# UNITED STATES

# SECURITIES AND EXCHANGE COMMISSION

# WASHINGTON, D.C. 20549

# FORM 10-Q

## (Mark One)

## [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

## For the quarterly period ended September 30, 2001

# OR

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

# For the transition period fromto

# Commission file number          333-64679

# Harborside Healthcare Corporation

|Delaware(State or other jurisdiction of incorporation or organization)           | 04-3307188(IRS employer identification no.)
|-------------------------------------------------------------------------------- | -------------------------------------------
|                                                                                
|One Beacon Street, Boston, Massachusetts(Address of principal executive offices) | 02108(Zip Code)                            

# (617) 646-5400

# (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x       No      Not Applicable

## Number of shares of common stock, par value $0.01 per share outstanding as of November 10, 2001:  7,925,832.

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Table of Contents

`Page
                                                                                ----

Part I   FINANCIAL INFORMATION

Item 1.  Financial Statements

         Condensed Consolidated Balance Sheets
            as of December 31, 2000 and September 30, 2001                      3

         Condensed Consolidated Statements of Operations
            for the Three Months and Nine Months ended
            September 30, 2000 and 2001                                         4

         Condensed Consolidated Statement of Changes
            in Stockholders' Deficit for the Nine Months
            ended September 30, 2001                                            5

         Condensed Consolidated Statements of Cash Flows
            for the Nine Months ended September 30, 2000 and 2001               6

         Notes to Condensed Consolidated Financial Statements                   7

Item 2.   Management's Discussion and Analysis of Financial
         Condition and Results of Operations                                    15

Item 3.  Quantitative and Qualitative Disclosures about Market Risk             22

Part II  OTHER INFORMATION                                                      23

         Signatures                                                             24`

# 2

# PART I.  FINANCIAL INFORMATION

# Item 1.  FINANCIAL STATEMENTS

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# CONDENSED CONSOLIDATED BALANCE SHEETS

# (dollars in thousands, except share amounts)

`December 31,  September 30,
                                                                                            2000           2001
                                                                                       ---------      ---------
            ASSETS ...............................................................                    (unaudited)
Current assets:
  Cash and cash equivalents ......................................................     $  10,724      $   9,865
  Accounts receivable, net of allowances for doubtful
  accounts of $2,272 and $3,694, respectively ....................................        48,659         44,918
  Prepaid expenses and other .....................................................        13,180         12,688
                                                                                       ---------      ---------
    Total current assets .........................................................        72,563         67,471

Restricted cash ..................................................................         4,805          5,656
Property and equipment, net ......................................................       105,089        107,681
Deferred financing and other non-current assets, net .............................        11,253          4,494
Other assets, net ................................................................         1,900          1,000
Note receivable ..................................................................         7,487          7,487
                                                                                       ---------      ---------
    Total assets .................................................................     $ 203,097      $ 193,789
                                                                                       =========      =========

          LIABILITIES
Current liabilities:
  Current maturities of long-term debt ...........................................     $   5,250      $   3,769
  Accounts payable ...............................................................        10,883         12,814
  Employee compensation and benefits .............................................        15,865         18,046
  Other accrued liabilities ......................................................         6,301          6,533
  Accrued interest ...............................................................           470            442
  Current portion of deferred income .............................................           514            521
                                                                                       ---------      ---------
    Total current liabilities ....................................................        39,283         42,125

Long-term portion of deferred income .............................................         1,910          1,617
Long-term debt (Note D) ..........................................................       173,866        114,327
Long-term accrued interest (Note D) ..............................................          --           48,324
                                                                                       ---------      ---------
    Total liabilities ............................................................       215,059        206,393
                                                                                       ---------      ---------

13 1/2% Exchangeable preferred stock, redeemable, $.01 par value,
  250,000 shares authorized; 55,112 and 23 shares issued and outstanding,
  respectively (Note D) ..........................................................        55,112           --

13% Convertible exchangeable preferred stock, redeemable, $.01 par value
  with a liquidation value of $1,000 per share; 100,000 shares authorized;
  0 and 15,774 shares issued and outstanding, respectively (Note D) ..............          --           15,774

        STOCKHOLDERS' DEFICIT
Common stock, $.01 par value, 19,000,000 and 40,000,000 shares
  authorized, respectively, and 15,275,664 shares issued .........................           153            153
Additional paid-in capital .......................................................       191,750        188,488
Common stock in treasury, at cost, 7,349,832 shares ..............................      (183,746)      (183,746)
Accumulated deficit ..............................................................       (75,231)       (33,273)
                                                                                       ---------      ---------
    Total stockholders' deficit ..................................................       (67,074)       (28,378)
                                                                                       ---------      ---------
    Total liabilities and stockholders' deficit ..................................     $ 203,097      $ 193,789
                                                                                       =========      =========`

# The accompanying notes are an integral part of the condensed
 consolidated financial statements.

# 3

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

# (Unaudited)

# (dollars in thousands, except per share amounts)

`For the three months ended      For the nine months ended
                                                              September 30,                September 30,
                                                   -----------------------------     -------------------------

                                                            2000           2001           2000           2001
                                                       ---------      ---------      ---------      ---------


Total net revenues ...............................     $  80,927      $  88,210      $ 239,317      $ 256,423
                                                       ---------      ---------      ---------      ---------

Expenses:
  Facility operating .............................        65,033         71,209        191,731        207,384
  General and administrative .....................         4,286          4,805         13,667         14,424
  Service charges paid to former affiliate........           295            250            845            801
  Amortization of prepaid management fee .........           300            300            900            900
  Depreciation and amortization ..................         2,613          2,117          7,996          6,548
  Facility rent ..................................         5,705          7,186         17,029         21,560
  Loss on termination of capital lease ...........         8,914           --            8,914           --
  Financial restructuring costs (Note D) .........          --             --             --            9,045
  Facility reorganization costs (Note E) .........          --              750           --              750
                                                       ---------      ---------      ---------      ---------

  Total expenses .................................        87,146         86,617        241,082        261,412
                                                       ---------      ---------      ---------      ---------

Income (loss) from operations ...................        (6,219)         1,593         (1,765)        (4,989)

Other:
  Interest expense, net ..........................         5,836          2,097         17,330          9,774
  Other expense (income) .........................          (111)           (49)           123           (138)
                                                       ---------      ---------      ---------      ---------

Loss before income taxes .........................       (11,944)          (455)       (19,218)       (14,625)
Income tax (benefit) .............................        (4,658)          --           (7,495)          --
                                                       ---------      ---------      ---------      ---------
  Net loss .......................................     $  (7,286)     $    (455)     $ (11,723)     $ (14,625)
                                                       =========      =========      =========      =========

Loss applicable to common shares:
  Net loss .......................................     $  (7,286)     $    (455)     $ (11,723)     $ (14,625)
  Preferred stock dividends ......................        (1,741)          (497)        (5,056)        (3,262)
                                                       ---------      ---------      ---------      ---------
Loss applicable to common shares .................     $  (9,027)     $    (952)     $ (16,779)     $ (17,887)
                                                       =========      =========      =========      =========

Loss per common share (Note C):
  Basic and diluted ..............................     $   (1.24)     $   (0.13)     $   (2.31)     $   (2.44)
                                                       =========      =========      =========      =========`

# The accompanying notes are an integral part of the condensed
 consolidated financial statements.

# 4

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT

# (Unaudited)

# (dollars in thousands)

`Additional
                                                   Common     Paid-In         Treasury       Accumulated
                                                   Stock      Capital           Stock          Deficit         Total
                                                 ----------    ----------     ---------      -----------    ----------



Stockholders' deficit, December 31, 2000 ...     $     153     $ 191,750      $(183,746)     $ (75,231)     $ (67,074)

Preferred stock dividends ..................          --          (3,262)          --             --           (3,262)

Reduction of liquidation preference and
  exchange of 131/2% exchangeable
  preferred stock (Note D) .................          --            --             --           56,583         56,583

Net loss for the nine months ended
  September 30, 2001 .......................          --            --             --          (14,625)       (14,625)
                                                 ---------     ---------      ---------      ---------      ---------

Stockholders' deficit, September 30, 2001        $     153     $ 188,488      $(183,746)     $ (33,273)     $ (28,378)
                                                 =========     =========      =========      =========      =========`

# The accompanying notes are an integral part of the condensed
 consolidated financial statements.

# 5

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

# (Unaudited)

# (dollars in thousands)

`For the nine months ended September 30,
                                                                                  ---------------------------------------
                                                                                             2000          2001
                                                                                          --------      --------
Operating activities:
  Net loss ..........................................................................     $(11,723)     $(14,625)
  Adjustments to reconcile net loss to net cash provided
    by operating activities:
    Depreciation of property and equipment ..........................................        6,168         5,603
    Amortization of deferred financing and other non-current assets .................        1,828           945
    Amortization of prepaid management fee ..........................................          900           900
    Amortization of deferred income .................................................         (508)         (388)
    Accretion of senior subordinated discount notes .................................        9,703         8,279
    Amortization of long-term accrued interest ......................................         --          (1,793)
    Amortization of loan costs and fees (included in rental and interest expense)....          103           107
    Loss on termination of capital lease ............................................        7,542          --
    Non cash charges related to financial restructuring .............................         --           4,896
    Accretion of interest on capital lease obligation ...............................        2,753          --
                                                                                          --------      --------
                                                                                            16,766         3,924
  Changes in operating assets and liabilities:
   Decrease in accounts receivable ..................................................        1,903         3,741
   Decrease in prepaid expenses and other ...........................................        6,810           492
   (Increase) in deferred income taxes ..............................................       (3,832)         --
   (Increase) in prepaid income taxes ...............................................         (295)         --
   Increase in accounts payable .....................................................          988         1,931
   Increase (decrease) in employee compensations and benefits .......................         (613)        2,181
   Increase (decrease) in accrued
interest ............................................................................            2           (28)
   Increase in other accrued liabilities ............................................          471           232
                                                                                          --------      --------
    Net cash provided by operating activities .......................................       22,200        12,473
                                                                                          --------      --------

Investing activities:
  Additions to property and equipment ...............................................       (5,123)       (8,195)
  Additions to deferred financing and other non-current assets ......................           (1)         (200)
  Transfers to restricted cash, net .................................................       (2,158)         (851)
                                                                                          --------      --------
    Net cash (used) by investing activities .........................................       (7,282)       (9,246)
                                                                                          --------      --------

