one other VIE in which it is not the primary beneficiary is accounted for under other accounting principles.  Investments in and the operatingresults of 20% to 50% owned companies, which are not VIEs, are included in the consolidated financial statements using the equity method of accounting.

 

8

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At December 31,2007 and 2006, the Company consolidated five VIEs.  At December 31, 2007, total assets and non-recourse debt of the consolidated VIEs are $51.0 million and $39.3 million, respectively; and at December 31, 2006, total assets andnon-recourse debt of the consolidated VIEs are $47.2 million and $39.7 million, respectively.  The total assets of the VIEs principally consist of property and equipment that serves as collateral for the VIEs’ non-recourse debt and is notavailable to satisfy any of the Company’s other obligations.  Creditors of the VIEs, including senior lenders, have no recourse against the general credit of the Company.  The consolidated VIEs at December 31, 2007 own andoperate skilled nursing and assisted living facilities having 563 beds.  The Company’s ownership interests in the consolidated VIEs range from 25% to 50% and the Company manages the day-to-day operations of the consolidated VIEs undermanagement agreements.  The Company’s involvement with the VIEs began in years prior to 2000.

 

Separate from the five VIEs previously described, at December 31, 2007 and 2006, the Company is not the primarybeneficiary of one VIE and, therefore, that VIE is not consolidated into its financial statements.  At December 31, 2007, total assets and debt of the unconsolidated VIE are $15.7 million and $13.0 million, respectively.  AtDecember 31, 2006, total assets and debt of the unconsolidated VIE are $15.7 million and $13.2 million, respectively.   The unconsolidated VIE owns and operates a skilled nursing facility having 224 beds.  The Company’sownership interests in the unconsolidated VIE is 33.3% and the Company manages the day-to-day operations of the unconsolidated VIE under a management agreement. The Company’s involvement with the unconsolidated VIE began in 1990.  AtDecember 31, 2007, the Company’s maximum exposure to loss associated with this unconsolidated VIE approximates the aggregate carrying-value of its equity method investments of $0.4 million.

 

Effective October 1, 2006, the Company consolidates two partnerships in accordance with Emerging Issues Task Force (EITF) Issue No. 04-5, “*Determining Whether a General Partner, or the General Partners asa Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights*” (EITF 04-5).  The Company, as the general partner in these entities, may exercise considerable control over the businesses withoutsubstantive kick out rights afforded to the limited partners.  One of the partnerships is a jointly owned and managed skilled nursing facility having 112 beds.  The second partnership owns the real estate of a skilled nursing facilityleased to the Company.  At December 31, 2007, total assets and non-recourse debt of these consolidated partnerships were $8.6 million and $4.0 million, respectively.  At December 31, 2006, total assets and non-recourse debt ofthese consolidated partnerships were $8.4 million and $4.4 million, respectively. The total assets of these consolidated partnerships consist of property and equipment that serves as collateral for the partnerships’ non-recourse debt and is notavailable to satisfy any of the Company’s other obligations.  Creditors of these consolidated partnerships, including senior lenders, have no recourse against the general credit of the Company.

 

**(2)****  ****Summary of Significant Accounting Policies**

 

The followingaccounting policies apply to both the Predecessor and Successor unless otherwise specified.

 

***Net Revenues and Accounts Receivable***

 

The Company receivespayments through reimbursement from Medicaid and Medicare programs and directly from individual residents (private pay), third-party insurers and long-term care facilities.

 

Inpatient services record revenue and the related receivables in the accountingrecords at the Company’s established billing rates in the period the related services are rendered.  The provision for contractual adjustments, which represents the differences between the established billing rates and predeterminedreimbursement rates, is deducted from gross revenue to determine net revenue.  Retroactive adjustments that are likely to result from future examinations by third party payors are accrued on an estimated basis in the period the related servicesare rendered and adjusted as necessary in future periods based upon new information or final settlements.

 

Rehabilitation therapy services and other ancillary services record revenue and the related receivables at the time services orproducts are provided or delivered to the customer.  Upon delivery of products or services, the Company has no additional performance obligation to the customer.

 

9

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***Use of Estimates***

 

The Company has made a number of estimates relating to the reporting of assets and liabilities, revenues and expenses and thedisclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with U.S. generally accepted accounting principles.  Some of the more significant estimates impact accounts receivable, long-livedassets, loss reserves for self-insurance programs and income taxes.  It is reasonable to assume that a change in estimate will occur in the near term and that change would be material if a different estimate were used in preparing theconsolidated financial statements.  Actual results could differ significantly from estimates.

 

***Cash and Equivalents***

 

Short-term investmentsthat have a maturity of ninety days or less at acquisition are considered cash equivalents.  Investments in cash equivalents are carried at cost, which approximates fair value.

 

***Restricted Cash and Investments in Marketable Securities***

 

Restricted cash includes cash and money market funds principally held by the Company’s wholly owned captive insurancesubsidiary, which is substantially restricted to securing the outstanding claims losses. Funds have also been set aside to satisfy approximately $7.4 million of mortgage obligations. The restricted cash and investments in marketable securitiesbalances at December 31, 2007 and 2006 were $106.0 million and $98.2 million, respectively.

 

Restricted investments in marketable securities, comprised of fixed interest rate securities and equity securities, are considered tobe available-for-sale and accordingly are reported at fair value with unrealized gains and losses, net of related tax effects, included within accumulated other comprehensive income (loss), a separate component of shareholders’ equity. Fair values for fixed interest rate securities and equity securities are based on quoted market prices.  Premiums and discounts on fixed interest rate securities are amortized or accreted over the life of the related security as an adjustmentto yield.

 

A decline in the market value of any security below cost that is deemed other-than-temporary is charged to earnings, resulting in the establishment of a new cost basis for the security.  Realized gains and losses forsecurities classified as available for sale are derived using the specific identification method for determining the cost of securities sold.

 

***Allowance for Doubtful Accounts***

 

The Company utilizesthe “aging method” to evaluate the adequacy of its allowance for doubtful accounts.  This method is based upon applying estimated standard allowance requirement percentages to each accounts receivable aging category for each type ofpayor.  The Company has developed estimated standard allowance requirement percentages by utilizing historical collection trends and its understanding of the nature and collectibility of receivables in the various aging categories and thevarious segments of the Company’s business.  The standard allowance percentages are developed by payor type as the accounts receivable from each payor type have unique characteristics.  The allowance for doubtful accounts alsoconsiders accounts specifically identified as uncollectible.  Accounts receivable that Company management specifically estimates to be uncollectible, based upon the age of the receivables, the results of collection efforts, or othercircumstances, are reserved for in the allowance for doubtful accounts until they are written-off.

 

***Prepaid expenses and other current assets***

 

Prepaid expenses andother current assets principally consist of expenses paid in advance of the provision of services, inventories of nursing center food and supplies, non-trade receivables and $24.9 million of escrowed funds held by third parties at December 31, 2007in accordance with loan and other contractual agreements.

 

***Property and Equipment***

 

Property and equipment are recorded at cost.  Depreciation is calculated using the straight-line method over estimated usefullives of 20-35 years for building improvements, land improvements and buildings, and 3-15 years for equipment, furniture and fixtures and information systems.  Depreciation expense on leasehold improvements and assets held under capital leasesis calculated using the straight-line method over the lesser of the lease term or the estimated useful life of the asset.  Expenditures for maintenance and repairs necessary to maintain property and equipment in efficient operating conditionare charged to operations as incurred.  Costs of additions and betterments are capitalized.  Interest costs associated with major construction projects are capitalized in the period in which they are incurred.

 

10

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Total depreciationexpense from continuing operations for the successor period from July 14, 2007 through December 31, 2007, and the predecessor periods from January 1, 2007 through July 13, 2007, the three months ended December 31, 2006 andthe year ended September 30, 2006 was $37.0 million $38.9 million, $17.0 million and $59.9 million, respectively.

 

***Allowance for Notes Receivable***

 

The Company classifies itsnotes receivable balances, net of allowances, in other long-term assets in its consolidated balance sheets.  These long-term receivables represent the net realizable value of the Company’s loans receivable resulting principally from theconversion of trade accounts receivable and consideration received for certain enterprise sales transactions.  The notes include varying payment terms, rates of interest and maturity dates based upon circumstances specific to eachagreement.  At least annually, the Company reviews the collectibility of its notes receivable on an individual basis to determine possible impairments and/or non-accrual status for interest terms.  Impairments or write-downs to netrealizable value are recorded in the consolidated statements of operations as a component of the provision for losses on accounts receivable and notes receivable.  Subsequent recoveries of reserved notes receivable are recorded as a reductionto the provision for losses on accounts receivable and notes receivable in the period of such recovery.

 

***Long-Lived Assets***

 

The Company’slong-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by comparison of the carryingamount of an asset to the future cash flows expected to be generated by the asset.  If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent the carrying amount of the assetexceeds the fair value of the asset.  Assets to be disposed of are reported at the lower of the carrying amount or the fair value less costs to sell.  Asset impairment charges totaling $5.5 million were recognized in the twelve monthsended September 30, 2006 associated with the write-down of two under performing properties. Approximately $2.7 million of the impairment charge is reflected in other operating expenses and $2.8 million is included in loss from discontinuedoperations in the consolidated statements of operations.

 

The Company performs an impairment test for goodwill with an indefinite useful life at least annually or more frequently if adverse events or changes in circumstances indicate that the asset may beimpaired.  The Company performs its annual impairment test in the September quarter of each year.  No goodwill impairment charge was recorded in any of the periods presented herein in connection with the annual impairmenttest.

 

***Self-Insurance Risks***

 

The Company provides for self-insurance risks for both general and professional liability and workers’ compensation claims basedon estimates of the ultimate costs for both reported claims and claims incurred but not reported.  Estimated losses from asserted and incurred but not reported claims are accrued based on our estimates of the ultimate costs of the claims, whichincludes costs associated with litigating or settling claims, and the relationship of past reported incidents to eventual claims payments.  All relevant information, including our own historical experience, the nature and extent of existingasserted claims and reported incidents, and independent actuarial analyses of this information is used in estimating the expected amount of claims.  The Company also considers amounts that may be recovered from excess insurance carriers inestimating the ultimate net liability for such risks.

 

***Income Taxes***

 

Deferred income taxes arise from the recognition of the tax consequences of temporary differences between the tax basis of assets andliabilities and their reported amounts in the consolidated financial statements.  These temporary differences will result in taxable or deductible amounts in future years when the reported amounts of the assets are recovered or liabilities aresettled.  The Company also recognizes as deferred tax assets the future tax benefits from net operating loss (NOL) carryforwards.  A valuation allowance is provided for these deferred tax assets if it is more likely than not that someportion or all of the net deferred tax assets will not be realized.

