##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q







|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended March 31, 2008.

or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to
.

Commission File Number 333-133319





LIFECARE HOLDINGS, INC.

(Exact name of registrant as specified in its
charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 51-0372090                          
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification Number)



|                                         |  |           
|---------------------------------------- |  | ----------
|5560 Tennyson Parkway Plano, Texas       |  | 75024     
|(Address of Principal Executive Offices) |  | (Zip Code)

(469) 241-2100

(Registrants telephone number, including area code)

None

(Former name, former address and former fiscal year, if changes since last report)





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   ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Please see definition of accelerated and large
accelerated filer in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer:   ̈    Accelerated Filer:   ̈    Non-Accelerated Filer:  x    Smaller
Reporting Company:   ̈

Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act).    Yes   ̈    No  x

As of May 15, 2008, the registrant had 100 shares of Common Stock, par value $0.01 per share, outstanding.









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##### Table of Contents

LIFECARE
HOLDINGS, INC.

TABLE OF CONTENTS



|           |  |                                                                                       |  |   
|---------- |  | ------------------------------------------------------------------------------------- |  | --
|PART I     |  | FINANCIAL INFORMATION                                                                 |  |   
|           |  |                                                                                      
|ITEM 1.    |  | CONSOLIDATED FINANCIAL STATEMENTS                                                     |  | 3 
|           |  |                                                                                      
|           |  | CONDENSED CONSOLIDATED BALANCE SHEETS                                                 |  | 3 
|           |  |                                                                                      
|           |  | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                       |  | 4 
|           |  |                                                                                      
|           |  | CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)                   |  | 5 
|           |  |                                                                                      
|           |  | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                       |  | 6 
|           |  |                                                                                      
|           |  | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                  |  | 7 
|           |  |                                                                                      
|ITEM 2.    |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 18
|           |  |                                                                                      
|ITEM 3.    |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  | 27
|           |  |                                                                                      
|ITEM 4.    |  | CONTROLS AND PROCEDURES                                                               |  | 27
|           |  |                                                                                      
|PART II    |  | OTHER INFORMATION                                                                     |  | 28
|           |  |                                                                                      
|ITEM 1.    |  | LEGAL PROCEEDINGS                                                                     |  | 28
|           |  |                                                                                      
|ITEM 1A.   |  | RISK FACTORS                                                                          |  | 28
|           |  |                                                                                      
|ITEM 2.    |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDINGS                        |  | 28
|           |  |                                                                                      
|ITEM 3.    |  | DEFAULTS UPON SENIOR SECURITIES                                                       |  | 28
|           |  |                                                                                      
|ITEM 4.    |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   |  | 28
|           |  |                                                                                      
|ITEM 5.    |  | OTHER INFORMATION                                                                     |  | 28
|           |  |                                                                                      
|ITEM 6.    |  | EXHIBITS                                                                              |  | 28
|           | 
|SIGNATURES |  | 29                                                                                   



2



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##### Table of Contents

PART 1: FINANCIAL INFORMATION



|ITEM 1: | CONSOLIDATED FINANCIAL STATEMENTS
|------- | ---------------------------------

LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

March 31, 2008 (unaudited) and December 31, 2007

(In thousands, except share data)