Financing activities:
  Issuance of preferred stock .......................................................         --          15,000
  Payment to holders of subordinated debt ...........................................         --         (15,000)
  Payment on revolving line of credit ...............................................         --          (4,000)
  Receipt in connection with lease ..................................................         --             102
  Repayment of note payable to affiliate ............................................       (5,000)         --
  Payments of long-term debt ........................................................         (183)         (182)
    Principal payments of capital lease obligation ..................................       (3,084)         --
  Dividends paid on preferred stock .................................................          (13)           (6)
                                                                                          --------      --------
    Net cash (used) by financing activities .........................................       (8,280)       (4,086)
                                                                                          --------      --------

Net increase (decrease) in cash and cash equivalents ................................        6,638          (859)
Cash and cash equivalents, beginning of period ......................................        1,386        10,724
                                                                                          --------      --------
  Cash and cash equivalents, end of period ..........................................     $  8,024      $  9,865
                                                                                          ========      ========

Supplemental Disclosure:
  Interest paid .....................................................................     $  5,060      $  4,179
                                                                                          ========      ========
    Income taxes paid ...............................................................     $    130      $    112
                                                                                          ========      ========
  Accretion of preferred stock dividends ............................................     $  5,043      $  3,256
                                                                                          ========      ========`

# The accompanying notes are an integral part of the condensed
 consolidated financial statements.

# 6

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

# (Unaudited)

## A. General

Harborside Healthcare
Corporation, through its subsidiaries (the Company or
Harborside), provides high quality long-term care, subacute care and
other specialty medical services in four principal regions: the Southeast
(Florida), the Midwest (Ohio and Indiana), New England (Connecticut,
Massachusetts, New Hampshire and Rhode Island), and the Mid-Atlantic (New Jersey
and Maryland). Within these regions, as of September 30, 2001, the Company
operated 50 licensed long-term care facilities (18 owned, 31 leased and one
managed) with a total of 6,124 licensed beds. The Company accounts for its
investment in one 75% owned facility using the equity method of accounting.

## B. Basis of Presentation

The accompanying unaudited
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Companys filing on Form 10-K for the year ended December 31, 2000 and with
the additional information provided in the Companys filing on Form 8-K on
May 11, 2001. In the opinion of management, the accompanying unaudited financial
statements reflect all adjustments (consisting of only normal recurring
accruals) necessary to present fairly the Companys financial position as
of September 30, 2001, the results of its operations for the three-month and
nine-month periods ended September 30, 2000 and 2001 and its cash flows for the
nine-month periods ended September 30, 2000 and 2001. The results of operations
for the three-month and nine-month periods ended September 30, 2001 are not
necessarily indicative of the results that may be expected for the full year.
See Managements Discussion and Analysis of Financial Condition
and Results of Operations included elsewhere in this report.

## C.  Loss Per Common Share

The following table sets
forth the computation of basic and diluted loss per common share for the periods
ended September 30, 2000 and 2001:

`Three Months Ended           Nine Months Ended
                                                              September 30,                September 30,
                                                          2000           2001           2000           2001
                                                          ----           ----           ----           ----
Numerator:
Net loss                                           $ (7,286,000)   $   (455,000)  $ (11,723,000)  $(14,625,000)
Preferred stock dividends                            (1,741,000)       (497,000)     (5,056,000)    (3,262,000)
                                                   -------------   -------------  -------------   ------------
Loss applicable to common shares                   $ (9,027,000)   $   (952,000)  $ (16,779,000)  $(17,887,000)
                                                   =============   =============  =============   ============

Denominator (for basic and diluted
 loss per common share):
Weighted average common shares outstanding             7,261,332       7,925,832      7,261,332      7,925,832
Adjustment for non-vested restricted shares                    -       (577,326)              -      (584,613)
                                                      ----------      ----------     ----------     ----------
Adjusted weighted-average shares                       7,261,332       7,348,506      7,261,332      7,341,219
                                                      ==========      ==========     ==========     ==========

Basic and diluted loss per common share               $    (1.24)     $    (0.13)    $    (2.31)    $    (2.44)
                                                      ==========      ==========     ==========     ==========`

For the three-month and
nine-month periods ended September 30, 2000 and 2001, the weighted-average
shares outstanding for the following potentially dilutive securities were
excluded from the computation of diluted loss per common share because the
effect would have been antidilutive:

`Three Months Ended             Nine Months Ended
                                                              September 30,                  September 30,
                                                           2000           2001            2000           2001
                                                           ----           ----            ----           ----
Options to purchase common stock                         611,926         109,994        620,949        109,994
Non-vested shares of restricted stock                     14,446         577,326          4,850        584,613
Conversion rights of convertible preferred stock               -       2,298,634              -      1,203,203
Warrants to purchase common stock                              -       4,326,641              -      2,282,184
                                                        --------       ---------       --------      ---------
                                                         626,372       7,312,595        625,799      4,179,994
                                                        ========       =========       ========      =========`

## D. Amendment of Credit Facility and Restructuring of Discount Notes and Preferred Stock

On March 28, 2001, the
Company obtained an amendment (the Third Amendment) to the
Companys existing credit facility (the New Credit Facility).
The Third Amendment resulted in a permanent reduction of the Companys
maximum borrowings under the New Credit Facility from $150 million to $60
million, revised certain financial covenants, changed the maturity date of the
New Credit Facility to March 31, 2004 and increased the Companys borrowing
rate. The Third Amendment also requires the Company to repay, on an annual
basis, the greater of $5,000,000 or 50% of the Companys excess cash flow
(as defined).

In March 2001, the Company
entered into an agreement (the Restructuring Agreement) with
Investcorp S.A. and the holders of more than a majority in interest of the
Companys Discount Notes and Preferred Stock for purposes of implementing a
restructuring of the Discount Notes and Preferred Stock. The Restructuring
Agreement contemplated that the Company would offer to exchange for each $1,000
amount at maturity of outstanding Discount Notes a combination of the following:
(1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the
New Notes) each having a principal amount at maturity equal to
$1,000 and an original issue price of $685.67 (assuming that the New Notes were
issued on May 4, 2001), (2)  $88.2353 in cash and (3) common stock
purchase warrants for approximately 10.9 shares of its Class A Common
Stock. The Company would also offer to exchange common stock purchase warrants
for approximately 10.7 shares of its Class A Common Stock for each $1,000
liquidation preference of Preferred Stock (based on the aggregate liquidation
preference to be outstanding on May 1, 2001) plus any dividends accrued on such
Preferred Stock after May 1, 2001. In conjunction with the restructuring
proposal, the Company would solicit consents from holders of outstanding
Discount Notes and Preferred Stock to amendments to the Indenture governing the
Discount Notes and to the Certificate of Designation governing the Preferred

## 7

Stock that would eliminate or modify certain restrictive covenants and other
provisions contained in the Indenture and the Certificate of Designation and
would substantially eliminate the preferences of the Preferred Stock, including
the reduction of the liquidation preference from $1,000 to $0.01 per share and
the elimination of the right of holders to be paid dividends on shares of
Preferred Stock. Also, the Company would issue to Investcorp S.A. (or one or
more of its affiliates or designees) up to 15,000 shares of a new series of 13%
convertible exchangeable preferred stock (the New Preferred Stock)
and 1,854,422 common stock purchase warrants for a total purchase price of up to
$15,000,000.

On April 6, 2001 the
Company initiated the exchange offer and consent solicitation contemplated by
the Restructuring Agreement. On May 10, 2001, the Company completed the exchange
offer and consent solicitation, thereby implementing each of the elements of the
Restructuring Agreement. All of the outstanding Discount Notes and 99.96% of the
Preferred Stock shares were tendered and exchanged in the exchange offer. As a
result of the exchange, (1) the Company has an aggregate principal amount at
maturity of $100,276,000 of New Notes outstanding and an aggregate liquidation
preference of $15,000,000 (as of May 10, 2001) of New Preferred Stock
outstanding, (2) warrants were issued to holders of Discount Notes, to
holders of Preferred Stock, and to Investcorp S.A. representing the right to
purchase an aggregate of approximately 15%, 5% and 15%, respectively, of the
total number of shares of all classes of the Companys common stock on a
fully diluted basis (excluding shares issuable upon conversion of the New
Preferred Stock, each share of which will initially be convertible into 150
shares of Class A Common Stock, and (3) the Company paid $15,000,000
in cash as partial consideration for the tendered Discount Notes.

The reduction in the
liquidation preference of the Preferred Stock was completed on May 10, 2001, as
contemplated by the Restructuring Agreement, the carrying amount of the
Preferred Stock was reduced from $57,595,000 to $576 and the amount of the
reduction, net of unamortized deferred financing costs related to the issuance
of the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directly
transferred to the Companys Accumulated Deficit account. With the exchange
of the New Notes for the Discount Notes (the Note Exchange), the
carrying value of the accreted principal of the Discount Notes was reduced to
$68,890,000, and the amount of the reduction, net of the aggregate cash payment
of $15,000,000, was directly transferred to the Companys Long-term Accrued
Interest account. Subsequent to their issuance, the carrying amount of the New
Notes increases as the result of accretion and results in a corresponding
decrease in the carrying amount of Long-term Accrued Interest. Interest expense
on the New Notes is recognized such that a constant effective interest rate is
applied to the aggregate carrying amount of the New Notes and Long-term Accrued
Interest for all periods between the issuance date and the maturity date of the
New Notes.

In connection with the
Third Amendment to the New Credit Facility and the implementation of the
Restructuring Agreement, the Company incurred a non-recurring charge of
approximately $9,000,000. The charge resulted from the write-off of
approximately $1,500,000 of unamortized deferred financing costs incurred when
the New Credit Facility was obtained, the write-off of approximately $3,400,000
of unamortized deferred financing costs related to the issuance of the Discount
Notes, and the recognition of various investment advisory, legal and other fees
associated with these events approximating $4,100,000.

The New Notes were issued at a discount and interest on the
New Notes accretes until August 1, 2004. Cash interest payments will be paid
semi-annually in arrears beginning on February 1, 2005 based on the fully
accreted value of the New Notes and a 12% cash interest payment rate. The New
Notes mature on August 1, 2007. The New Preferred Stock is mandatorily
redeemable on February 1, 2008. The holders of the New Preferred Stock are
entitled to dividends quarterly in arrears beginning August 1, 2001 and payable
in additional shares of New Preferred Stock. Warrants to purchase a total of
4,326,641 shares of common stock at $0.01 per share were issued on May 10, 2001.

## E. Facility Reorganization Costs

During the third quarter of
2001, the Company incurred a non-recurring charge of $750,000 in connection with
its decision to revise the marketing approach for facilities operated through
subsidiaries in Florida. The Company determined that a local community-based
marketing approach would better serve the needs of these facilities. The
marketing approach stresses ties to the local community and required renaming
these facilities in order to emphasize this approach. In connection with this
effort, the Company also restructured certain of its subsidiaries effective
October 1, 2001. In order to implement this strategy, the Company incurred
non-recurring marketing, legal and other expenses.