 

11

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***Comprehensive Income (Loss)***

 

Comprehensive income (loss) includes changes to shareholders’ equity during a period, except those resulting from investments byand distributions to shareholders.  The components of comprehensive income (loss) are shown in the consolidated statements of shareholders’ equity.

 

***Leases***

 

Lease arrangements arecapitalized when such leases convey substantially all the risks and benefits incidental to ownership.  Capital leases are amortized over either the lease term or the life of the related assets, depending upon available purchase options andlease renewal features.  Amortization related to capital leases is included in the consolidated statements of operations within depreciation and amortization expense.

 

For operating leases, minimum lease payments, including minimum scheduled rentincreases, are recognized as lease expense on a straight-line basis over the applicable lease terms and any periods during which the Company has use of the property but is not charged rent by a landlord.  Lease terms, in most cases, provide forrent escalations and renewal options.

 

Favorable and unfavorable lease amounts are recorded as components of other identifiable intangible assets and other long-term liabilities, respectively, when the Company purchases businesses that have leaseagreements.  Favorable and unfavorable leases are amortized to lease expense on a straight-line basis over the remaining term of the leases.  Upon early termination of a lease, the favorable or unfavorable lease contract balance associatedwith the lease contract is recognized as a loss or gain in the consolidated statement of operations.

 

***Reimbursement of Managed Property Labor Costs***

 

The Company managesthe operations of 35 independently and jointly owned eldercare centers, including consolidated VIEs, and six transitional care units as of December 31, 2007.  Under these arrangements, the Company employs the operational staff of themanaged center for ease of benefit administration and bills the related wage and benefit costs on a dollar-for-dollar basis to the owner of the managed property.  In this capacity, the Company operates as an agent on behalf of the managedproperty owner and is not the primary obligor in the context of a traditional employee/employer relationship.  Historically, the Company has treated these transactions on a “net basis,” thereby not reflecting the billed labor andbenefit costs as a component of its net revenue or expenses.  For the successor period from July 14, 2007 through December 31, 2007, and the predecessor periods from January 1, 2007 through July 13, 2007, the three monthsended December 31, 2006 and the year ended September 30, 2006 the Company billed its managed clients $51.9 million, $60.0 million, $28.5 million, and $119.5 million, respectively, for such labor related costs.

 

***Stock-Based Benefit Plans***

 

The Company recognizes compensation costs related to stock-based benefit plans in the consolidated financial statements.  The costis measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity award).  The Successor Company does nothave any stock-based benefit plans.

 

***Derivative Financial Instruments***

 

The Company recognizes all derivatives as either assets or liabilities on the balance sheet and measures those instruments at fairvalue.  The fair value adjustments will affect either shareholders’ equity or net income, depending on whether the derivative instrument is designated as or qualifies as a hedge for accounting purposes and, if so, the nature of the hedgingactivity.  The Company uses interest rate swap and interest rate cap agreements for the specific purpose of hedging the exposure to variability in market rates of interest.

 

12

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***Asset Retirement Obligations***

 

The fair value of aliability for an asset retirement obligation is recognized in the period when the asset is placed in service.  The fair value of the liability is estimated using discounted cash flows.  In subsequent periods, the retirement obligation isaccreted to its future value or the estimate of the obligation at the asset retirement date.  The accretion charge is reflected separately on the consolidated statement of operations.  A corresponding retirement asset equal to the fairvalue of the retirement obligation is also recorded as part of the carrying amount of the related long-lived asset and depreciated over the asset’s useful life.

 

***Other Income***

 

The Predecessor realized a$3.0 million gain on the sale of a cost method investment in the period from January 1, 2007 through July 13, 2007.

 

***New Accounting Pronouncements***

 

*FairValue Measurements*

 

InSeptember 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, *Fair Value Measurements*.  SFAS No. 157 defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair value measurements.  SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements.  SFAS No. 157 is effective for fiscal yearbeginning January 1, 2009 for the Company.  The Company is evaluating the impact this statement will have on its consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115* (SFAS No. 159).  This statement permits entities to choose to measure many financial instruments and certain other items at fair valuethat are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets andliabilities. SFAS No. 159 is effective January 1, 2008 for the Company. The Company is evaluating the impact of this statement on its consolidated financial statements.

 

*Income Tax Uncertainties*

 

In June 2006, the FASB issuedInterpretation No. 48, *Accounting for Uncertainty in Income Taxes*, (FIN 48), which prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in anenterprise’s financial statements in accordance with SFAS No. 109, *Accounting for Income Taxes*.  Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption ofFIN 48 and in subsequent periods.  The provisions of FIN 48 will be applied to all tax positions accounted for under SFAS No. 109 upon initial adoption.  The cumulative effect of applying the provisions of this interpretation will bereported as an adjustment to the opening balance of retained earnings for that fiscal year.

 

In January 2008, the FASB offered non-public entities an election option to defer adoption of FIN 48 until the preparation oftheir annual financial statements for years that begin after December 15, 2007.  Under this deferral election, the Company is required to adopt FIN 48 in connection with the preparation of its annual consolidated financial statements forthe year ending December 31, 2008, but not for interim periods prior to December 31, 2008.  The Company is currently evaluating the potential impact of FIN 48 on its consolidated financial statements.

 

*Business Combinations*

 

In December 2007, the FASB issued SFAS No. 141(revised 2007), *Business Combinations* (SFAS No. 141R). SFAS No. 141R will replace SFAS No. 141, *BusinessCombinations*, but retains the fundamental requirements in SFAS No. 141 that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination.  SFASNo. 141R defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control.  SFAS No. 141R requires anacquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their fair values at the acquisition date.  Costs incurred by the acquirer to effect the acquisition are not allocated to theassets acquired or liabilities assumed, but are recognized separately.  SFAS No. 141R is effective 

 

13

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prospectively to business combinations forwhich the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which for the Company will be business combinations with an acquisition date beginning on or afterJanuary 1, 2009.

 

*Noncontrolling Interests*

 

In December 2007, the FASB issued SFAS No. 160, *Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51* (SFAS No. 160). SFAS No. 160amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary, for the deconsolidation of a subsidiary and clarifies that a noncontrolling interest in a subsidiary is an ownership interestthat should be reported as equity in the consolidated financial statements. SFAS No. 160 establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation andrequires a parent to recognize a gain or loss in net income when a subsidiary is deconsolidated. SFAS No. 160 also requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and thenoncontrolling interest and to disclose, on the face of the consolidated statement of income, the amounts of consolidated net income attributable to the parent and to the noncontrolling interest.  SFAS No. 160 is effective for fiscal yearsbeginning on or after December 15, 2008, which for the Company will be the fiscal year beginning on January 1, 2009.  The Company is currently evaluating the impact that SFAS No. 160 may have on its consolidated financialstatements.

 

**(3)****  ****Significant Transactions and Events**

 

***Successor***

 

*The Merger*

 

The Merger was completed as of the close of business on July 13, 2007 and was financedwith equity contributions of $300 million and the issuance of $1,679.1 million of debt.

 

The Merger sources and uses of funds are summarized below (in thousands)

 
| **Sources**                                                 |   |    |      |
|-------------------------------------------------------------|--------|---------|-----------|
| ** **                                                  |   |    |      |
| Senior termloan                                             |   | $       | 1,300,000 |   |
| Mezzanine term loan                                         |   | 379,140 |      |
| Equity contributions                                        |   | 300,000 |      |
| **Total Sources**                                           |   | $       | 1,979,140 |   |
| **Uses**                                                    |   |    |      |
|                                                        |   |    |      |
| Purchase ofpredecessor company common stock and equivalents |   | $       | 1,438,894 |   |
| Repayment of predecessor company debt and accruedinterest   |   | 347,189 |      |
| Fees andexpenses                                            |   | 158,255 |      |
| Cash held for operating activities                          |   | 34,802  |      |
|                                                        |   |    |      |
| **Total Uses**                                              |   | $       | 1,979,140 |   |

 

The net assets acquired of $1,944.3 million is net of $34.8 million of cash in excess of the financing sources of $1,979.1 million.  The total purchase price of the transaction was allocated to the Company’s nettangible and identifiable intangible assets based upon the estimated fair values at July 14, 2007.  The excess of the purchase price over the net tangible and identifiable intangible assets was recorded as goodwill.  The allocation ofthe purchase price to property and equipment, identifiable intangible assets and deferred income taxes was based upon valuation data and estimates. The purchase accounting adjustments made in the accompanying consolidated financial statements aresubstantially complete. Once the final allocation is determined, any remaining excess of the investment over identifiable net assets acquired will be adjusted through goodwill.  

14

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The following tablesummarizes the allocation of the purchase price as of July 14, 2007:

 
| **(in thousands)**         | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------|------------|
|                            |       |       |       |
| Net currentassets               |       | $          | 216,687    |   |
| Property and equipment          |       | 1,768,837  |       |
| Other assets                    |       | 199,829    |       |
| Identifiable intangible assets  |       | 118,939    |       |
| Goodwill                        |       | 265,678    |       |
| Debt assumed                    |       | (124,626   | )          |
| Non-currentliabilities          |       | (142,207   | )          |
| Deferred income tax liabilities |       | (358,799   | )          |
|                            |       |       |       |
| **Net assets acquired**         |       | $          | 1,944,338  |   |

 

The goodwill recognized from the transaction is a result of the expected (i) cost savings from the elimination of stock-based benefits and compliance costs associated with being a publicly held company,(ii) implementation of certain organizational and legal structure modifications that better protect assets from liability risks, (iii) the Company’s cash flows supported by high occupancy and quality mix, and (iv) the growthopportunity the investors anticipate in the Company’s core businesses.

 

Transaction consideration on the consolidated statement of cash flows of $1,388.5 million excludes cash and equivalents acquired of$50.4 million.  Included in the transaction consideration are pre-payment penalties and conversion premiums of $83.0 million related to debt obligations of the Predecessor Company that were redeemed in connection with thetransaction.

 

During the period from January 1, 2007 through July 13, 2007, the Successor recorded costs of approximately $57.6 million related to the transaction. These costs, which are included in Merger related costs in theconsolidated statements of operations, consist of approximately $26.0 million of accounting, investment banking, legal and other costs associated with the transaction, a compensation charge of approximately $22.3 million related to the acceleratedvesting of employee stock options and restricted stock, a $8.3 million charge related to the write-off of unamortized deferred financing fees related to the Predecessor debt and a charge of approximately $1.0 million for transaction related paymentsto certain executives.