## F. Condensed Consolidating Financial Information

Certain of the Companys subsidiaries are precluded from
guaranteeing the debt of the parent company (the Non-Guarantors),
based on current agreements in effect. The Companys remaining subsidiaries
(the Guarantors) are not restricted from serving as guarantors of
the parent company debt. The Guarantors are comprised of Harborside Healthcare
Limited Partnership, Belmont Nursing Center Corp., Orchard Ridge Nursing Center
Corp., Oakhurst Manor Nursing Center Corp., Riverside Retirement Limited
Partnership, Harborside Connecticut Limited Partnership, Harborside of Florida
Limited Partnership, Harborside of Ohio Limited Partnership, Harborside
Healthcare Baltimore Limited Partnership, Harborside of Cleveland Limited
Partnership, Harborside of Dayton Limited Partnership, Harborside Massachusetts
Limited Partnership, Harborside of Rhode Island Limited Partnership, Harborside
North Toledo Limited Partnership, Harborside Healthcare Advisors Limited
Partnership, Harborside Toledo Corp., KHI Corporation, Harborside Danbury
Limited Partnership, Harborside Acquisition Limited Partnership V, Harborside
Acquisition Limited Partnership VI, Harborside Acquisition Limited Partnership
VII, Harborside Acquisition Limited Partnership VIII, Harborside Acquisition
Limited Partnership IX, Harborside Acquisition Limited Partnership X, Sailors,
Inc., New Jersey Harborside Corp., Bridgewater Assisted Living Limited
Partnership, Maryland Harborside Corp., Harborside Homecare Limited Partnership,
Harborside Rehabilitation Limited Partnership, Harborside Healthcare Network
Limited Partnership and Harborside Health I Corporation.

The information which
follows presents the condensed consolidating financial position as of September
30, 2000 and September 30, 2001; the condensed consolidating results of
operations for the three-month and nine-month periods ended September 30, 2000
and 2001; and the consolidating cash flows for the nine-month periods ended
September 30, 2000 and 2001 of (a) the parent company only (the
Parent), (b) the combined Guarantors, (c) the combined Non-Guarantors, (d)
eliminating entries and (e) the Company on a consolidated basis.

## 8

## F. Condensed Consolidating Financial Information (continued)

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Balance Sheet

# As of December 31, 2000

# (Unaudited)

# (dollars in thousands)

`Parent       Guarantors     Non-Guarantors  Elimination  Consolidated
                                                                       ---------      ---------      --------------  -----------  ------------
ASSETS
Current assets:
  Cash and cash equivalents .......................................     $    --        $   9,317      $   1,407      $    --        $  10,724
  Accounts receivable, net of allowance for
   doubtful accounts of $2,272 ....................................          --           33,111         15,548           --           48,659
  Intercompany receivable .........................................       146,953           --             --         (146,953)          --
  Prepaid expenses and other ......................................         3,128          8,403          1,649           --           13,180
                                                                        ---------      ---------      ---------      ---------      ---------
   Total current assets ...........................................       150,081         50,831         18,604       (146,953)        72,563

Restricted cash ...................................................          --            4,116            689           --            4,805
Investments in limited partnerships ...............................        15,584           --            4,044        (19,628)          --
Property and equipment, net .......................................          --           85,719         19,370           --          105,089
Deferred financing and other
 non-current assets, net ..........................................         7,109          3,001          1,143           --           11,253
Other assets, net .................................................         1,900           --             --             --            1,900
Note receivable ...................................................          --            7,487           --             --            7,487
                                                                        ---------      ---------      ---------      ---------      ---------
   Total assets ...................................................     $ 174,674      $ 151,154      $  43,850      $(166,581)     $ 203,097
                                                                        =========      =========      =========      =========      =========

LIABILITIES
Current liabilities:
  Current maturities of long-term debt ............................     $   5,000      $      22      $     228      $      -       $   5,250
  Accounts payable ................................................          --            8,331          2,552           --           10,883
  Intercompany payable ............................................          --          119,147         11,543       (130,690)          --
  Employee compensation and benefits ..............................          --           12,293          3,572           --           15,865
  Other accrued liabilities .......................................          --            5,364            937           --            6,301
  Accrued interest ................................................           470           --             --             --              470
  Current portion of deferred income ..............................          --             --             --              514            514
                                                                        ---------      ---------      ---------      ---------      ---------
   Total current liabilities ......................................         5,470        145,157         18,832       (130,176)        39,283

Long-term portion of deferred income ..............................          --              582          1,842           (514)         1,910
Long-term debt ....................................................       156,692          1,498         15,676           --          173,866
                                                                        ---------      ---------      ---------      ---------      ---------
   Total liabilities ..............................................       162,162        147,237         36,350       (130,690)       215,059
                                                                        ---------      ---------      ---------      ---------      ---------

13 1/2% Exchangeable preferred stock, redeemable,
 $.01 par value with a liquidation value of
 $1,000 per share; 250,000 shares authorized;
 55,112 issued and outstanding ....................................        55,112           --             --             --           55,112

STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.01 par value, 19,000,000
  shares authorized, 15,275,664 shares issued .....................           153          2,569          3,885         (6,454)           153
Additional paid-in capital ........................................       191,524           --             --              226        191,750
Common stock in treasury, at cost, 7,349,832 shares................      (183,746)          --             --             --         (183,746)
Retained earnings (accumulated deficit) ...........................       (50,531)       (23,407)        (3,459)         2,166        (75,231)
Partners' equity ..................................................          --           24,755          7,074        (31,829)          --
                                                                        ---------      ---------      ---------      ---------      ---------
   Total stockholders' equity (deficit) ...........................       (42,600)         3,917          7,500        (35,891)       (67,074)
                                                                        ---------      ---------      ---------      ---------      ---------
   Total liabilities and stockholders' equity (deficit)                 $ 174,674      $ 151,154      $  43,850      $(166,581)     $ 203,097
                                                                        =========      =========      =========      =========      =========`

## 9

## E. Condensed Consolidating Financial Information (continued)

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Balance Sheet

# As of September 30, 2001

# (Unaudited)

# (dollars in thousands)

`Parent       Guarantors     Non-Guarantors Elimination    Consolidated
                                                                 ---------      ---------      ---------      ---------      ---------
ASSETS
Current assets:
  Cash and cash equivalents ................................     $    --        $   7,842      $   2,023      $    --        $   9,865
  Accounts receivable, net of allowance for
   doubtful accounts of $3,694 .............................          --           29,684         15,234           --           44,918
  Intercompany receivable ..................................       145,466           --             --         (145,466)          --
  Prepaid expenses and other ...............................         1,262          9,686          1,740           --           12,688
                                                                 ---------      ---------      ---------      ---------      ---------
   Total current assets ....................................       146,728         47,212         18,997       (145,466)        67,471

Restricted cash ............................................          --            4,922            734           --            5,656
Investment in limited partnership ..........................        15,584           --            4,044        (19,628)          --
Property and equipment, net ................................          --           86,568         21,113           --          107,681
Deferred financing and other
  non-current assets, net ..................................           729          2,797            968           --            4,494
Other assets, net ..........................................         1,000           --             --             --            1,000
Note receivable ............................................          --            7,487           --             --            7,487
                                                                 ---------      ---------      ---------      ---------      ---------
   Total assets ............................................     $ 164,041      $ 148,986      $  45,856      $(165,094)     $ 193,789
                                                                 =========      =========      =========      =========      =========

LIABILITIES
Current liabilities:
  Current maturities of long-term debt .....................     $   3,500      $      22      $     247      $    --        $   3,769
Accounts payable ...........................................             1         10,688          2,125           --           12,814
Intercompany payable .......................................          --          114,297         15,045       (129,342)          --
Employee compensation and benefits .........................          --           14,690          3,356           --           18,046
Other accrued liabilities ..................................          --            5,109          1,424           --            6,533
Accrued interest ...........................................           442           --             --             --              442
Current portion of deferred income .........................          --             --             --              521            521
                                                                 ---------      ---------      ---------      ---------      ---------

   Total current liabilities ...............................         3,943        144,806         22,197       (128,821)        42,125


Long-term portion of deferred income .......................          --              572          1,566           (521)         1,617
Long-term debt .............................................        97,355          1,484         15,488           --          114,327
Long-term accrued interest .................................        48,324           --             --             --           48,324
                                                                 ---------      ---------      ---------      ---------      ---------
   Total liabilities .......................................       149,622        146,862         39,251       (129,342)       206,393
                                                                 ---------      ---------      ---------      ---------      ---------

13% Convertible exchangeable preferred stock,
   redeemable,  $.01 par value with a liquidation
   value of $1,000 per share; 100,000 shares
   authorized; 15,774 shares issued and outstanding.........        15,774           --             --             --           15,774

STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.01 par value; 40,000,000
    shares authorized; 15,275,664 shares issued ............           153          2,569          3,885         (6,454)           153
Additional paid-in capital .................................       188,261           --             --              227        188,488
Common stock in treasury, at cost, 7,349,832 shares.........      (183,746)          --             --             --         (183,746)

Retained earnings (accumulated deficit) ....................        (6,023)       (25,200)        (4,354)         2,304        (33,273)
Partners' equity ...........................................          --           24,755          7,074        (31,829)          --
                                                                 ---------      ---------      ---------      ---------      ---------

   Total stockholders' equity (deficit) ....................        (1,355)         2,124          6,605        (35,752)       (28,378)
                                                                 ---------      ---------      ---------      ---------      ---------
   Total liabilities and stockholders' equity (deficit) ....     $ 164,041      $ 148,986      $  45,856      $(165,094)     $ 193,789
                                                                 =========      =========      =========      =========      =========`

## 10

## F. Condensed Consolidating Financial Information (continued)

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Statement of Operations

# For the three months ended September 30, 2000

# (Unaudited)

# (dollars in thousands)

`Parent      Guarantors Non-Guarantors  Elimination   Consolidated
                                                         --------      --------      --------      --------      --------


Total net revenues .................................     $   --        $ 56,042      $ 25,325      $   (440)     $ 80,927
                                                         --------      --------      --------      --------      --------


Expenses:
  Facility operating ...............................         --          43,883        21,590          (440)       65,033
  General and administrative .......................           13         4,273          --            --           4,286
  Service charges paid to former affiliate .........         --             295          --            --             295
  Amortization of prepaid management fee ...........          300          --            --            --             300
  Depreciation and amortization ....................          452         1,673           488          --           2,613
  Facility rent ....................................         --           3,570         2,135          --           5,705
  Loss on termination of capital lease .............         --           8,914          --            --           8,914
  Management fees paid to affiliates ...............         --          (1,499)        1,499          --            --
                                                         --------      --------      --------      --------      --------
   Total expenses ..................................          765        61,109        25,712          (440)       87,146
                                                         --------      --------      --------      --------      --------


Income (loss) from operations ......................         (765)       (5,067)          387          --          (6,219)

Other:
  Interest expense, net ............................        1,025         4,397           414          --           5,836
  Other (income) ...................................         --            --            --            (111)         (111)
                                                         --------      --------      --------      --------      --------

Income (loss) before income taxes ..................       (1,790)       (9,464)         (801)          111       (11,944)
Income tax expense (benefit) .......................         (699)       (3,708)         (312)           61        (4,658)
                                                         --------      --------      --------      --------      --------
  Net income (loss) ................................     $ (1,091)     $ (5,756)     $   (489)     $     50      $ (7,286)
                                                         ========      ========      ========      ========      ========`

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Statement of Operations

# For the three months ended September 30, 2001

# (Unaudited)

# (dollars in thousands)

`Parent      Guarantors Non-Guarantors  Elimination   Consolidated
                                                         --------      --------      --------      --------      --------

Total net revenues .................................     $   --        $ 63,466      $ 26,493      $ (1,749)     $ 88,210
                                                         --------      --------      --------      --------      --------


Expenses:
Facility operating .................................         --          51,030        21,928        (1,749)       71,209
General and administrative .........................           21         4,784          --            --           4,805
Service charges paid to former affiliate ...........         --             250          --            --             250
Amortization of prepaid management fee .............          300          --            --            --             300
Depreciation and amortization ......................           52         1,522           543          --           2,117
  Facility rent ....................................         --           4,953         2,233          --           7,186
  Facility reorganization costs ....................         --             750          --            --             750
  Management fees paid to affiliates ...............         --          (1,550)        1,550          --            --
                                                         --------      --------      --------      --------      --------
   Total expenses ..................................          373        61,739        26,254        (1,749)       86,617
                                                         --------      --------      --------      --------      --------

Income (loss) from operations ......................         (373)        1,727           239          --           1,593

Other:
  Interest expense, net ............................          278         1,316           503          --           2,097
  Other (income) ...................................         --            --            --             (49)          (49)
                                                         --------      --------      --------      --------      --------

Income (loss) before income taxes ..................         (651)          411          (264)           49          (455)
Income tax expense .................................         --            --            --            --            --
                                                         --------      --------      --------      --------      --------
  Net income (loss) ................................     $   (651)     $    411      $   (264)     $     49      $   (455)
                                                         ========      ========      ========      ========      ========`

## 11

## F. Condensed Consolidating Financial Information (continued)

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Statement of Operations

# For the nine months ended September 30, 2000

# (Unaudited)

# (dollars in thousands)

`Parent       Guarantors  Non-Guarantors    Elimination    Consolidated
                                                         ---------      ---------      ---------      ---------      ---------

Total net revenues .................................     $    --        $ 164,213      $  76,080      $    (976)     $ 239,317
                                                         ---------      ---------      ---------      ---------      ---------


Expenses:
 Facility operating ................................          --          130,255         62,452           (976)       191,731
 General and administrative ........................            20         13,647           --             --           13,667
 Service charges paid to former affiliate ..........          --              845           --             --              845
 Amortization of prepaid management fee ............           900           --             --             --              900
 Depreciation and amortization .....................         1,356          5,199          1,441           --            7,996
 Facility rent .....................................          --           10,572          6,457           --           17,029
 Loss on termination of capital lease ..............          --            8,914           --             --            8,914
 Management fees paid to affiliates ................          --           (4,494)         4,494           --             --
                                                         ---------      ---------      ---------      ---------      ---------
  Total expenses ...................................         2,276        164,938         74,844           (976)       241,082
                                                         ---------      ---------      ---------      ---------      ---------

Income (loss) from operations ......................        (2,276)          (725)         1,236           --           (1,765)

Other:
  Interest expense, net ............................         2,985         13,087          1,258           --           17,330
  Other expense ....................................          --             --             --              123            123
                                                         ---------      ---------      ---------      ---------      ---------

Loss before income taxes ...........................        (5,261)       (13,812)           (22)          (123)       (19,218)
Income tax benefit .................................        (2,052)        (5,386)            (9)           (48)        (7,495)
                                                         ---------      ---------      ---------      ---------      ---------
  Net loss .........................................     $  (3,209)     $  (8,426)     $     (13)     $     (75)     $ (11,723)
                                                         =========      =========      =========      =========      =========`

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Statement of Operations

# For the nine months ended September 30, 2001

# (Unaudited)

# (dollars in thousands)

`Parent       Guarantors  Non-Guarantors    Elimination    Consolidated
                                                         ---------      ---------      ---------      ---------      ---------

Total net revenues .................................     $    --        $ 181,868      $  78,976      $  (4,421)     $ 256,423
                                                         ---------      ---------      ---------      ---------      ---------


Expenses:
  Facility operating ...............................          --          146,067         65,738         (4,421)       207,384
  General and administrative .......................            57         14,367           --             --           14,424
  Service charges paid to former affiliate .........          --              801           --             --              801
  Amortization of prepaid management fee ...........           900           --             --             --              900
  Depreciation and amortization ....................           473          4,514          1,561           --            6,548
  Facility rent ....................................          --           14,981          6,579           --           21,560
  Financial restructuring costs ....................         8,645            400           --             --            9,045
  Facility reorganization costs ....................          --              750           --             --              750
  Management fees paid to affiliates ...............          --           (4,682)         4,682           --             --
                                                         ---------      ---------      ---------      ---------      ---------
   Total expenses ..................................        10,075        177,198         78,560         (4,421)       261,412
                                                         ---------      ---------      ---------      ---------      ---------

Income (loss) from operations ......................       (10,075)         4,670            416           --           (4,989)

Other:
  Interest expense, net ............................         2,000          6,463          1,311           --            9,774
  Other (income) ...................................          --             --             --             (138)          (138)
                                                         ---------      ---------      ---------      ---------      ---------

Income (loss) before income taxes ..................       (12,075)        (1,793)          (895)           138        (14,625)
Income tax expense .................................          --             --             --             --             --
                                                         ---------      ---------      ---------      ---------      ---------
  Net income (loss) ................................     $ (12,075)     $  (1,793)     $    (895)     $     138      $ (14,625)
                                                         =========      =========      =========      =========      =========`

## 12

## F. Condensed Consolidating Financial Information (continued)

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Statement of Cash Flows

# For the nine months ended September 30, 2000

# (Unaudited)

# (dollars in thousands)

`Parent     Guarantors  Non-Guarantors     Elimination    Consolidated
                                                             --------      --------      --------      ---------------     --------
Operating activities:
   Net cash provided by operating activities: ..........     $  5,014      $ 15,099      $  2,087      $          --       $ 22,200
                                                             --------      --------      --------      ---------------     --------

Investing activities:
  Additions to property and equipment ..................         --          (3,620)       (1,503)                --         (5,123)
  Additions to deferred financing and other
   non-current assets ..................................           (1)         --            --                   --             (1)
  Transfers (to) restricted cash, net ..................         --          (2,100)          (58)                --         (2,158)
                                                             --------      --------      --------      ---------------     --------
   Net cash (used) by investing activities .............           (1)       (5,720)       (1,561)                --         (7,282)
                                                             --------      --------      --------      ---------------     --------

Financing activities:
  Repayment of note payable to affiliate ...............       (5,000)         --            --                   --         (5,000)
  Payments of long-term debt ...........................         --             (34)         (149)                --           (183)
  Principal payments of capital lease obligation .......         --          (3,084)         --                   --         (3,084)
  Dividends paid on exchangeable preferred stock .......          (13)         --            --                   --            (13)
                                                             --------      --------      --------      ---------------     --------
   Net cash (used) by financing activities .............       (5,013)       (3,118)         (149)                --         (8,280)
                                                             --------      --------      --------      ---------------     --------

Net increase in cash and cash equivalents ..............         --           6,261           377                 --          6,638
Cash and cash equivalents, beginning of period .........         --             355         1,031                 --          1,386
                                                             --------      --------      --------      ---------------     --------
  Cash and cash equivalents, end of period .............     $   --        $  6,616      $  1,408      $          --       $  8,024
                                                             ========      ========      ========      ===============     ========

Supplemental Disclosure:
  Interest paid ........................................     $    872      $  3,821      $    367      $          --       $  5,060
                                                             ========      ========      ========      ===============     ========
  Income taxes paid ....................................     $    130      $   --        $   --        $          --       $    130
                                                             ========      ========      ========      ===============     ========
  Accretion of preferred stock dividends ...............     $  5,043      $   --        $   --        $          --       $  5,043
                                                             ========      ========      ========      ===============     ========`

## 13

## F. Condensed Consolidating Financial Information (continued)

# HARBORSIDE HEALTHCARE CORPORATION AND SUBSIDIARIES

# Condensed Consolidating Statement of Cash Flows

# For the nine months ended September 30, 2001

# (Unaudited)

# (dollars in thousands)

`Parent     Guarantors  Non-Guarantors  Elimination   Consolidated
                                                             --------      --------    -----------    --------      --------
Operating activities:
   Net cash provided by operating activities: ..........     $  3,904      $  4,594      $  3,975     $   --        $ 12,473
                                                             --------      --------      --------     --------      --------

Investing activities:
  Additions to property and equipment ..................         --          (5,050)       (3,145)        --          (8,195)
  Additions to deferred financing and other
   non-current assets ..................................         --            (200)         --           --            (200)
  Transfers to restricted cash, net ....................         --            (806)          (45)        --            (851)
                                                             --------      --------      --------     --------      --------
   Net cash (used) by investing activities .............         --          (6,056)       (3,190)        --          (9,246)
                                                             --------      --------      --------     --------      --------

Financing activities:
  Issuance of preferred stock ..........................       15,000          --            --           --          15,000
  Payment to holders of subordinated debt ..............      (15,000)         --            --           --         (15,000)
  Payment on revolving line of credit ..................       (4,000)         --            --           --          (4,000)
  Receipt in connection with lease .....................          102          --            --           --             102
  Payments of long-term debt ...........................         --             (13)         (169)        --            (182)
  Dividends paid on preferred stock ....................           (6)         --            --           --              (6)
                                                             --------      --------      --------     --------      --------
   Net cash (used) by financing activities .............       (3,904)          (13)         (169)        --          (4,086)
                                                             --------      --------      --------     --------      --------

Net increase (decrease) in cash and cash equivalents ...         --          (1,475)          616        --             (859)

Cash and cash equivalents, beginning of period .........         --           9,317         1,407        --           10,724
                                                             --------      --------      --------     --------      --------
  Cash and cash equivalents, end of period .............     $   --        $  7,842      $  2,023     $  --         $  9,865
                                                             ========      ========      ========     ========      ========

Supplemental Disclosure:
  Interest paid ........................................     $    855      $  2,763      $    561     $  --         $  4,179
                                                             ========      ========      ========     ========      ========
  Income taxes paid ....................................     $    112      $    -        $    --      $  --         $    112
                                                             ========      ========      ========     ========      ========
  Accretion of preferred stock dividends ...............     $  3,256      $    -        $    --      $  --         $  3,256
                                                             ========      ========      ========     ========      ========`

## 14

# Item 2.

# MANAGEMENT'S DISCUSSION AND

# ANALYSIS OF FINANCIAL CONDITION AND

# RESULTS OF OPERATIONS

This Managements
Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements including those concerning Managements
expectations regarding future financial performance and future events. These
forward-looking statements involve significant risk and uncertainties, including
those described herein and included under Special Note Regarding
Forward-Looking Statements below. Actual results may differ materially
from those anticipated by such forward-looking statements.