 

During the three months ended December 31, 2006, Predecessor incurred legal fees, investment banking advisory fees, special committee board fees and other related costs of $2.8 million in connection with the proposedtransaction with the Successor and other companies.  These costs are included in Merger related costs in the consolidated statements of operations.

 

***Predecessor***

 

*Lease andPurchase Option Agreements*

 

In January 2007, the Predecessor completed a transaction involving a lease and purchase option agreement for 11 facilities in Maine with 748 skilled nursing and 220 residential care beds.  The transaction waseffective January 1, 2007.  Under the agreement the Predecessor leased 11 nursing and residential care facilities for 25 years with an annual lease payment of approximately $5 million.  Additionally, the Predecessor paid approximately$16.5 million in cash in exchange for tangible operating assets and entered into a $53 million fixed price purchase option exercisable in 2026.  The transaction was recorded as a capital lease resulting in $40.0 million of capital leaseobligations and added $56.4 million of property and equipment.

 

15

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*Acquisitions of ElderCare Centers*

 

Effective May 1, 2007, the Predecessor purchased a 118 bed skilled nursing facility in Pennsylvania.  The purchase price of$3.1 million was financed with cash.

 

Effective December 1, 2006, the Predecessor completed a purchase of two skilled nursing facilities and four assisted living facilities in West Virginia for a net purchase price of $41.2 million.  The purchase wasfinanced with $33.0 million of debt from the revolving credit facility, which was subsequently repaid, and $8.2 million of cash.

 

Effective November 1, 2006, the Predecessor purchased a 115 bed skilled nursing facility in Maryland.  The purchase priceof $8.0 million was financed with $6.0 million of debt from the revolving credit facility and $2.0 million of cash.

 

In connection with these acquisitions, the majority of the purchase prices were allocated to property and equipment.  The resultsof operations of these acquisitions were included from the acquisition date.

 

**(4)****  ****CertainSignificant Risks and Uncertainties**

 

***Revenue Sources***

 

The Company receives revenues from Medicare, Medicaid, private insurance, self-pay residents, other third-party payors and long-termcare facilities that utilize its rehabilitation therapy and other services.  The Company’s inpatient services derives approximately 80% of its revenue from the Medicare and various state Medicaid programs.

 

The sources andamounts of the Company’s revenues are determined by a number of factors, including licensed bed capacity and occupancy rates of its eldercare centers, the mix of patients and the rates of reimbursement among payors.  Likewise, payment forancillary medical services, including services provided by the Company’s rehabilitation therapy services business, vary based upon the type of payor and payment methodologies.  Changes in the case mix of the patients as well as payor mixamong Medicare, Medicaid and private pay can significantly affect the Company’s profitability.

 

It is not possible to quantify fully the effect of legislative changes, the interpretation or administration of such legislation orother governmental initiatives on the Company’s business and the business of the customers served by the Company’s rehabilitation therapy business.  Accordingly, there can be no assurance that the impact of any future healthcarelegislation or regulation will not adversely affect the Company’s business.  There can be no assurance that payments under governmental and private third-party payor programs will be timely, will remain at levels similar to present levelsor will, in the future, be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs.  The Company’s financial condition and results of operations will be affected by the reimbursementprocess, which in the healthcare industry is complex and can involve lengthy delays between the time that revenue is recognized and the time that reimbursement amounts are settled.

 

Laws and regulations governing the Medicare and Medicaid programs are complex and subjectto interpretation. The Company believes that it is in material compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving material allegations of potential wrongdoing. While no suchregulatory inquiries have been made, noncompliance with such laws and regulations can be subject to regulatory actions including fines, penalties, and exclusion from the Medicare and Medicaid programs.

 

16

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**(5)****  ****Restricted Cash and Investments in Marketable Securities**

 

The current portion of restricted cash and investments in marketable securities principallyrepresents an estimate of the level of outstanding self-insured losses the Company expects to pay in the succeeding year through its wholly owned captive insurance company.

 

Restricted cash and equivalents and investments in marketable securities atDecember 31, 2007 consist of the following (in thousands):

 
| ** **                                       | ** ** | ** **         | ** ** | ** **           | ** ** | **Unrealized losses** | ** ** | ** **                | ** ** |
|--------------------------------------------------|------------|--------------------|------------|----------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                                       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **                 | ** ** | ** **                | ** ** | ** ** | ** ** |
| **Successor**                                    | ** ** | **Amortized cost** | ** ** | **Unrealized gains** | ** ** | **Lessthan 12 months**     | ** ** | **Greaterthan 12 months** | ** ** | **Fairvalue** | ** ** |
|                                             |       |               |       |                 |       |                       |       |                      |       |   |   |
|                                             |       |               |       |                 |       |                       |       |                      |       |   |   |
| Restricted cash and equivalents:                 |       |               |       |                 |       |                       |       |                      |       |   |   |
| Cash                                             |       | $                  | 33,248     |                 | $          | —                     |       | $                         | —     |   | $ | — |   | $ | 33,248 |   |
| Money market funds                               |       | 3,831              |       | —               |       | —                     |       | —                    |       | 3,831 |   |
|                                             |       |               |       |                 |       |                       |       |                      |       |   |   |
| Restricted investments in marketable securities: |       |               |       |                 |       |                       |       |                      |       |   |   |
| U.S. mortgagebacked securities                   |       | 19,127             |       | 360                  |       | —                     |       | —                    |       | 19,487 |   |
| Corporate bonds                                  |       | 15,446             |       | 943                  |       | (12                        | )          | —                    |       | 16,377 |   |
| Government bonds                                 |       | 33,245             |       | 247                  |       | (35                        | )          | (405                      | )          | 33,052 |   |
|                                             |       | $                  | 104,897    |                 | $          | 1,550                      |       | $                         | (47        | ) | $ | (405 | ) | $ | 105,995 |   |
|                                             |       |               |       |                 |       |                       |       |                      |       |   |   |
| Less: Current portion of restricted investments  |       |               |       |                 |       |                       |       |                      |       | (23,538 | ) |
| Long-term restricted investments                 |       |               |       |                 |       |                       |       |                      |       | $ | 82,457 |   |

 

Restricted cash andequivalents and investments in marketable securities at December 31, 2006 consist of the following (in thousands):

 
| ** **                                       | ** ** | ** **         | ** ** | ** **           | ** ** | **Unrealized losses**        | ** ** | ** **                           | ** ** |
|--------------------------------------------------|------------|--------------------|------------|----------------------|------------|-----------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | ** **         | ** ** | ** **           | ** ** | ** **                        | ** ** | ** **                           | ** ** |
| **Predecessor**                                  | ** ** | **Amortized cost** | ** ** | **Unrealized gains** | ** ** | **Less than 12 months** | ** ** | **Greater than 12 months** | ** ** | **Fair value** | ** ** |
|                                             |       |               |       |                 |       |                              |       |                                 |       |   |   |
|                                             |       |               |       |                 |       |                              |       |                                 |       |   |   |
| Restricted cash and equivalents:                 |       |               |       |                 |       |                              |       |                                 |       |   |   |
| Cash                                             |       | $                  | 11,879     |                 | $          | —                            |       | $                                    | —     |   | $ | — |   | $ | 11,879 |   |
| Money market funds                               |       | 3,593              |       | —               |       | —                            |       | —                               |       | 3,593 |   |
|                                             |       |               |       |                 |       |                              |       |                                 |       |   |   |
| Restricted investments in marketable securities: |       |               |       |                 |       |                              |       |                                 |       |   |   |
| U.S. mortgagebacked securities                   |       | 25,083             |       | 66                   |       | (8                                | )          | (168                                 | )          | 24,973 |   |
| Corporate bonds                                  |       | 21,333             |       | 285                  |       | (52                               | )          | (73                                  | )          | 21,493 |   |
| Government bonds                                 |       | 36,572             |       | 126                  |       | (28                               | )          | (385                                 | )          | 36,285 |   |
|                                             |       |               |       |                 |       |                              |       |                                 |       |   |   |
|                                             |       | $                  | 98,460     |                 | $          | 477                               |       | $                                    | (88        | ) | $ | (626 | ) | $ | 98,223 |   |
|                                             |       |               |       |                 |       |                              |       |                                 |       |   |   |
| Less: Current portion of restricted investments  |       |               |       |                 |       |                              |       |                                 |       | (32,403 | ) |
| Long-term restricted investments                 |       |               |       |                 |       |                              |       |                                 |       | $ | 65,820 |   |

 

Maturities of restrictedinvestments yielded proceeds of $23.0 million, $12.0 million, $6.0 million and less than $0.1 million for the successor period from July 14, 2007 through December 31, 2007, and the predecessor periods from January 1, 2007 throughJuly 13, 2007, the three months ended December 31, 2006 and the year ended September 30, 2006, respectively.

 

Sales of investments yielded proceeds of $10.2 million, $15.8 million, $7.3 million and $93.3 million for the successor period fromJuly 14, 2007 through December 31, 2007, and the predecessor periods from January 1, 2007 through July 13, 2007, the three months ended December 31, 2006 and the year ended September 30, 2006, respectively. Associatedgross realized gains and losses for the presented periods were not significant.

 

17

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During the Successorperiod, the Company determined that the decline in the estimated value of a corporate bond, with an aggregate carrying value of $2.0 million prior to the impairment, was other-than-temporarily impaired.  The Company recognized a non-cash,pre-tax impairment charge of $0.4 million in the Successor period.

 

The majority of the Company’s investments are investment grade government and corporate debt securities that have maturities of five years or less, and the Company has both the abilityand intent to hold the investments until maturity.

 

Restricted investments in marketable securities held at December 31, 2007 mature as follows (in thousands):

 
| **Successor**                     | ** ** | **Amortized cost** | ** ** | **Fairvalue** | ** ** |
|-----------------------------------|------------|--------------------|------------|---------------|------------|
|                              |       |               |       |          |       |
| Due in one year or less           |       | $                  | 14,035     |          | $          | 14,015 |   |
| Due after 1 year through 5 years  |       | 42,481             |       | 43,133        |       |
| Due after 5years through 10 years |       | 6,197              |       | 6,546         |       |
| Due after 10 years                |       | 5,105              |       | 5,222         |       |
|                              |       |               |       |          |       |
|                              |       | $                  | 67,818     |          | $          | 68,916 |   |

 

Actual maturities may differ from stated maturities because borrowers have the right to call or prepay certain obligations with or without prepayment penalties.

 

The Company has issuedletters of credit totaling $82.6 million at December 31, 2007 to its third party administrators and the Company’s excess insurance carriers.  Restricted cash of $25.9 million and restricted investments with an amortized cost of $67.6million and a market value of $68.9 million are pledged as security for these letters of credit as of December 31, 2007.