## OVERVIEW

Harborside Healthcare
Corporation, through its subsidiaries, (Harborside or the
Company), is a leading provider of high-quality long-term care and
specialty medical services in the eastern United States. The Company has focused
on establishing strong local market positions with high-quality facilities in
four principal regions: the Southeast (Florida), the Midwest (Ohio and Indiana),
New England (Connecticut, Massachusetts, New Hampshire and Rhode Island) and the
Mid-Atlantic (New Jersey and Maryland). As of September 30, 2001, the Company
operated 50 facilities (18 owned, 31 leased and one managed) with a total of
6,124 licensed beds. As described in Note A to the unaudited condensed
consolidated financial statements included elsewhere in this report, the Company
accounts for its investment in one of its owned facilities using the equity
method of accounting. The Company provides a broad continuum of medical services
including: (i) traditional skilled nursing care and (ii) specialty medical
services, including a variety of subacute care programs such as orthopedic
rehabilitation, CVA/stroke care, cardiac recovery, pulmonary rehabilitation and
wound care, as well as distinct programs for the provision of care to
Alzheimers and hospice patients. As part of its subacute services, the
Company provides physical, occupational and speech rehabilitation therapy
services at Company-operated facilities.

The following table sets
forth the number of facilities and the number of licensed beds operated by the
Company:

`As of September 30,
                                                   ---------------------------------
                                                         2000             2001
                                                         ----             ----

Facilities operated (1)                                    50               50
Licensed beds (1)                                       6,124            6,124


  The following table sets forth certain operating data for the periods indicated:

                             For the three months ended         For the nine months ended
                                     September 30,                     September 30,

                                   2000         2001                  2000         2001
                                   ----         ----                  ----         ----
     Patient days (2):
       Private and other         115,761      105,083               343,010      313,113
       Medicare                   56,421       73,749               179,541      217,259
       Medicaid                  313,695      301,602               932,343      898,624
                                 -------      -------             ---------    ---------
     Total                       485,877      480,434             1,454,894    1,428,996
                                 =======      =======             =========    =========

     Total net revenues:
       Private and other           26.0%        22.5%                 26.2%        22.8%
       Medicare                    23.8%        30.8%                 24.7%        30.6%
       Medicaid                    50.2%        46.7%                 49.1%        46.6%
                                 -------      -------               -------      -------
     Total                        100.0%       100.0%                100.0%       100.0%
                                 =======      =======               =======       ======

     Average Occupancy Rate (3)    89.7%        88.8%                  90.2%       89.0%
     Quality Mix (4)               49.8%        53.3%                  50.9%       53.4%


(1)  Includes one managed  facility with 106 licensed beds on September 30, 2000
     and September 30, 2001.
(2)  "Patient  Days"  includes  billed  bed  days  for the  facilities
     operated by the Company  excluding  billed bed days of the managed facility
     and the facility accounted for using the equity method of accounting.
(3)  "Average  occupancy  rate" is computed  by dividing  the number of
     billed bed days by the total number of  available  licensed bed days during
     each of the periods  indicated.  This  calculation  includes all facilities
     operated by the Company excluding the managed facility.
(4)  "Quality  Mix"  consists of the percentage of the  Companys
     total net revenues that are derived from Medicare,  commercial insurers and
     other private payors.`

## 15

## RESULTS OF OPERATIONS

The Companys total
net revenues include net patient service revenues and other revenues. The
Company derives its net patient service revenues primarily from private pay
sources, the federal Medicare program for certain elderly and disabled patients,
and state Medicaid programs for indigent patients. Private net patient service
revenues are recorded at established per diem billing rates. Net patient service
revenues to be reimbursed under contracts with third-party payors, primarily the
Medicare and Medicaid programs, are recorded at amounts estimated to be realized
under these contractual arrangements.

The Companys facility
operating expenses consist primarily of payroll and employee benefits related to
nursing, housekeeping and dietary services provided to patients, as well as
maintenance and administration of the facilities. Other significant facility
operating expenses include the cost of rehabilitation therapy services, medical
and pharmacy supplies, food, utilities, insurance and taxes. The Companys
general and administrative expenses include costs associated with its regional
and corporate operations.

Total Net Revenues.
Total net revenues increased by $7,283,000 or 9.0%, from $80,927,000 in the
third quarter of 2000 to $88,210,000 in the third quarter of 2001. The increase
in total revenues, from 2000 to 2001, was primarily the result of higher average
revenues per patient day. The average occupancy rate at all of the
Companys facilities decreased from 89.7% during the third quarter of 2000
to 88.8% during the third quarter of 2001. Average net patient service revenues
(including ancillary services) per patient day at the Companys facilities
increased from $164 in the third quarter of 2000 to $181 in the third quarter of
2001. The Companys average Medicare Part A per diem rate increased from
$323 per Medicare patient day in the third quarter of 2000 to $344 per Medicare
patient day in the third quarter of 2001, while the Companys average per
diem Medicaid rate increased from $129 in the third quarter of 2000 to $136 in
the third quarter of 2001. In December 2000, the Medicare, Medicaid, and State
Child Health Insurance Program Benefits Improvement and Protection Act of 2000
(BIPA) was enacted. BIPA increased the prior nursing rate component
of the Federal per diem rate, for each RUG category, by 16.66% effective April
1, 2001 through September 30, 2002. In addition, BIPA eliminated the 20% add-on
for three of the fifteen rehabilitation services RUG categories and substituted
a 6.7% add-on for all fifteen rehabilitation services RUG categories. The
Balanced Budget Refinement Act of 1999 had temporarily increased the Federal per
diem rates by 20% for fifteen acuity categories beginning on April 1, 2000. BIPA
also extended the moratorium on the annual limitation on Part B therapy charges
of $1,500 per beneficiary through calendar year 2002 and repealed a previous
requirement to implement consolidated billing for Part B services. The current
rate mechanism will stay in effect until the date on which the Centers for
Medicare and Medicaid Services (CMS), previously known as Health
Care Financing Administration, implements a revised PPS system that more
accurately reimburses the costs of caring for medically complex patients. The
Company believes that it is unlikely that a new PPS system will be implemented
prior to October 1, 2002. Primarily as the result of the Medicare rate increases
implemented on April 1, 2001, the Companys average Medicare Part A payment
rate increased from $323 per Medicare patient day during the third quarter of
2000 to $344 per Medicare patient day during the third quarter of 2001. The
Companys quality mix of private, Medicare and insurance revenues was 49.8%
for the three months ended September 30, 2000 as compared to 53.3% for the three
months ended September 30, 2001.

Facility Operating
Expenses. Facility operating expenses increased by $6,176,000 or 9.5%, from
$65,033,000 in the third quarter of 2000 to $71,209,000 in the third quarter of
2001. The overall increase in operating expenses in 2001 was primarily the
result of higher expenditures for employee benefit costs and temporary nursing
personnel. Consistent with other long-term care providers, the Company continues
to find it difficult to recruit and retain employees, most notably nursing
personnel. As a result of these difficulties, the Company has been forced to
rely more heavily on temporary nursing personnel.

General and
Administrative; Service Charges Paid to Former Affiliate. General and
administrative expenses increased by $519,000, from $4,286,000 in the third
quarter of 2000 to $4,805,000 in the third quarter of 2001. The Company
reimburses a former affiliate for data processing services provided to the
Company. During the third quarter of 2000, such reimbursements totaled $295,000
compared to $250,000 during the third quarter of 2001.

Amortization of Prepaid
Management Fees. Amortization of prepaid management fees was $300,000 during
the third quarter of 2000 and the third quarter of 2001.

Depreciation and
Amortization. Depreciation and amortization decreased from $2,613,000 in the
third quarter of 2000 to $2,117,000 in the third quarter of 2001. Depreciation
expense decreased primarily as the result of the refinancing of the
Companys four Cleveland-area facilities. On September 27, 2000, the
Company terminated its capital leases for these properties and entered into new
operating leases for each of the Cleveland facilities. As a result of this
transaction, the Companys annual depreciation and interest expense
decreased by approximately $1,400,000 and $4,100,000, respectively, while the
Companys annual rent expense increased by approximately $5,900,000. The
Companys amortization expense decreased in the third quarter of 2001
primarily as a result of the write-off of deferred financing costs in September
2000 and the first half of 2001. The write-off of deferred financing costs in
the first half of 2001 were made in connection with amendments to the
Companys bank credit facility and the financial restructuring completed in
the second quarter of 2001.

Facility Rent.
Facility rent expense increased by $1,481,000 from $5,705,000 in the third
quarter of 2000 to $7,186,000 in the third quarter of 2001 as a result of the
refinancing of the Companys Cleveland-area facilities.

Facility Reorganization
Costs.During the third quarter of 2001, the Company incurred a
non-recurring charge of $750,000 in connection with its decision to revise the
marketing approach for facilities operated through subsidiaries in Florida. The
Company determined that a local community-based marketing approach would better
serve the needs of these facilities. The marketing approach stresses ties to the
local community and required renaming these facilities in order to emphasize
this approach. In connection with this effort, the Company also restructured
certain of its subsidiaries effective October 1, 2001. In order to implement
this strategy, the Company incurred non-recurring marketing, legal and other
expenses.

Interest Expense,
net. Interest expense, net, decreased from $5,836,000 in the third quarter
of 2000 to $2,097,000 in the third quarter of 2001. This decrease is the result
of the refinancing of the Cleveland-area facilities in September 2000 and the
restructuring of the Companys Discount Notes completed in May 2001. The
termination of the Cleveland-area capital leases reduced the Companys
interest expense by approximately $4,100,000 on an annual basis. The
restructuring of the Discount Notes reduced both the carrying amount of the debt
and its effective interest rate.

Income Tax Benefit.
As a result of losses incurred in the third quarter of 2000, an income tax
benefit of $4,658,000 was recognized for that period. As a result of the
uncertainty of future realization of deferred tax assets, for the quarter ended
September 30, 2001, the Company has recorded a valuation allowance equal to the

## 16

income  tax benefit that would  otherwise have been recorded by
the Company.

Net Loss.
The net loss was $7,286,000 in the third quarter of 2000 as compared to $455,000
in the third quarter of 2001.

Nine Months Ended September 30, 2000 Compared to Nine Months
Ended September 30, 2001

Total Net Revenues.
Total net revenues increased by $17,106,000 or 7.2%, from $239,317,000 in the
first nine months of 2000 to $256,423,000 in the first nine months of 2001. The
increase in total revenues, from 2000 to 2001, was primarily the result of
higher average revenues per patient day. The average occupancy rate at all of
the Companys facilities decreased from 90.2% during the first nine months
of 2000 to 89.0% during the first nine months of 2001. Average net patient
service revenues (including ancillary services) per patient day at the
Companys facilities increased from $162 in the first nine months of 2000
to $177 in the first nine months of 2001. The Companys average Medicare
Part A per diem rate increased from $313 per Medicare patient day in the first
nine months of 2000 to $338 per Medicare patient day in the first nine months of
2001, while the Companys average per diem Medicaid rate increased from
$126 in the first nine months of 2000 to $133 in the first nine months of 2001.
In December 2000, the Medicare, Medicaid, and State Child Health Insurance
Program Benefits Improvement and Protection Act of 2000 (BIPA) was
enacted. BIPA increased the prior nursing rate component of the Federal per diem
rate, for each RUG category, by 16.66% effective April 1, 2001 through September
30, 2002. In addition, BIPA eliminated the 20% add-on for three of the fifteen
rehabilitation services RUG categories and substituted a 6.7% add-on for all
fifteen rehabilitation services RUG categories. The Balanced Budget Refinement
Act of 1999 had temporarily increased the Federal per diem rates by 20% for
fifteen acuity categories beginning on April 1, 2000. BIPA also extended the
moratorium on the annual limitation on Part B therapy charges of $1,500 per
beneficiary through calendar year 2002 and repealed a previous requirement to
implement consolidated billing for Part B services. The current rate mechanism
will stay in effect until the date on which the Centers for Medicare and
Medicaid Services (CMS), previously known as Health Care Financing
Administration, implements a revised PPS system that more accurately reimburses
the costs of caring for medically complex patients. The Company believes that it
is unlikely that a new PPS system will be implemented prior to October 1, 2002.
Primarily as the result of the Medicare rate increases implemented on April 1,
2001, the Companys average Medicare Part A payment rate increased from
$313 per Medicare patient day during the first nine months of 2000 to $338 per
Medicare patient day during the first nine months of 2001. The Companys
quality mix of private, Medicare and insurance revenues was 50.9% for the nine
months ended September 30, 2000 as compared to 53.4% for the nine months ended
September 30, 2001.

Facility Operating
Expenses. Facility operating expenses increased by $15,653,000 or 8.2%, from
$191,731,000 in the first nine months of 2000 to $207,384,000 in the first nine
months of 2001. The overall increase in operating expenses in 2001 was primarily
the result of higher expenditures for employee benefit costs and temporary
nursing personnel. Consistent with other long-term care providers, the Company
continues to find it difficult to recruit and retain employees, most notably
nursing personnel. As a result of these difficulties, the Company has been
forced to rely more heavily on temporary nursing personnel.

General and
Administrative; Service Charges Paid to Former Affiliate. General and
administrative expenses increased by $757,000, from $13,667,000 in the first
nine months of 2000 to $14,424,000 in the first nine months of 2001. The Company
reimburses a former affiliate for data processing services provided to the
Company. During the first nine months of 2000, such reimbursements totaled
$845,000 compared to $801,000 during the first nine months of 2001.

Amortization of Prepaid
Management Fees. Amortization of prepaid management fees was $900,000 during
the first nine months of 2000 and the first nine months of 2001.

Depreciation and
Amortization. Depreciation and amortization decreased from $7,996,000 in the
first nine months of 2000 to $6,548,000 in the first nine months of 2001.
Depreciation expense decreased primarily as the result of the refinancing of the
Companys four Cleveland-area facilities. On September 27, 2000, the
Company terminated its capital leases for these properties and entered into new
operating leases for each of the Cleveland facilities. As a result of this
transaction, the Companys annual depreciation and interest expense
decreased by approximately $1,400,000 and $4,100,000, respectively, while the
Companys annual rent expense increased by approximately $5,900,000. The
Companys amortization expense decreased in the first nine months of 2001
primarily as a result of the write-off of deferred financing costs in September
2000 and the first half of 2001. The write-off of deferred financing costs in
the first half of 2001 were made in connection with amendments to the
Companys bank credit facility and the financial restructuring completed in
the second quarter of 2001.

Facility Rent.
Facility rent expense increased by $4,531,000, from $17,029,000 in the first
nine months of 2000 to $21,560,000 in the first nine months of 2001 as a result
of the refinancing of the Companys Cleveland-area facilities.

Financial Restructuring
Costs. In connection with the amendment to the Companys bank credit
facility and the financial restructuring completed in the first half of 2001,
the Company recorded non-recurring charges totaling $9,045,000. The charges
resulted from the write-off of unamortized deferred financing costs, related to
obtaining the Companys bank credit facility and issuing its Discount
Notes, and the recognition of various investment advisory, legal and other fees
associated with completing the amendment to the bank credit facility and the
financial restructuring.

Loss on Termination of
Capital Lease.In connection with the termination of a capital lease during
the third quarter of 2000, the Company recorded a non-recurring charge of
$8,914,000. The principal components of this charge included the write-off of
capital leased assets in excess of the related capital lease obligation
($5,700,000) and the write-off of deferred financing costs ($1,800,000) related
to the Companys bank credit facility.

Facility Reorganization
Costs.During the third quarter of 2001, the Company incurred a
non-recurring charge of $750,000 in connection with its decision to revise the
marketing approach for facilities operated through subsidiaries in Florida. The
Company determined that a local community-based marketing approach would better
serve the needs of these facilities. The marketing approach stresses ties to the
local community and required renaming these facilities in order to emphasize
this approach. In connection with this effort, the Company also restructured
certain of its subsidiaries effective October 1, 2001. In order to implement
this strategy, the Company incurred non-recurring marketing, legal and other
expenses.

Interest Expense,
net. Interest expense, net, decreased from $17,330,000 in the first nine
months of 2000 to $9,774,000 in the first nine months of 2001. This decrease is
the result of the refinancing of the Cleveland-area facilities in September 2000
and the restructuring of the Companys Discount Notes completed in May
2001. The termination of the Cleveland-area capital leases reduced the
Companys interest expense by approximately $4,100,000 on an annual basis.
The restructuring of the Discount Notes reduced both the carrying amount of the
debt and its effective interest rate.

Income Tax Benefit.
As a result of losses incurred in the first nine months of 2000, an income tax
benefit of $7,495,000 was recognized for that period.

## 17

As a result of the uncertainty of future realization of deferred
tax assets,  for the nine  months  ended  September  30,  2001,  the Company has
recorded  a  valuation  allowance  equal to the income  tax  benefit  that would
otherwise have been recorded by the Company.

Net Loss. The net loss was $11,723,000 in the first nine
months  of  2000  as  compared  to  $14,625,000  in the  first  nine  months  of
2001.

## LIQUIDITY AND CAPITAL RESOURCES

The Companys primary
cash needs are for acquisitions, capital expenditures, working capital, debt
service and general corporate purposes. The Company has historically financed
these requirements primarily through a combination of internally generated cash
flow, mortgage financing and operating leases, in addition to funds borrowed
under a credit facility. The Companys existing leased facilities are
leased from either the owner of the facilities, from a real estate investment
trust that has purchased the facilities from the owner, or through synthetic
lease borrowings. The Companys existing facility leases generally require
it to make monthly lease payments and pay all property operating costs. The
Company generally negotiates leases that provide for extensions beyond the
initial lease term and an option to purchase the leased facility. In some cases,
the option to purchase the leased facility is at a price based on the fair
market value of the facility at the time the option is exercised. In other
cases, the lease for the facility sets forth a fixed purchase option price which
the Company believes is equal to the fair market value of the facility at the
inception date of such lease, thus allowing the Company to realize the value
appreciation of the facility while maintaining financial flexibility.

In connection with the
leveraged recapitalization completed on August 11, 1998, the Company obtained
gross proceeds of $99.5 million through the issuance of 11% Senior Subordinated
Discount Notes (the Discount Notes) due 2008 and $40 million through
the issuance of 13.5% Exchangeable Preferred Stock (the Preferred
Stock) mandatorily redeemable in 2010. Interest on the Discount Notes was
to accrete at 11% per annum until August 1, 2003 and then become payable in
cash, semi-annually in arrears, beginning on February 1, 2004. Dividends on the
Preferred Stock were payable, at the option of the Company, in additional shares
of the Preferred Stock until August 1, 2003. After that date dividends were
required to be paid in cash. In August 1998, the Company also entered into a new
$250 million collateralized credit facility (the New Credit
Facility). The terms of the New Credit Facility originally provided up to
$75 million on a revolving credit basis plus an additional $175 million
initially funded on a revolving basis that would convert to a term loan on an
annual basis on each anniversary of the closing. During the first four years of
the facility, any or all of the full $250 million of availability under the
facility could be used for synthetic lease financings. Proceeds of loans under
the facility can be used for acquisitions, working capital purposes, capital
expenditures and general corporate purposes. Interest is based on either LIBOR
or prime rates of interest (plus applicable margins determined by the
Companys leverage ratio) at the election of the Company. The New Credit
Facility contains various financial and other restrictive covenants and limits
aggregate borrowings under the New Credit Facility to a predetermined multiple
of earnings before interest, taxes, depreciation and amortization
(EBITDA).