 

**(6)****  ****Property andEquipment**

 

Property andequipment at December 31, 2007 and 2006 consist of the following (in thousands):

 
| ** **                       | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|---------------|------------|------------|------------|------------|
|                             | ** ** | **Successor** | ** ** | ** ** | ** ** | ** ** | **Predecessor** | ** ** |
| ** **                       | ** ** | **2007**      | ** ** | ** ** | **2006**   | ** ** |
| ** **                       | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** |
| Land andimprovements             |       | $             | 245,005    |       |       | $          | 94,307 |   |
| Buildings and improvements       |       | 1,417,435     |       |       | 874,533    |       |
| Equipment,furniture and fixtures |       | 136,339       |       |       | 213,972    |       |
| Construction in progress         |       | 5,568         |       |       | 6,502      |       |
|                             |       |          |       |       |       |       |
| Gross propertyand equipment      |       | 1,804,347     |       |       | 1,189,314  |       |
| Less: accumulated depreciation   |       | (36,892       | )          |       | (257,322   | )          |
|                             |       |          |       |       |       |       |
| Net property and equipment       |       | $             | 1,767,455  |       |       | $          | 931,992 |   |
|                                  |            |               |            |            |            |            |  |  |  |  |

 

Assets held under capital leases, which are principally carried in building and improvements above, were $151.8 million and $60.1 million at December 31, 2007 and 2006, respectively.  Accumulated depreciation onassets held under capital leases was $2.9 million and $10.6 million at December 31, 2007 and 2006, respectively.

 

18

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**(7)****  ****Other Long-Term Assets**

 

Other long-term assets at December 31, 2007 and 2006 consist of the following (in thousands):

 
| ** **                              | ** ** | **Successor** | ** ** | ** ** | ** ** | ** ** | **Predecessor** | ** ** |
|-----------------------------------------|------------|---------------|------------|------------|------------|------------|-----------------|------------|
| ** **                              | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **2007**      | ** ** | ** ** | **2006**   | ** ** |
| ** **                              | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** |
| Notesreceivable, net                    |       | $             | 6,604      |       |       | $          | 9,946           |       |
| Assets held in Rabbi Trust              |       | 14            |       |       | 20,411     |       |
| Insuranceclaims recoverable             |       | 8,692         |       |       | 8,315      |       |
| Deferred financing fees, net            |       | 31,228        |       |       | 10,751     |       |
| Deposits andfunds held in escrow        |       | 17,609        |       |       | 26,273     |       |
| Advanced rents                          |       | 4,273         |       |       | 6,666      |       |
| Investments inunconsolidated affiliates |       | 10,856        |       |       | 2,314      |       |
| Cost report receivables                 |       | 6,321         |       |       | 5,130      |       |
| Other, net                              |       | 392           |       |       | 1,666      |       |
|                                    |       |          |       |       |       |       |
| Other long-term assets                  |       | $             | 85,989     |       |       | $          | 91,472          |       |
|                                         |            |               |            |            |            |            |                 |            |  |  |  |

 

Notes receivable are net of allowances of $22.6 million at December 31, 2006.  All allowances were eliminated at July 13, 2007 in connection with purchase accounting.

 

Deferred financing feesare recorded net of accumulated amortization of $9.1 million and $5.4 million at December 31, 2007 and 2006, respectively.

 

**(8)****  ****Goodwill andIdentifiable Intangible Assets**

 

The changes in the carrying value of goodwill are as follows (in thousands):

 
| **Successor**                                                                     | ** ** | **Period from July 14, 2007 through December 31, 2007** | ** ** | ** ** | ** **                                | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------|-------------------------------------------|------------|
| ** **                                                                        | ** ** | ** **                                                                  | ** ** | ** ** | ** **                                | ** ** |
| GHC Merger                                                                        |       | $                                                                           | 265,678    |       |                                      |       |   |
|                                                                              |       |                                                                        |       |       |                                      |       |
| **Predecessor**                                                                   | ** ** | **Period from January 1, 2007 through July 13, 2007**             | ** ** | ** ** | **3 months ended December 31, 2006** | ** ** |
|                                                                              |       |                                                                        |       |       |                                      |       |
| Balance atbeginning of period                                                     |       | $                                                                           | 10,758     |       |                                      | $          | 8,645 |   |
| Goodwill related to acquisitions of skillednursing and assisted living facilities |       | —                                                                      |       |       | 2,113                                     |       |
|                                                                              |       |                                                                        |       |       |                                      |       |
| Balance at end of period                                                          |       | $                                                                           | 10,758     |       |                                      | $          | 10,758 |   |

 

19

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Identifiable intangibleassets consist of the following (in thousands):

 
| **Successor**                                                        | ** ** | **2007** | ** ** | ** ** | **Weighted Average Life (Years)** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|------------|----------------------------------------|------------|
|                                                                 |       |     |       |       |                                   |       |
| Customerrelationship assets, net of accumulated amortization of $595 |       | $        | 19,263     |       |                                   | 16         |   |
| Favorable leases, net of accumulated amortizationof $4,077           |       | 95,004   |       |       | 15                                     |       |
|                                                                 |       |     |       |       |                                   |       |
| Indentifiable intangible assets, net                                 |       | $        | 114,267    |       |                                   |       |   |

 
| **Predecessor**                                                        | ** ** | **2006** | ** ** | ** ** | **Weighted Average Life (Years)** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|------------|----------------------------------------|------------|
|                                                                   |       |     |       |       |                                   |       |
| Customerrelationship assets, net of accumulated amortization of $1,355 |       | $        | 250        |       |                                   | 5          |   |
| Non-competition agreements, net of accumulatedamortization of $932     |       | 190      |       |       | 5                                      |       |
| Favorableleases, net of accumulated amortization of $3,845             |       | 3,725    |       |       | 11                                     |       |
|                                                                   |       |     |       |       |                                   |       |
| Indentifiable intangible assets, net                                   |       | $        | 4,165      |       |                                   |       |   |

 

Acquisition-related identified intangibleassets at December 31, 2007 consist of customer relationship assets and favorable lease contracts.  Customer relationship assets are being amortized on a straight-line basis over the expected period of benefit.  Favorable leasecontracts are amortized on a straight-line basis over the lease terms.

 

Amortization expense related to identifiable intangible assets in the Successor period from July 14, 2007 through December 31, 2007, the Predecessor periods of January 1, 2007through July 13, 2007, the three months ended December 31, 2006 and the year ended September 30, 2006 was $4.7 million, $0.7 million, $0.3 million and $1.3 million, respectively.

 

Based upon amountsrecorded at December 31, 2007, total estimated amortization expense of identifiable intangible assets for fiscal years 2008 through 2012 follows (in thousands):

 
|  2008 |   | $     | 10,049 |   |
|------------|--------|-------|--------|--------|
|  2009 |   | 9,978 |   |
|  2010 |   | 9,840 |   |
|  2011 |   | 9,786 |   |
|  2012 |   | 9,745 |   |

 

20

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**(9)   Long-Term Debt**

 

Long-term debtat December 31, 2007 and 2006 consists of the following (in thousands):

 
| ** **                                                  | ** ** | **Successor** | ** ** | ** ** | **Predecessor** | ** ** |
|-------------------------------------------------------------|------------|---------------|------------|------------|-----------------|------------|
| ** **                                                  | ** ** | **2007**      | ** ** | ** ** | **2006**        | ** ** |
| ** **                                                  | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** |
| ** **                                                  | ** ** | ** **    | ** ** | ** ** | ** **      | ** ** |
| Senior secured term loan                                    |       | $             | 1,300,000  |       |            | $          | — |   |
| Mezzanine term loan                                         |       | 375,000       |       |       | —          |       |
| Senior credit facility - revolvingcredit                    |       | —        |       |       | 39,000          |       |
| Senior subordinated notes                                   |       | —        |       |       | 145,935         |       |
| Convertible senior subordinateddebentures                   |       | —        |       |       | 180,000         |       |
| Mortgages and other secured debt (recourse)                 |       | 7,345         |       |       | 27,864          |       |
| Capital lease obligations                                   |       | 84,431        |       |       | 34,838          |       |
| Mortgages and other secured debt (non recourse)             |       | 42,790        |       |       | 44,079          |       |
| Unamortized debt premium on mortgagesand other secured debt |       | 592           |       |       | —          |       |
|                                                        |       |          |       |       |            |       |
|                                                        |       |          |       |       |            |       |
|                                                        |       | 1,810,158     |       |       | 471,716         |       |
| Less:                                                       |       |          |       |       |            |       |
| Current installments of long-term debt                      |       | (10,664       | )          |       | (14,178         | )          |
|                                                        |       |          |       |       |            |       |
|                                                        |       |          |       |       |            |       |
| Long-term debt                                              |       | $             | 1,799,494  |       |            | $          | 457,538 |   |

 

Inconnection with the completion of the Genesis Acquisition on July 13, 2007, the Company entered into a senior secured credit facility and a mezzanine term loan.  The senior credit facility and the mezzanine term loan required the Companyto enter into certain interest rate hedge agreements to mitigate the risk of rising variable rates of interest. See note 20 — “Subsequent Events”.

 

***Senior secured creditfacility***

 

The senior secured credit facility consists of the following subfacilities:  (i) a $1.3 billion senior secured term loan, (ii) a $100 million delayed draw term loan and (iii) a$100 million revolving credit facility.  The Company pays interest monthly on the outstanding loans under the senior secured credit facility.

 

Borrowings bear interest at a rate equal to, at theCompany’s option, either a base rate or at the London Interbank Offered Rate (LIBOR) plus a margin.  The base rate is determined by reference to the higher of (i) a lender-defined prime rate plus 1.0%, and (ii) the federal fundsrate plus 1.5%.  The applicable margin with respect to LIBOR borrowings is 2%.  LIBOR borrowings under the senior secured credit facility bore interest of approximately 6.6% at December 31, 2007.

 

Principal amounts outstanding under each of the three subfacilities are due and payable in full at maturity, July 13, 2009.  If certain conditions are met, the Company can extend the maturity of the subfacilitiespursuant to three one-year extension options.

 

The senior secured term loan and the delay draw term loan cannot be voluntarily prepaid prior to July 13, 2008 unless certainevents occur, and can only be prepaid in full between July 14, 2008 and July 13, 2009.  Any prepayment that occurs on or before July 13, 2009 is subject to a prepayment penalty.  The senior secured term loan can be prepaidin full or in part without penalty if the maturity is extended beyond July 13, 2009.  The senior secured term loan and the delayed draw term loan are subject to partial mandatory prepayment under certain circumstances, including the

 

21

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Company’sreceipt of insurance proceeds received following damage to properties or the receipt of proceeds upon the sale of real property.  In these circumstances, the proceeds received must be used to prepay the senior secured term loan and or thedelayed draw term loan.