During the first quarter of
1999, the Company determined that its anticipated financial results for that
quarter would cause the Company to be out of compliance with certain financial
covenants of the New Credit Facility. The Companys reduced level of EBITDA
during the first quarter of 1999 was attributable to transitional difficulties
associated with the implementation of the new Medicare prospective payment
system which became effective at all of the Companys facilities on January
1, 1999. Such transitional difficulties resulted in lower than expected
revenues, primarily due to fewer than expected Medicare patient days, lower
Medicare Part A rates, reduced revenues from therapy services provided to
non-affiliated long-term care centers and a reduction in revenues from the
provision of Medicare Part B services at the Companys own facilities. In
response, during the first quarter of 1999, the Company initiated additional
facility-based training directed towards the documentation requirements of the
revised Medicare reimbursement system. The Company also continued to refine its
admission and assessment protocols in order to increase patient admissions and
introduced a series of targeted initiatives to lower operating expenses. Such
initiatives included wage and staffing reductions (primarily related to the
delivery of rehabilitative therapy services and indirect nursing support),
renegotiation of vendor contracts and ongoing efforts to reduce the
Companys reliance on outside nurse agency personnel. All of the staffing
reductions were implemented, on or prior to, April 1, 1999. Effective March 30,
1999, the Company obtained an amendment (the First Amendment) to the
New Credit Facility which limited borrowings under the New Credit Facility to an
aggregate of $58,500,000 (exclusive of undrawn letters of credit outstanding as
of March 30, 1999) and which modified certain financial covenants. Beginning
with the first quarter of 1999, the First Amendment replaced the original
financial covenants with one new financial covenant, a minimum cumulative amount
of EBITDA. The original financial covenants provided maximum ratios of total
indebtedness to EBITDA and senior indebtedness to EBITDA, and a minimum debt
service coverage ratio. The First Amendment required minimum amounts of EBITDA,
measured quarterly, but calculated on a rolling twelve-month basis, through
December 31, 2000. As long as the Company met or exceeded the required minimum
cumulative amounts of EBITDA, the Company could access the New Credit Facility
for general corporate purposes, subject to the reduced amount of availability.

Until September 27, 2000,
the Company, through a wholly-owned limited partnership, leased and operated
four facilities in Ohio (the Cleveland Facilities) that it acquired
in 1996 through capital leases. Each of the four leases contained an option to
purchase the facility beginning July 1, 2001 and each lease was guaranteed by
the Company. The guaranty provided that failure by the Company to have a
specified minimum consolidated net worth at the end of any two consecutive
quarters would be an event of default under the guaranty, which in turn would be
an event of default under each lease. During the third quarter of 1999, the
Company recorded a $5.7 million restructuring charge to terminate its contracts
to provide rehabilitation therapy services to non-affiliated long-term care
facilities. As a result of this restructuring charge, the Companys
consolidated net worth as of September 30, 1999 (as calculated for purposes of
this requirement) had fallen below the required level. The Company anticipated
that its net worth would continue to be below the required level at December 31,
1999, which would have resulted in an event of default under each of these
leases with the Company potentially facing the loss of these operations. Such
default could also have triggered cross-defaults under the Companys other
lease and debt obligations. In December 1999, the Company paid $5 million to its
landlord and obtained an option (the New Option) to acquire the
Cleveland Facilities. The Company borrowed $5 million from an affiliate of
Investcorp S.A. to fund this payment. The New Option allowed the Company to
exercise its right to purchase the Cleveland Facilities beginning as of the date
of the New Option, required the Company to complete the acquisition prior to
December 31, 2000 and provided a waiver of the net worth covenant through that
date. The Company exercised the New Option on June 30, 2000 and on September 27,
2000 the Company terminated the Cleveland Facilities capital leases and assigned
its purchase rights for these facilities to an investment entity organized by
Investcorp S.A. for $5.0 million that acquired the Cleveland Facilities on
September 27, 2000. On that date, the Company entered into new operating leases
for each of the Cleveland Facilities with combined annual rent expense of
approximately $5.9 million. The Company also repaid the $5.0 million loan from
an affiliate of Investcorp S.A. As a result of the capital lease termination,
the Company recorded a non-recurring charge of $8.9 million. The principal
components of this charge included the write-off of capital leased assets in
excess of the related capital lease obligation ($5.7 million) and the write-off
of deferred financing costs ($1.8 million) originally incurred in obtaining the
Companys New Credit Facility. In order to complete the Cleveland Facility
leasing transaction, the Company was required to obtain the release of certain
collateral held by the bank group that provides the New Credit Facility. The
Company obtained the release of the collateral as part of an amendment (the
Second Amendment) to the New Credit Facility that also resulted in a
permanent reduction of the Companys maximum borrowings under the New
Credit Facility from $250 million to $150 million and an increase in the
Companys borrowing rate. As a result of the permanent reduction in funds

## 18

available  through  the New Credit  Facility,  the  Company was
required to write off a  proportionate  amount of the deferred  financing  costs
incurred when the New Credit Facility was originally obtained.

On March 28, 2001, the
Company obtained an additional amendment (the Third Amendment) to
the New Credit Facility. The Third Amendment resulted in a permanent reduction
of the Companys maximum borrowings under the New Credit Facility from $150
million to $60 million, revised certain financial covenants, changed the
maturity date of the New Credit Facility to March 31, 2004 and increased the
Companys borrowing rate. The Third Amendment also requires the Company to
repay, on an annual basis, the greater of $5.0 million or 50% of the
Companys excess cash flow (as defined).

In March 2001, the Company
entered into an agreement (the Restructuring Agreement) with
Investcorp S.A. and the holders of more than a majority in interest of the
Companys Discount Notes and Preferred Stock for purposes of implementing a
restructuring of the Discount Notes and Preferred Stock. The Restructuring
Agreement contemplated that the Company would offer to exchange for each $1,000
amount at maturity of outstanding Discount Notes a combination of the following:
(1) 0.5899118 of a new 12% Senior Subordinated Discount Note due 2007 (the
New Notes) each having a principal amount at maturity equal to
$1,000 and an original issue price of $685.67 (assuming that the New Notes were
issued on May 4, 2001), (2)  $88.2353 in cash and (3) common stock
purchase warrants for approximately 10.9 shares of its Class A Common
Stock. The Company would also offer to exchange common stock purchase warrants
for approximately 10.7 shares of its Class A Common Stock for each $1,000
liquidation preference of Preferred Stock (based on the aggregate liquidation
preference to be outstanding on May 1, 2001) plus any dividends accrued on such
Preferred Stock after May 1, 2001. In conjunction with the restructuring
proposal, the Company would solicit consents from holders of outstanding
Discount Notes and Preferred Stock to amendments to the Indenture governing the
Discount Notes and to the Certificate of Designation governing the Preferred
Stock that would eliminate or modify certain restrictive covenants and other
provisions contained in the Indenture and the Certificate of Designation and
would substantially eliminate the preferences of the Preferred Stock, including
the reduction of the liquidation preference from $1,000 to $0.01 per share and
the elimination of the right of holders to be paid dividends on shares of
Preferred Stock. Also, the Company would issue to Investcorp S.A. (or one or
more of its affiliates or designees) up to 15,000 shares of a new series of 13%
convertible exchangeable preferred stock (the New Preferred Stock)
and 1,854,422 common stock purchase warrants for a total purchase price of up to
$15,000,000.

On April 6, 2001 the
Company initiated the exchange offer and consent solicitation contemplated by
the Restructuring Agreement. On May 10, 2001, the Company completed the exchange
offer and consent solicitation, thereby implementing each of the elements of the
Restructuring Agreement. All of the outstanding Discount Notes and 99.96% of the
shares of Preferred Stock were tendered and exchanged in the exchange offer. As
a result of the exchange, (1) the Company has an aggregate principal amount at
maturity of $100,276,000 of New Notes outstanding and an aggregate liquidation
preference of $15,000,000 (as of May 10, 2001) of New Preferred Stock
outstanding, (2) warrants were issued to holders of Discount Notes, to
holders of Preferred Stock, and to Investcorp S.A. representing the right to
purchase an aggregate of approximately 15%, 5% and 15%, respectively, of the
total number of shares of all classes of the Companys common stock on a
fully diluted basis (excluding shares issuable upon conversion of the New
Preferred Stock, each share of which will initially be convertible into 150
shares of Class A Common Stock, and (3) the Company paid $15,000,000
in cash as partial consideration for the tendered Discount Notes.

The reduction in the
liquidation preference of the Preferred Stock was completed on May 10, 2001, as
contemplated by the Restructuring Agreement, the carrying amount of the
Preferred Stock was reduced from $57,595,000 to $576 and the amount of the
reduction, net of unamortized deferred financing costs related to the issuance
of the Preferred Stock (approximately $1,011,000 at May 10, 2001), was directly
transferred to the Companys Accumulated Deficit account. With the exchange
of the New Notes for the Discount Notes (the Note Exchange), the
carrying value of the accreted principal of the Discount Notes was reduced to
$68,890,000, and the amount of the reduction, net of the aggregate cash payment
of $15,000,000, was directly transferred to the Companys Long-term Accrued
Interest account. Subsequent to their issuance, the carrying amount of the New
Notes increases as the result of accretion and results in a corresponding
decrease in the carrying amount of Long-term Accrued Interest. Interest expense
on the New Notes is recognized such that a constant effective interest rate is
applied to the aggregate carrying amount of the New Notes and Long-term Accrued
Interest for all periods between the issuance date and the maturity date of the
New Notes.

In connection with the
Third Amendment to the New Credit Facility and the implementation of the
Restructuring Agreement, the Company incurred a non-recurring charge of
$9,045,000. The charge resulted from the write-off of approximately $1,500,000
of unamortized deferred financing costs incurred when the New Credit Facility
was obtained, the write-off of approximately $3,400,000 of unamortized deferred
financing costs related to the issuance of the Discount Notes, and the
recognition of various investment advisory, legal and other fees associated with
these events approximating $4,100,000.

The New Notes were issued at a discount and interest on the
New Notes accretes until August 1, 2004. Cash interest payments will be paid
semi-annually in arrears beginning on February 1, 2005 based on the fully
accreted value of the New Notes and a 12% cash interest payment rate. The New
Notes mature on August 1, 2007. The New Preferred Stock is mandatorily
redeemable on February 1, 2008. The holders of the New Preferred Stock are
entitled to dividends quarterly in arrears beginning August 1, 2001 and payable
in additional shares of New Preferred Stock. Warrants to purchase a total of
4,326,641 shares of common stock at $0.01 per share were issued on May 10, 2001.

As of September 30, 2001,
total borrowings under the New Credit Facility were $53,061,000 and consisted of
$28,750,000 of revolver loans, $13,700,000 of synthetic lease obligations and
$10,611,000 of undrawn letters of credit. As of September 30, 2001, the Company
had approximately $6,939,000 of funding available under the New Credit Facility
(as amended by the Third Amendment) and was not in default of the financial
covenants of the New Credit Facility as amended by the Third Amendment.

The Companys
operating activities during the first nine months of 2000 provided net cash of
$22,200,000 as compared to providing net cash of $12,473,000 during the first
nine months of 2001. Cash flows from operations in 2001 decreased as the result
of non-recurring cash charges incurred in connection with completing the Third
Amendment and the Financial Restructuring.

Net cash used by investing
activities was $7,282,000 during the first nine months of 2000 as compared to
$9,246,000 used during the first nine months of 2001. The primary use of cash
for investing purposes during 2000 was to fund additions to property and
equipment associated with the maintenance of the Companys existing
facilities and the development of its data processing capabilities. The primary
use of cash for investing purposes during 2001 was to fund additions of property
and equipment associated with the maintenance of the Companys nursing
facilities

Net cash used by financing
activities was $8,280,000 during the first nine months of 2000 as compared to
$4,086,000 during the first nine months of 2001. During the first nine months of
2000, the Company repaid a $5,000,000 note payable from an affiliate of
Investcorp S.A. Substantially all of the remaining cash used in the first nine

## 19

months  of 2000 related to principal  payments  associated
with the  Cleveland-area  facilities  capital  leases.  The refinancing of these
leases in September 2000 eliminated the principal  payments  associated with the
capital leases.  The financing  activities  during the first nine months of 2001
consisted of the issuance of $15.0 million of New Preferred  Stock, a payment of
$15.0  million to the  holders of the  Discount  Notes and a  repayment  of $4.0
million of borrowings outstanding under the New Credit Facility. As of September
30, 2001, the Company had repaid $4.0 million of the $5.0 million it is required
to repay  against the New Credit  Facility by December 31, 2001,  in  accordance
with the terms of the Third Amendment.

As of September 30, 2001,
in addition to the Discount Notes (which had an accreted balance of
$72,104,000), the Company had two mortgage loans outstanding totaling
$17,242,000 and $28,750,000 in advances on its New Credit Facility. One mortgage
loan had an outstanding principal balance of $15,735,000 of which $15,140,000 is
due at maturity in 2004. This loan bears interest at an annual rate of 10.65%
plus additional interest equal to 0.3% of the difference between the operating
revenues of the four mortgaged facilities in each applicable year and operating
revenues during the twelve-month base period. The Companys other mortgage
loan, which encumbers a single facility, had an outstanding principal balance of
$1,507,000 at September 30, 2001, of which $1,338,000 is due in 2010.

Harborside expects that its
capital expenditures for 2001, excluding acquisitions of new long-term care
facilities, will aggregate approximately $10,000,000. Harborsides expected
capital expenditures will relate to maintenance capital expenditures, systems
enhancements, special construction projects and other capital improvements.
Harborside expects that its future facility acquisitions will be financed with
borrowings under the New Credit Facility, direct operating leases or assumed
debt. Harborside may be required to obtain additional equity financing to
finance any significant acquisitions in the future.

The Companys general and professional liability
insurance policy expired on September 1, 2001. Given the overall state of the
professional and general liability insurance market for the long-term care
industry and the lack of available underwriters in the State of Florida, the
Company determined that effective September 1, 2001 it would be more cost
effective to assume a higher level of retained risk. As a result, the Company
implemented a new professional liability program effective on that date that
resulted in the Company becoming self-insured with respect to Florida
facilities. With respect to the non-Florida facilities, the Company retains
insurance with unaffiliated commercial insurance companies in amounts and with
deductibles which management believes are sufficient for its operations. At this
time, the Company estimates that its annual cost for professional and general
liability insurance will increase from approximately $2,500,000 under the prior
program to approximately $6,500,000 under the new program. There can be no
assurance, however, that the coverage limits of the Company's insurance program
will be adequate or that insurance will continue to be available to the Company
in the future. Although this year the State of Florida has implemented certain
tort reforms related to professional liability claims, the Company is unable at
this time to quantify the likely effect of this legislation on the Company's
claims experience.

The Health Insurance
Portability and Accountability Act of 1997 (HIPAA) became effective
on January 1, 1997 and mandated the adoption of regulations designed to (a)
standardize transaction formats and billing codes for documenting medical
services and processing medical claims; and (b) protect the privacy and security
of individually identifiable health information. Final HIPAA regulations were
published during the fourth quarter of 2000. The Company is currently working in
conjunction with its software vendors to evaluate the impact of HIPAA
regulations on the Companys systems and operating procedures. The Company
has not yet completed its analysis or its estimate of the expected costs of
HIPAA compliance. There can be no assurances that compliance with HIPAA
regulations will not have an adverse effect on the Companys results of
operations, cash flows or its financial position.

## SEASONALITY

The Companys earnings
generally fluctuate from quarter to quarter. This seasonality is related to a
combination of factors, which include the timing and amount of Medicaid rate
increases, seasonal census cycles, and the number of days in a given fiscal
quarter.

## INFLATION

The healthcare industry is
labor intensive. Wages and other labor related costs are especially sensitive to
inflation. Certain of the Companys other expense items, such as supplies
and real estate costs are also sensitive to inflationary pressures. Shortages in
the labor market or general inflationary pressure could have a significant
effect on the Company. In addition, suppliers pass along rising costs to the
Company in the form of higher prices. When faced with increases in operating
costs, the Company has sought to increase its charges for services and its
requests for reimbursement from government programs. The Companys private
pay customers and third party reimbursement sources may be less able to absorb
increased prices for the Companys services. The Companys operations
could be adversely affected if it is unable to recover future cost increases or
experiences significant delays in increasing rates of reimbursement of its labor
or other costs from Medicare and Medicaid revenue sources.

## 20

## SPECIAL NOTE
REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this
Form 10-Q, including information set forth under the caption
Managements Discussion and Analysis of Financial Condition and
Results of Operations, constitute Forward-Looking Statements
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
Reform Act). The Company desires to take advantage of certain
safe harbor provisions of the Reform Act and is including this
special note to enable the Company to do so. Forward-looking statements included
in this Form 10-Q, or hereafter included in other publicly available documents
filed with the Securities and Exchange Commission, reports to the Companys
stockholders and other publicly available statements issued or released by the
Company involve known and unknown risks, uncertainties, and other factors which
could cause the Companys actual results, performance (financial or
operating) or achievements to differ materially from the future results,
performance (financial or operating) or achievements expressed or implied by
such forward-looking statements. The Company believes the following important
factors could cause such a material difference to occur:

`1.   The  occurrence  of changes in the mix of payment  sources  utilized by the
     Company's patients to pay for the Company's services.

2.   The  adoption of cost  containment  measures by private pay sources such as
     commercial insurers and managed care  organizations,  as well as efforts by
     governmental reimbursement sources to impose cost containment measures.

3.   Changes  in the  United  States  healthcare  system,  including  changes in
     reimbursement  levels and the method of  reimbursement,  under Medicaid and
     Medicare, and other changes in applicable government regulations that might
     affect the profitability of the Company.

4.   The  Companys  continued  ability to  operate in a heavily  regulated
     environment  and to  satisfy  regulatory  authorities,  thereby  avoiding a
     number of  potentially  adverse  consequences,  such as the  imposition  of
     fines,  temporary suspension of admission of patients,  restrictions on the
     ability to acquire  new  facilities,  suspension  or  decertification  from
     Medicaid  or  Medicare  programs,  and in extreme  cases,  revocation  of a
     facilitys license or the closure of a facility, including as a result
     of unauthorized activities by employees.

5.   The  Companys  ability to secure the capital and the related  cost of
     such capital  necessary to fund its future growth through  acquisition  and
     development, as well as internal growth.

6.   Changes in certificate of need laws that might increase  competition in the
     Companys industry,  including,  particularly,  in the states in which
     the Company currently operates or anticipates operating in the future.

7.   The  Companys  ability  to staff its  facilities  appropriately  with
     qualified  healthcare  personnel,  including  in times of shortages of such
     personnel and to maintain a satisfactory relationship with labor unions.

8.   The level of competition in the Companys industry,  including without
     limitation,  increased competition from acute care hospitals,  providers of
     assisted  and  independent  living and  providers  of home  healthcare  and
     changes  in the  regulatory  systems  in the  states in which  the  Company
     operates that facilitate such competition.

9.   The continued  availability and pricing of insurance for the inherent risks
     of liability in the healthcare industry.

10.  Price increases in  pharmaceuticals,  durable  medical  equipment and other
     items.

11.  The  Companys  reputation  for delivering  high-quality  care and its
     ability to attract and retain patients,  including patients with relatively
     high acuity levels.

12.  Changes in general  economic  conditions,  including  changes that pressure
     governmental  reimbursement  sources  to  reduce  the  amount  and scope of
     healthcare coverage.

The  foregoing  review  of  significant  factors  should  not  be  construed  as
exhaustive or as an admission  regarding the adequacy of disclosures  previously
made by the Company.`

## 21

# Item 3.QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Most of the Companys
debt obligations bear interest at fixed rates and are not affected by changes in
market interest rates; however, borrowings under the Companys New Credit
Facility are sensitive to changes in interest rates. Under the New Credit
Facility, interest is based on either LIBOR or prime rates of interest (plus
applicable margins determined by the Companys leverage), at the
Companys election. As the prime and LIBOR rates of interest increase,
interest expense associated with the Companys borrowings under the New
Credit Facility would also increase. An increase of 1% in the applicable rate
would increase the Companys annual interest cost by approximately
$328,000.

The Company did not
experience significant changes in interest rates during the nine months ended
September 30, 2001. As part of the Companys risk management program, the
Company continuously reviews its overall exposure to interest rate risk and
evaluates the benefits of interest rate hedging through the use of derivative
instruments, such as interest rate swaps. By entering into an interest rate
swap, the Company can effectively transform variable rate debt into fixed rate
debt. The Company did not have any interest rate swap arrangements outstanding
during the nine-month periods ending September 30, 2000 or September 30, 2001.

## 22

# PART II -
OTHER INFORMATION

`Item 1.     Legal Proceedings
                 None.

Item 2.     Changes in Securities
                 None.

Item 3.    Defaults upon Senior Securities
                 None.

Item 4.     Submission of Matters to a Vote of Security Holders
                 None.

Item 5.     Other Information
                 None.

Item 6.     Exhibits and Reports on Form 8-K

            (a)      Exhibits

                     None.


            (b)      Reports on 8-K

                     None.`

## 23

# SIGNATURES

Pursuant to the
requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

`Harborside Healthcare Corporation



                                    By:    /s/ Stephen L. Guillard
                                           -------------------------
                                               Stephen L. Guillard
                                               Chairman and
                                               Chief Executive Officer


                                    By:   /s/ William H. Stephan
                                              ------------------
                                              William H. Stephan
                                              Senior Vice President and
                                              Chief Financial Officer









DATE:   November 14, 2001`

## 24