 

The senior secured credit agreement requires funds be placed in escrow for property tax and property insurance obligations.  In addition, the senior secured credit agreement requires that cash beplaced in escrow on a monthly basis (approximately $6.8 million annually) to fund routine maintenance and the replacement of furniture, fixtures and equipment.  The lender releases funds from this escrow when the Company presents evidence thatoperating funds have been expended for such routine maintenance and replacement activities.  At December 31, 2007, $2.3 million is held in escrow for routine maintenance, which is included in prepaid expenses and other currentassets.

 

All obligations under the senior secured credit facility are secured by a security interest in substantially all of the assets of the Company.

 

The senior secured credit agreement contains a number ofcovenants that, among other things, restrict, subject to certain exceptions, the Company’s ability to:  incur additional indebtedness; provide guarantees; create liens on assets; engage in mergers, acquisitions or consolidations; sellassets; make distributions; make investments, loans or advances; repay indebtedness, except as scheduled or at maturity; engage in certain transactions with affiliates; amend material agreements governing the Company’s outstanding indebtedness;and fundamentally change the Company’s business.  In addition, the senior secured credit facility agreement requires the Company to meet defined financial covenants, including a maximum consolidated leverage ratio, a minimum consolidatedfixed charge coverage ratio and a minimum consolidated project yield.  The senior secured credit agreement also contains certain customary affirmative covenants, such as financial and other reporting, and certain events of default.  AtDecember 31, 2007, the Company was in compliance with all of these covenants.

 

*Senior secured term loan.* The senior secured term loanof $1.3 billion was fully drawn on July 13, 2007 to fund the Merger.

 

*Delayed draw term loan.* The $100 million delayed drawterm loan was established to provide the Company a source of financing to make certain qualifying capital improvements or acquisitions.  Amounts repaid under the delayed draw term loan may not be reborrowed.  As of December 31, 2007,the Company had no outstanding borrowings under the delayed draw term loan.

 

*Revolving credit facility.* The $100 million revolvingcredit facility was established to provide the Company a source of financing to fund general working capital requirements.  Borrowings under the revolving credit facility may be in the form of revolving loans or swing line loans. Aggregate outstanding swing line loans have a sub-limit of $10 million.  The revolving credit facility also provides a sub-limit of $35 million for letters of credit.  Borrowing levels under the revolving credit facility are limited to aborrowing base that is computed based upon the level of Company eligible accounts receivable, as defined.  In addition to paying interest on the outstanding principal borrowed under the revolving credit facility, the Company is required to paya commitment fee to the lenders for any unutilized commitments.  The commitment fee rate is 0.375% per annum.  As of December 31, 2007, the Company had no outstanding borrowings under the revolving credit facility and had $31.2million of undrawn letters of credit and other encumbrances, leaving the Company with $68.8 million of borrowing capacity under the revolving credit facility.

 

***Mezzanine TermLoan***

 

The mezzanine term loan of $379.1 million was fully drawn on July 13, 2007 to fund the Merger.  Borrowings bear interest at a rate equal to LIBOR plus 7.5%.  Borrowings under the mezzanine term loan boreinterest at approximately 12.1% at December 31, 2007.  A principal amount of $4.1 million is required to be repaid within the first year of the borrowing with the remaining principal amount outstanding due and payable in full at maturity,July 13, 2012.

 

The mezzanine term loan agreement contains both voluntary and mandatory prepayment restrictions subject to prepayment penalties set forth in the agreement.  The Company must maintain a debtservice reserve held by the lender without interest equal to $4.1 million.  The balance is included in prepaid expenses and other current assets.

 

22

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All obligations under the mezzanine term loan are secured by a security interest in substantially all of the assets of the Company, subject to subordination to the senior secured credit facility.

 

The mezzanine term loan contains covenants similar to, and no more restrictive than, those required under the senior secured credit agreement.  At December 31, 2007, the Company was in compliance with all of thesecovenants.

 

***Other Debt***

 

*Mortgages and other secured debt (recourse). *AtDecember 31, 2007 and 2006, the Company had $7.3 million and $27.9 million, respectively, of other secured debt consisting principally of revenue bonds and secured bank loans, including loans insured by the Department of Housing and UrbanDevelopment.  These loans are secured by the underlying real and personal property of individual eldercare centers and have fixed or variable rates of interest ranging from 7.1% to 8.9% at December 31, 2007.

 

*Capital lease obligations.*  The capital lease obligations represent the present value of minimum lease payments under such capital leasearrangements and bear imputed interest at rates ranging from 7.00% to 16.2% at December 31, 2007 and mature at dates ranging primarily from 2008 to 2025.

 

*Mortgages and other secured debt(non-recourse).* These loans are carried by certain of the Company’s joint ventures consolidated pursuant to FIN 46.  The loansconsist principally of revenue bonds and secured bank loans.  These loans are secured by the underlying real and personal property of individual eldercare centers and have fixed or variable rates of interest ranging from 3.5% to 8.7% atDecember 31, 2007, with maturity dates ranging from 2010 to 2038.  These loans are labeled “non-recourse” because neither the Company nor a wholly owned subsidiary is obligated to perform under the respective loan agreements.

 

***Repayment of Predecessor Debt***

 

With the proceeds of new borrowings and the equity contributions in connection with the Merger, the Company repaid the outstandingbalances of its predecessor company senior credit facility, senior subordinated notes, convertible senior subordinated debentures, certain mortgages and other secured debt.  In connection with the repayment of the senior subordinated notes andthe convertible senior subordinated debentures, the Company incurred combined prepayment penalties and conversion premiums of $83.0 million, which were included in the purchase price of the transaction.

 

The maturity of total debt, excluding capital lease obligations, of $1,725.7 million at December 31, 2007 is as follows:  $10.7 million in fiscal 2008, $1,308.2 million in fiscal 2009, $7.5 million in fiscal 2010,$1.2 million in fiscal 2011, $376.3 million in fiscal 2012 and $21.8 million thereafter.

 

**(10) Derivative Financial Instruments**

 

***Successor***

 

The senior secured credit facility agreement and the mezzanine term loan agreement require the Company to enter into financial instruments to protect against fluctuations in interest rates for a notional amount equal to thecombined outstanding principal balance of the senior secured credit facility and the mezzanine term loan such that LIBOR does not exceed 6.5%.  Accordingly, on July 13, 2007, the Company entered into an interest rate swap contract and aninterest rate cap contract.

 

These contracts are not designated for hedge accounting treatment, and therefore, the Company records the fair value (estimated unrealized gain or loss) of the agreements as an asset or liability andthe change in any period as an adjustment to interest expense in the consolidated statement of operations.  Realized gains and losses associated with these contracts are recorded as adjustments to interest expense each reporting period. The counterparties to the derivative financial instruments are major financial institutions.  The Company does not use derivative financial instruments for any trading or speculative purposes.

 

23

----

 

The interest rate swap agreement has a notional amount of $1 billion.  The Company is required to make payments to the counterparty at the fixed rate of 5.34% and in return, the Company receives payments at a variablerate based on the one month LIBOR, which was 4.6% at December 31, 2007.  The fair value of the interest rate swap agreement at December 31, 2007 is recorded as a liability of $40.3 million, in other long-term liabilities in theconsolidated balance sheet with a corresponding charge to interest expense in the consolidated statement of operations of the Successor.  The interest rate swap agreement expires on July 13, 2010.

 

The interest rate cap agreement has a notional amount of $675 million.  Under this agreement, the Company receives variable interest rate payments when the one-month LIBOR rises above 6.0%.  The Company paid a feeof $0.9 million at the inception of the interest rate cap agreement, which is being amortized to interest expense over the term of the agreement.  The interest rate cap agreement expires on July 13, 2009.

 

The Company is exposed to credit loss, in the event of nonperformance by the counterparties to the interest rate swap and interest rate cap agreements.  As of December 31, 2007, we do not anticipate nonperformanceby the counterparties to these agreements and no material loss would be expected from any such nonperformance.

 

***Successor and Predecessor***

 

The Company consolidates one VIE that entered into an interest rate swap agreement.  The VIE is exposed to the impact of interest rate changes because its long-term debt bears interest at a variable rate.  TheVIE’s obligation under the interest rate swap agreement is non-recourse to the Company.  The interest rate swap agreement effectively converts approximately $6.7 million and $6.9 million at December 31, 2007 and 2006, respectively, ofvariable-rate debt (one month LIBOR) into fixed-rate debt (4.38%).  The interest rate swap agreement matures on July 29, 2010.  The counterparty to the interest rate swap agreement is a major institutional bank.

 

The VIE’s objective in managing exposure to interest rate changes is to limit the impact of such changes on its earnings and cash flows and to lower its overall borrowing costs.  The VIE’s debt and obligationunder the interest rate swap agreement are non-recourse to the Company.   The VIE does not enter into such arrangements for trading purposes.  Such instruments are recognized on the consolidated balance sheet at fair value. Changes in the fair value of a derivative that is designated as and meets all of the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income (loss) and reclassified as an adjustment to interest expense as theunderlying hedged item affects earnings.

 

**(11)****Leases and Lease Commitments**

 

The Company leases certain facilities under capital and operating leases.  Futureminimum payments for the next five years and thereafter under such leases at December 31, 2007 are as follows (in thousands):

 
| **Yearending December 31,**           | ** ** | **Capital Leases** | ** ** | **Operating Leases** | ** ** |
|--------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                 | ** ** | ** **         | ** ** | ** **           | ** ** |
| 2008                                       |       | $                  | 8,517      |                 | $          | 21,580 |   |
| 2009                                       |       | 36,037             |       | 19,934               |       |
| 2010                                       |       | 6,261              |       | 19,134               |       |
| 2011                                       |       | 6,376              |       | 16,873               |       |
| 2012                                       |       | 6,191              |       | 15,548               |       |
| Thereafter                                 |       | 103,808            |       |                 | 35,518     |   |
| Total future minimum leasepayments         |       | 167,190            |       |                 | $          | 128,587 |   |
| Less amount representing interest          |       | (82,759            | )          |                 |       |   |
| Present value of net minimum leasepayments |       | 84,431             |       |                 |       |   |
| Less current portion                       |       | (1,645             | )          |                 |       |   |
| Long-term capital leaseobligation          |       | $                  | 82,786     |                 |       |   |   |

 

24

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The Company holds fixed price purchase options to acquire the land and buildings of nineteen centers for $123.5 million with expirations ranging from 2009 to 2025.  Three of these options are deemed to be bargainpurchases and, consequently, these leases have been classified as capital leases contributing $29.8 million in capital lease obligations of the total $84.4 million at December 31, 2007.  The large capital lease obligation in fiscal 2009 iscaused by the three bargain purchase options which become exercisable in that year.  The Company also classifies 14 other center leases as capital leases contributing $54.6 million to the capital lease obligation at December 31,2007.

 

Deferred lease balances carried on the consolidated balance sheets represent future differences between accrual basis and cash basis lease costs.  Differences between lease expense on an accrual basis and the amount ofcash dispersed for lease obligations is caused by:

 

·                  Unfavorable or favorable lease balances principally established inconnection with the Merger and deferred gains on sale leaseback transactions which are amortized on a straight-line basis over the lease term;

 

·                  Lease balances established to account for operating lease costs on astraight-line basis; and

 

·                  Advanced rent payments made to lessors in order to reduce future lease payments which are amortized on a straight-line basis over the lease term.

 

At December 31, 2007, the Company had $95.0 millionof favorable leases net of accumulated amortization, included in other identifiable intangible assets and $5.9 million of unfavorable leases net of accumulated amortization included in other long-term liabilities on the consolidated balancesheet.  The favorable leases will be amortized as an increase to lease expense over the remaining lease terms, which have a weighted average term of 15 years.  The unfavorable leases will be amortized as a decrease to lease expense overthe remaining lease terms, which have a weighted average term of 8 years.

 

The net balance of the straight-line lease adjustment at December 31, 2007 of $1.3 million is included in other long-termliabilities on the consolidated balance sheets.

 

The balance of advanced rent payments at December 31, 2007 of $4.3 million is included in other long-term assets in theconsolidated balance sheet and will be amortized as an increase to lease expense over the remaining lease terms, which have a weighted average term of 3.7 years.

 

** (12)****Income Taxes**

 

Total income tax (benefit) expense was as follows (in thousands):

 
| ** **                                     | ** ** | **Successor**                                                        | ** ** | ** ** | **Predecessor**                                                    | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Period from July  14, 2007 through  December 31,  2007** | ** ** | ** ** | **Period from  January 1, 2007  through July 13,  2007** | ** ** | **Three months  ended December 31, 2006** | ** ** | **Year Ended  September 30,  2006** | ** ** |
|                                           |       |                                                                 |       |       |                                                               |       |   |   |   |   |
| From continuing operations                     |       | $                                                                    | (25,570    | )          |                                                               | $          | 6,484 |   | $ | 8,835 |   | $ | 27,026 |   |
| From cumulative effect of an accounting change |       | —                                                               |       |       | —                                                             |       | — |   | (1,054 | ) |
| From discontinued operations                   |       | 670                                                                  |       |       | (172                                                               | )          | 65 |   | (1,548 | ) |
| From shareholders’equity                  |       | (2,129                                                               | )          |       | (3,309                                                             | )          | (1,353 | ) | (7,297 | ) |
|                                           |       |                                                                 |       |       |                                                               |       |   |   |   |   |
| Total                                          |       | $                                                                    | (27,029    | )          |                                                               | $          | 3,003 |   | $ | 7,547 |   | $ | 17,127 |   |

 

25

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The components of the provision for income taxes on (loss) income from continuing operations for the periods presented were as follows (in thousands):

 
| ** ** | ** ** | **Successor**                                                        | ** ** | ** ** | **Predecessor**                                                  | ** ** |
|------------|------------|----------------------------------------------------------------------|------------|------------|------------------------------------------------------------------|------------|
| ** ** | ** ** | **Period from July  14, 2007 through  December 31,  2007** | ** ** | ** ** | **Period from January 1, 2007 through July 13,  2007** | ** ** | **Three months ended December 31, 2006** | ** ** | **Year Ended September 30, 2006** | ** ** |
|       |       |                                                                 |       |       |                                                             |       |   |   |   |   |
| Current:   |       |                                                                 |       |       |                                                             |       |   |   |   |   |
| Federal    |       | $                                                                    | (5,024     | )          |                                                             | $          | (5,439 | ) | $ | 6,611 |   | $ | 4,995 |   |
| State      |       | 20                                                                   |       |       | (1,394                                                           | )          | 2,451 |   | 4,486 |   |
|       |       |                                                                 |       |       |                                                             |       |   |   |   |   |
|       |       | (5,004                                                               | )          |       | (6,833                                                           | )          | 9,062 |   | 9,481 |   |
|       |       |                                                                 |       |       |                                                             |       |   |   |   |   |
| Deferred:  |       |                                                                 |       |       |                                                             |       |   |   |   |   |
| Federal    |       | (15,109                                                              | )          |       | 10,674                                                           |       | 1,570 |   | 16,089 |   |
| State      |       | (5,457                                                               | )          |       | 2,643                                                            |       | (1,797 | ) | 1,456 |   |
|       |       |                                                                 |       |       |                                                             |       |   |   |   |   |
|       |       | (20,566                                                              | )          |       | 13,317                                                           |       | (227 | ) | 17,545 |   |
|       |       |                                                                 |       |       |                                                             |       |   |   |   |   |
| Total      |       | $                                                                    | (25,570    | )          |                                                             | $          | 6,484 |   | $ | 8,835 |   | $ | 27,026 |   |

 

Total income tax (benefit) expense for the periods presented differed from the amounts computed by applying the U.S. federal income tax rate of 35% to (loss) income from continuing operationsbefore income taxes, equity in net income of unconsolidated affiliates and minority interests as illustrated below (in thousands):

 
| ** **                                               | ** ** | **Successor**                                                        | ** ** | ** ** | **Predecessor**                                                    | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Period from July  14, 2007 through  December 31,  2007** | ** ** | ** ** | **Period from  January 1, 2007  through July 13,  2007** | ** ** | **Three months  ended December  31, 2006** | ** ** | **Year Ended  September 30,  2006** | ** ** |
| ** **                                               | ** ** | ** **                                                           | ** ** | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Computed “expected” (benefit)tax               |       | $                                                                    | (21,704    | )          |                                                               | $          | (245 | ) | $ | 7,751 |   | $ | 23,176 |   |
| Increase (reduction) in income taxes resulting from:     |       |                                                                 |       |       |                                                               |       |   |   |   |   |
| State and local income taxes, net of federaltax benefits |       | (3,353                                                               | )          |       | 810                                                                |       | 425 |   | 3,832 |   |
| Targetedjobs tax credit                                  |       | (697                                                                 | )          |       | (322                                                               | )          | (326 | ) | (629 | ) |
| Non deductible transaction costs                         |       | —                                                               |       |       | 6,021                                                              |       | 975 |   | — |   |
| Other, net                                               |       | 184                                                                  |       |       | 220                                                                |       | 10 |   | 647 |   |
|                                                     |       |                                                                 |       |       |                                                               |       |   |   |   |   |
|                                                     |       |                                                                 |       |       |                                                               |       |   |   |   |   |
| Total income tax(benefit) expense                        |       | $                                                                    | (25,570    | )          |                                                               | $          | 6,484 |   | $ | 8,835 |   | $ | 27,026 |   |

 

26

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The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2007 and 2006 are presented below (in thousands):

 
|                                            |   | **Successor** |       |       | **Predecessor** |
|-------------------------------------------------|--------|---------------|------------|------------|-----------------|
|                                            |   | **2007**      | ** ** | ** ** | **2006**        |
|                                            |   | ** **    | ** ** | ** ** | ** **      |
|                                            |   |          |       |       |            |
| Deferred Tax Assets:                            |   |          |       |       |            |
| Accounts receivable                             |   | $             | 21,490     |       |            | $ | 20,560 |
| Accruedliabilities and reserves                 |   | 52,833        |       |       | 42,454          |
| Net operating loss carryforwards (NOL)          |   | 85,036        |       |       | 78,445          |
| Netunfavorable leases                           |   | 3,063         |       |       | 967             |
| Other                                           |   | 16,837        |       |       | 7,539           |
| Total deferred tax assets                       |   | 179,259       |       |       | 149,965         |
| Valuation allowance                             |   | (46,700)      |       |       | (46,700)        |
| Deferred tax assets, net of valuation allowance |   | 132,559       |       |       | 103,265         |
| Deferred Tax Liabilities:                       |   |          |       |       |            |
| Accrued liabilities and reserves                |   | (3,861)       |       |       | (651)           |
| Long-lived assets                               |   | (395,912)     |       |       | (49,927)        |
| Total deferred tax liabilities                  |   | (399,773)     |       |       | (50,578)        |
| Net deferred tax (liability) asset              |   | $             | (267,214)  |       |            | $ | 52,687 |
|                                                 |        |               |            |            |                 |  |  |  |

 

 

Management believes the deferred tax assets at December 31, 2007 and 2006 are morelikely than not to be realized.  As of December 31, 2007, the Company expects it will have sufficient taxable income in future periods from the reversal of existing taxable temporary differences and expected profitability such that theremaining NOL would be utilized within the carryforward period.  The Company had federal NOL carryforwards remaining of $83.5 million at December 31, 2007.  The earliest and most significant NOL arose in fiscal 2001 and has acarryforward period of 20 years.

 

The Company’s NOL carryforwards for state purposes have a tax value of $60.8 million and expire from 2008 to 2028.  These deferred tax assets are subject to a valuation allowance of $46.7million.  Substantially all of the NOL was recorded in connection with the Predecessor Company, and reduction in the valuation allowance will result principally in a corresponding reduction to goodwill.

 

Utilization of deferred tax assets existing at the Predecessor Company’s October 2, 2001 bankruptcy emergence date must be applied first as a reduction of any Predecessor Company identifiable intangible assetsand, then, as an increase to shareholders’ equity.  The Company recorded an increase to shareholders’ equity in the Successor period from July 14, 2007 through December 31, 2007, the Predecessor periods of January 1,2007 through July 13, 2007, the three months ended December 31, 2006 and the year ended September 30, 2006 of $2.6 million, $3.5 million, $1.4 million and $7.6 million, respectively.

 

** (13)****Related Party Transactions**

 

**       **In connection with the Merger, the Company paid affiliates of the Sponsors $2.3 million of transaction, acquisition advisory services and similar fees.  This amount is included in the total purchase price of theMerger.

 

        Following the July 13, 2007 transaction, the Company pays an affiliate of one of the Sponsors a monthly fee for the provision of administrative services.  The fee isbased upon the number of licensed owned, leased and managed beds operated by the Company.  Based upon the Company’s current bed count, the fee approximates $2.9 million per annum.

 

**(14)****Shareholders’ Equity**

 

***Successor***

 

*Capital stock*

 

Total authorized capital stock consists of 1,500 shares, no par value, all of which is issued and outstanding as of December 31, 2007 and are held by the Parent.  Each share of capital stock is entitled, on allmatters for a vote or the consent of holders of the capital stock, to one vote.

 

27

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*Capital Contributed by Parent*

 

The Company received $300.0 million from the Parent to fund the Merger.  During the Successor period, the Company made $8 millionof cash distributions to the Parent.

 

***Predecessor***

 

*Shareholders’ Equity*

 

The Company, through Merger Corp, acquired all of the outstanding common stock and common stock equivalents of the Predecessor Company in connection with the Merger on July 13, 2007.  Accordingly, the PredecessorCompany common stock is retired.

 

**(15)****Stock-Based Benefit Plans**

 

***Successor***

 

The Successor Company does not have any stock-based benefit plans.  Accordingly, no stock-based compensation expense is recognized in the Successor period.

 

***Predecessor***

 

Prior to the Merger, the Company had two stock-based benefit plans involving stock options and restricted stock awards.  Pursuantto the Merger, all outstanding stock options and restricted stock awards became fully vested and the holders became entitled to receive cash consideration equal to the difference between the exercise price and $69.35 per share for stock options and$69.35 for each share of restricted stock.  The Predecessor Company stock-based benefit plans were discontinued in connection with the Merger.  Under the terms of the stock option and restricted stock agreements, the terms of the awardswere fixed at the grant date.

 

In addition to stock-based benefit plans, the Predecessor had a non-qualified deferred compensation plan for certain of its employees.  Under theprovision of the plan, a rabbi trust was established to maintain the amounts deferred by the participants.  Certain of the plan participants elected to invest their deferred compensation in Predecessor stock units, which effectively mirroredthe performance of the Predecessor common stock.  To satisfy a portion of the obligations under the deferred compensation plan, the Predecessor held shares of its common stock in an amount that approximated the number of stock units invested byplan participants.  For those participant accounts holding stock units for which the Predecessor was not required to settle its obligations by the delivery of shares of employer stock, the Predecessor recognized changes in the fair value ofsuch common stock held in the rabbi trust as periodic charges or credits to compensation cost.

 

For the period January 1, 2007 to July 13, 2007, the three months ended December 31, 2006 and the twelve months endedSeptember 30, 2006, compensation cost charged to expense for stock-based benefit plans and the impact of changes in the fair value of the common stock held in the rabbi trust was approximately $7.9 million (before taxes of $3.2 million), $2.8million (before taxes of $1.2 million) and $11.1 million (before taxes of $4.5 million), respectively.  The compensation cost recognized is classified as general and administrative expenses in the consolidated statements of operations.  Nocost was capitalized.

 

*Stock Options*

 

Compensation cost for stock options was recognized in the Predecessor period based upon the estimated fair value on the date of grantcomputed using a lattice-based binomial option pricing model over the vesting period during which employees performed the related services.

 

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For the period January 1, 2007 to July 13, 2007, the three months ended December 31, 2006 and the twelve months ended September 30, 2006, compensation cost charged to expense for stock options wasapproximately $1.8 million, $0.9 million and $4.5 million, respectively.

 

For the twelve months ended September 30, 2006, the weighted average grant date fair value of the 599,500 stock options grantedwas approximately $18.31 per option.  There were no stock options granted beyond September 30, 2006.

 

In connection with the Merger, and pursuant to certain change in control provisions of the stock option plan, allnonvested stock options vested immediately, which resulted in a charge of $4.9 million during the Predecessor period from January 1, 2007 to July 13, 2007 for the recognition of all unrecognized compensation costs.  The charge isrecorded in Merger related costs in the consolidated statements of operations.

 

*Restricted stock*

 

Compensation cost for restricted stock was recognized in thePredecessor period ratably over the service period at the market value of the Predecessor common stock on the date of the grant.

 

For the period January 1, 2007 to July 13, 2007, the three months endedDecember 31, 2006 and the twelve months ended September 30, 2006, compensation cost charged to expense for restricted stock was approximately $3.1 million, $2.0 million and $5.1 million, respectively.

 

Pursuant to the Merger agreement, all restrictions placed on nonvested restricted stock automatically lapsed on July 13, 2007, which resulted in a charge of $17.4 million during the Predecessor period fromJanuary 1, 2007 to July 13, 2007 for the fair value of the unvested restricted stock awards at July 13, 2007.  The charge is recorded in Merger related costs in the consolidated statements of operations.

 

**(16)****Commitments and Contingencies**

 

***Loss Reserves For Certain Self-InsuredPrograms***

 

*General and Professional Liability and Workers’ Compensation*

 

The Company uses a combination of insurance and self-insurance mechanisms, including awholly owned captive insurance subsidiary that is domiciled in Bermuda, to provide for potential liabilities for general and professional liability claims and workers’ compensation claims.  Policies are written for a duration of twelvemonths and are measured on a “claims made” basis.

 

Excess coverage above self-insured retention limits is provided through third party insurance policies generally in the form of perincident limits and aggregate policy limits for both general and professional liability and workers’ compensation claims.

 

As of December 31, 2007, the Company’s estimated range of outstanding lossesfor these liabilities on an undiscounted basis is $115.9 million to $152.4 million ($107.8 million to $134.4 million net of amounts recoverable from third-party insurance carriers).  The Company recorded reserves for these liabilities were$124.8 million as of December 31, 2007, net of $8.7 million recoverable from third-party insurance carriers, and are included in self-insurance liability reserves in its consolidated balance sheet.  The amount recoverable from third-partyinsurance carriers is included in other long-term assets in the consolidated balance sheets. The Company includes in current liabilities the estimated loss and loss expense payments that are projected to be satisfied within one year of the balancesheet date.

 

The Company, through its wholly owned captive insurance subsidiary has restricted cash and investments in marketable securities of $98.6 million at December 31, 2007, which are substantially restricted to securing theoutstanding claim losses of insured through the captive.

 

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Although management believes that the amounts provided in the Company’s consolidated financial statements are adequate and reasonable, there can be no assurances that the ultimate liability for such self-insured riskswill not exceed management’s estimates.

 

*Health Insurance*

 

The Company offers employees an option to participate in aself-insured health plan.  Health claims under this plan are self-insured with a stop-loss umbrella policy in place to limit maximum potential liability for both individual claims and total claims for a plan year.  Health insurance claimsare paid as they are submitted to the plan administrator.  The Company maintains an accrual for claims that have been incurred but not yet reported to the plan administrator and therefore have not been paid.  The liability for theself-insured health plan is recorded in accrued compensation in the consolidated balance sheets.  Although management believes that the amounts provided in the Company’s consolidated financial statements are adequate and reasonable, therecan be no assurances that the ultimate liability for such self-insured risks will not exceed management’s estimates.

 

***Financial Commitments***

 

Requests for providing commitments to extend financial guarantees and extend credit are reviewed and approved by senior management subject to obligational authority limitations.  Management regularly reviewsoutstanding commitments, letters of credit and financial guarantees, and the results of these reviews are considered in assessing the need for any reserves for possible credit and guarantee loss.

 

The Company has extended $3.1 million in working capital lines of credit to certain jointly owned and managed companies, including certain consolidated VIEs, of which $1.4 million was unused at December 31, 2007. In addition, the Company has agreed to extend credit for working capital needs of one managed nursing center.  Under that arrangement, the property’s owner is responsible for funding working capital needs up to $0.9 million and the Companywould be required to cover deficits in excess of that limit.  To date, the Company has not had to perform under that agreement.  Credit risk represents the accounting loss that would be recognized at the reporting date if the affiliatecompanies were unable to repay any amounts utilized under the working capital lines of credit.  Commitments to extend credit to third parties are conditional agreements generally having fixed expiration or termination dates and specificinterest rates and purposes.

 

The Company has posted $26.9 million of outstanding letters of credit.  The letters of credit guarantee performance to third parties of various trade activities.  The letters of credit arenot recorded as liabilities on the Company’s consolidated balance sheet unless they are probable of being utilized by the third party.  The financial risk approximates the amount of outstanding letters of credit.

 

The Company is a party to joint venture partnerships whereby its ownership interests are 50% or less of the total capital of the partnerships.  The Company accounts for certain of these partnerships using either thecost or equity method of accounting depending on the percentage of ownership interest, and therefore, the assets, liabilities and operating results of these partnerships are not consolidated with the Company’s.  Certain other of theCompany’s joint venture partnerships qualify as VIEs, and where the Company is determined to be the primary beneficiary of such arrangements, are consolidated.  The carrying value of the Company’s investment in unconsolidated jointventure partnerships is $10.9 million and $2.3 million at December 31, 2007 and 2006, respectively.  Although the Company is not contractually obligated to fund operating losses of these partnerships, in certain cases it has extendedcredit to such joint venture partnerships in the past and may decide to do so in the future in order to realize economic benefits from its joint venture relationship.  Management assesses the creditworthiness of such partnerships in the samemanner it does other third parties.  The underlying debt obligations of the Company’s consolidated VIEs are non-recourse to it.  Guarantees are not recorded as liabilities on the Company’s consolidated balance sheet unless it isrequired to perform under the guarantee.  Credit risk represents the accounting loss that would be recognized at the reporting date if the counter-parties failed to perform completely as contracted.  The credit risk amounts are equal tothe contractual amounts, assuming that the amounts are fully advanced and that no amounts could be recovered from other parties.

 

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***Legal Proceedings***

 

The Company is a party to litigation and regulatory investigations arising in the ordinary course of business.  Management doesnot believe the results of such litigation and regulatory investigations, even if the outcome is unfavorable, would have a material adverse effect on the results of operations, financial position or cash flows of the Company.

 

***Conditional Asset Retirement Obligations***

 

Certain of the Company’s real estate assets contain asbestos.  The asbestos isbelieved to be appropriately contained in accordance with environmental regulations.  If these properties were demolished or subject to renovation activities that disturb the asbestos, certain environmental regulations are in place, whichspecify the manner in which the asbestos must be handled and disposed.

 

At December 31, 2007, the Company has a liability for the fair value of the asset retirement obligation associated primarily withthe cost of asbestos removal aggregating approximately $4.2 million, which is included in other long-term liabilities.  The liability for each facility will be accreted to its present value, which is estimated to approximate $16.2 millionthrough the estimated settlement dates extending from 2008 through 2042.  Due to the time over which these obligations could be settled and the judgment used to determine the liability, the ultimate obligation may differ from theestimate.  Upon settlement, any difference between actual cost and the estimate is recognized as a gain or loss in that period.

 

Upon initial establishment on September 30, 2006, Predecessor recognized aliability for the fair value of the asset retirement obligation aggregating approximately $5.3 million and an asset aggregating approximately $2.3 million.  In addition, the Predecessor Company recognized the cumulative effect, totalingapproximately $1.7 million, net of taxes, $1.5 million of which is included in cumulative effect of an accounting change and $0.2 million of which is included in loss from discontinued operations in the consolidated statements of operation for theyear ended September 30, 2006.

 

Annual accretion of the liability and depreciation expense is recorded each year for the impacted assets until the obligation year is reached, either by sale of the property, demolition orsome other future event such as a government action.

 

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The changes in the carrying amounts of the Company’s asset retirement obligations for the Successor period from July 14, 2007 to December 31, 2007 and the Predecessor period from January 1, 2007 toJuly 13, 2007 and for the three months ended December 31, 2006 are as follows (in thousands):

 
| **Predecessor**                                                                | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                                     | ** ** | ** ** | ** ** |
| Assetretirement obligations, September 30, 2006                           |       | $          | 5,277      |   |
| Accretion expense                                                              |       | 78         |       |
| Asset retirement obligations, December 31, 2006                           |       | $          | 5,355      |   |
|                                                                           |       |       |       |
| Asset retirement obligations, December 31,2006                            |       | $          | 5,355      |   |
| Assetretirement obligations incurred                                           |       | 175        |       |
| Asset retirement obligations settled                                           |       | (467       | )          |
| Accretionexpense                                                               |       | 168        |       |
|                                                                           |       |       |       |
| Asset retirement obligations, July 13, 2007                               |       | $          | 5,231      |   |
|                                                                           |       |       |       |
| **Successor**                                                                  | ** ** | ** ** | ** ** |
| ** **                                                                     | ** ** | ** ** | ** ** |
| Establishmentof asset retirement obligations at fair value, July 14, 2007 |       | $          | 4,367      |   |
| Asset retirement obligations settled                                           |       | (280       | )          |
| Accretionexpense                                                               |       | 134        |       |
|                                                                           |       |       |       |
| Asset retirement obligations, December 31, 2007                           |       | $          | 4,221      |   |

 

***Employment Agreements***

 

The Company has employment agreements and arrangements with its executive officers and certain members of management. The agreements generally continue until terminated by the executive or the Company, and provide forseverance payments under certain circumstances.

 

***Other***

 

The Company is pursuing a restructuring of its operationspursuant to which virtually all of the owned and leased land, property and equipment are separated from the rights and responsibilities related to the operations of the Company into separate special purpose entities.  The restructuring, ifconsummated, is expected to occur prior to December 31, 2008.

 

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**(17)****Fair Value of Financial Instruments**

 

The carrying amount and fair value of financial instruments at December 31, 2007and 2006 consist of the following (in thousands):

 
| ** **                                              | ** ** | **Successor**       |       |           |       |       | **Predecessor**     |       |
|---------------------------------------------------------|------------|---------------------|------------|----------------|------------|------------|---------------------|------------|
| ** **                                              | ** ** | **2007**            |       |           |       |       | **2006**            |       |
| ** **                                              | ** ** | ** **          |       |           | ** ** |       |
| ** **                                              | ** ** | **Carrying Amount** | ** ** | **Fair Value** | ** ** | ** ** | **Carrying Amount** | ** ** | **Fair Value** |   |
|                                                    |       |                |       |           |       |       |                |       |   |   |
| Cash andequivalents                                     |       | $                   | 53,419     |           | $          | 53,419     |                |       | 66,270 |   | $ | 66,270 |   |
| Restricted cash and investments in marketablesecurities |       | 105,995             |       | 105,995        |       |       | 98,223              |       | 98,223 |   |
| Accountsreceivable, net                                 |       | 249,710             |       | 249,710        |       |       | 244,515             |       | 244,515 |   |
| Accounts payable                                        |       | 49,601              |       | 49,601         |       |       | 51,914              |       | 51,914 |   |
| Debt,excluding capital leases                           |       | 1,725,727           |       | 1,728,038      |       |       | 436,878             |       | 456,123 |   |
| Pay fixed/receive variable interest rate swap           |       | (40,338             | )          | (40,338        | )          |       | 136                 |       | 136 |   |
|                                                    |       |                |       |           |       |       |                |       |   |   |
|                                                         |            |                     |            |                |            |            |                     |            |  |  |  |  |  |  |  |

 

The carrying value of cash and equivalents, net accounts receivable and accounts payable is equal to its fair value due to their short maturity.  The Company’s restricted investments inmarketable securities are carried at fair value.  The fair value of debt is based upon quoted market prices or is computed using discounted cash flow analysis, based on the Company’s estimated borrowing rate at the end of each fiscalperiod presented.  The fair value of the interest rate swap agreement was determined using confirmations from third-party financial institutions.

 

The Company places its cash and equivalents and restrictedinvestments in marketable securities in quality financial instruments and limits the amount invested in any one institution or in any one type of instrument.  The Company has not experienced any significant losses on its cash or restrictedinvestments in marketable securities.

 

**(18) Investment Income**

 

Investment income is****earned principally on short-term investments of cash on hand, restricted cash and investments of marketablesecurities held by the Company’s wholly owned captive insurance company and assets held in a rabbi trust of the Predecessor Company’s deferred compensation plan.

 

The following table sets forth the components ofinvestment income (in thousands):

 
| ** **                               | ** ** | **Successor**                                                               | ** ** | ** ** | ** **                                                                                       | ** ** | **Predecessor**                                                      | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                               | ** ** | ** **                                                                  | ** ** | ** ** | ** **                                                                                       | ** ** | ** **                                                           | ** ** |
| ** **                               | ** ** | **Period from July 14, 2007 through December 31, 2007** | ** ** | ** ** | **Period from  January 1,  2007 through  July 13, 2007** | ** ** | **Three months  ended  December 31,  2006** | ** ** | **Year Ended  September 30, 2006** | ** ** |
| ** **                               | ** ** | ** **                                                                  | ** ** | ** ** | ** **                                                                                       | ** ** | ** **                                                           | ** ** | ** ** | ** ** |
| Income oncash and short-term investments |       | $                                                                           | 1,991      |       |                                                                                             | $          | 1,575                                                                |       | $ | 964 |   | $ | 3,994 |   |
| Income on restricted cash andinvestments |       | 1,885                                                                       |       |       | 2,250                                                                                            |       | 1,082                                                                |       | 3,332 |   |
| Income onassets held in rabbi trust      |       | —                                                                      |       |       | 1,866                                                                                            |       | 1,050                                                                |       | 1,511 |   |
| Interest income on notes receivable      |       | 296                                                                         |       |       | 441                                                                                              |       | 73                                                                   |       | 446 |   |
|                                     |       |                                                                        |       |       |                                                                                             |       |                                                                 |       |   |   |
| Total investment income                  |       | $                                                                           | 4,172      |       |                                                                                             | $          | 6,132                                                                |       | $ | 3,169 |   | $ | 9,283 |   |

 

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**(19)****Assets Held for Sale and Discontinued Operations**

 

In the normal course of business, the Company continually evaluates the performance ofits operating units, with an emphasis on selling or closing under-performing or non-strategic assets.  Discontinued businesses are removed from the results of continuing operations.  The results of operations in the current and prior yearperiods, along with any cost to exit such businesses in the year of discontinuation, are classified as discontinued operations in the consolidated statements of operations.

 

The following table sets forth net revenues and thecomponents of income (loss) from discontinued operations (in thousands):

 
| ** **                                              | ** ** | **Successor**                                                                                       | ** ** | ** ** | ** **                                                                                       | ** ** | **Predecessor**                                                      | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Period from  July 14, 2007  through  December 31,  2007** | ** ** | ** ** | **Period from  January 1,  2007 through  July 13, 2007** | ** ** | **Three months  ended  December 31,  2006** | ** ** | **Year Ended  September 30,  2006** | ** ** |
| ** **                                              | ** ** | ** **                                                                                          | ** ** | ** ** | ** **                                                                                       | ** ** | ** **                                                           | ** ** | ** ** | ** ** |
| Net revenues                                            |       | $                                                                                                   | 6,827      |       |                                                                                             | $          | 2,417                                                                |       | $ | 1,798 |   | $ | 7,841 |   |
|                                                    |       |                                                                                                |       |       |                                                                                             |       |                                                                 |       |   |   |
| Net operating income (loss) ofdiscontinued businesses   |       | $                                                                                                   | 1,648      |       |                                                                                             | $          | (424                                                                 | )          | $ | 160 |   | $ | (655 | ) |
| Loss ondiscontinuation of businesses                    |       | —                                                                                              |       |       | —                                                                                           |       | —                                                               |       | (2,783 | ) |
| Cumulative effect of an accountingchange                |       | —                                                                                              |       |       | —                                                                                           |       | —                                                               |       | (372 | ) |
| Income tax(expense) benefit                             |       | (670                                                                                                | )          |       | 172                                                                                              |       | (65                                                                  | )          | 1,548 |   |
|                                                    |       |                                                                                                |       |       |                                                                                             |       |                                                                 |       |   |   |
| Income (loss) from discontinuedoperations, net of taxes |       | $                                                                                                   | 978        |       |                                                                                             | $          | (252                                                                 | )          | $ | 95 |   | $ | (2,262 | ) |
|                                                    |       |                                                                                                |       |       |                                                                                             |       |                                                                 |       |   |   |

 

The income (loss) on discontinuation of businesses includes the write-down of assets to estimated net realizable value.  The cumulative effect of an accounting change represents a charge recognized upon the initialadoption of FIN 47.

 

**(20) Subsequent Events**

 

***Amendments to Debt Agreements***

* *

On March 27, 2008, the senior secured credit agreement and the mezzanine term loan agreement were amended.  

 

The amendments provide that if the previously described restructuring does not occur onor before December 31, 2008, the senior secured credit facility lenders will receive an $8.0 million fee and the interest rate on the mezzanine term loan will be adjusted upwards and deferred with the outstanding balance of the mezzanine term loan.

 

The amendment to the senior secured credit agreement reduced the maximum available borrowing under the delayed draw term loan from $100.0 million to $37.5 million, and the revolving credit facility from $100.0 million to$50.0 million.

 

The amendment to the senior secured credit agreement provides that a portion of the senior secured term loan be repaid with proceeds from a borrowing under an anticipated multi year revolving creditfacility that the operating company will enter into contemporaneously with the closing of the restructuring.

 

***Other***

 

On January 1, 2008, the Parent contributed 100% of the capital stock of the Company to a related entity, FC-GEN Acquisition Holding, LLC.

 

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