|                                                                                                |  |               |          |   |                  |   |          |  
|----------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                |  | March 31,2008 |          |   | December 31,2007 |  
|Assets                                                                                          |  |               |          |   |                  |   |          |  
|Current assets:                                                                                 |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                                                                       |  | $             | 6,667    |   |                  | $ | 17,816   |  
|Accounts receivable, net of allowance for doubtful accounts of $20,756 and $19,394 respectively |  |               | 76,580   |   |                  |   | 66,911   |  
|Income taxes                                                                                    |  |               | 1,821    |   |                  |   | 2,025    |  
|Other current assets                                                                            |  |               | 12,584   |   |                  |   | 13,597   |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Total current assets                                                                            |  |               | 97,652   |   |                  |   | 100,349  |  
|Property and equipment, net                                                                     |  |               | 88,630   |   |                  |   | 83,317   |  
|Other assets                                                                                    |  |               | 15,091   |   |                  |   | 15,675   |  
|Identifiable intangibles, net                                                                   |  |               | 18,160   |   |                  |   | 18,445   |  
|Goodwill                                                                                        |  |               | 263,970  |   |                  |   | 263,970  |  
|                                                                                                |  |               |          |   |                  |   |          |  
|                                                                                                |  | $             | 483,503  |   |                  | $ | 481,756  |  
|                                                                                                |  |               |          |   |                  |   |          |  
|                                                                                                |  |              
|Liabilities and Stockholders Equity (Deficit)                                                  |  |               |          |   |                  |   |          |  
|Current liabilities:                                                                            |  |               |          |   |                  |   |          |  
|Current installments of long-term debt                                                          |  | $             | 2,550    |   |                  | $ | 2,550    |  
|Current installments of obligations under capital leases                                        |  |               | 1,565    |   |                  |   | 1,604    |  
|Current installment of lease financing obligation                                               |  |               | 395      |   |                  |   |         |  
|Estimated third party payor settlements                                                         |  |               | 3,625    |   |                  |   | 5,744    |  
|Accounts payable                                                                                |  |               | 24,679   |   |                  |   | 23,438   |  
|Accrued payroll                                                                                 |  |               | 9,524    |   |                  |   | 6,351    |  
|Accrued vacation                                                                                |  |               | 4,279    |   |                  |   | 3,489    |  
|Accrued insurance                                                                               |  |               | 1,120    |   |                  |   | 1,087    |  
|Accrued interest                                                                                |  |               | 1,781    |   |                  |   | 5,181    |  
|Accrued other                                                                                   |  |               | 3,109    |   |                  |   | 2,739    |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Total current liabilities                                                                       |  |               | 52,627   |   |                  |   | 52,183   |  
|Long-term debt, excluding current installments                                                  |  |               | 393,075  |   |                  |   | 393,713  |  
|Obligations under capital leases, excluding current installments                                |  |               | 2,608    |   |                  |   | 741      |  
|Lease financing obligation, excluding current installments                                      |  |               | 19,130   |   |                  |   | 16,590   |  
|Accrued insurance                                                                               |  |               | 4,944    |   |                  |   | 4,714    |  
|Other noncurrent liabilities                                                                    |  |               | 13,704   |   |                  |   | 13,582   |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Total liabilities                                                                               |  |               | 486,088  |   |                  |   | 481,523  |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Commitments and contingencies                                                                   |  |               |          |   |                  |   |          |  
|                                                                                                |  |              
|Stockholders equity (deficit):                                                                 |  |               |          |   |                  |   |          |  
|Common stock, $0.01 par value, 100 shares authorized, issued and outstanding in 2008 and 2007   |  |               |         |   |                  |   |         |  
|Additional paid-in capital                                                                      |  |               | 171,776  |   |                  |   | 171,677  |  
|Accumulated deficit                                                                             |  |               | (174,361 | ) |                  |   | (171,444 | )
|                                                                                                |  |               |          |   |                  |   |          |  
|Total stockholders equity (deficit)                                                            |  |               | (2,585   | ) |                  |   | 233      |  
|                                                                                                |  |               |          |   |                  |   |          |  
|                                                                                                |  | $             | 483,503  |   |                  | $ | 481,756  |  
|                                                                                                |  |               |          |   |                  |   |          |  

See accompanying notes to condensed consolidated financial statements.



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LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

For the three months ended March 31, 2008 and 2007

(In thousands)

(Unaudited)



|                                          |  |      |        |   |      |   |        |  
|----------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                          |  | 2008 |        |   | 2007 |  
|Net patient service revenue               |  | $    | 88,761 |   |      | $ | 82,369 |  
|                                          |  |      |        |   |      |   |        |  
|Salaries, wages, and benefits             |  |      | 41,088 |   |      |   | 37,980 |  
|Supplies                                  |  |      | 9,051  |   |      |   | 8,397  |  
|Rent                                      |  |      | 6,170  |   |      |   | 5,122  |  
|Other operating expenses                  |  |      | 20,735 |   |      |   | 20,683 |  
|Provision for doubtful accounts           |  |      | 1,847  |   |      |   | 1,413  |  
|Depreciation and amortization             |  |      | 2,753  |   |      |   | 2,844  |  
|Interest expense, net                     |  |      | 9,834  |   |      |   | 8,476  |  
|                                          |  |      |        |   |      |   |        |  
|Total expenses                            |  |      | 91,478 |   |      |   | 84,915 |  
|                                          |  |      |        |   |      |   |        |  
|Loss before income taxes                  |  |      | (2,717 | ) |      |   | (2,546 | )
|Provision for (benefit from) income taxes |  |      | 200    |   |      |   | (851   | )
|                                          |  |      |        |   |      |   |        |  
|Net loss                                  |  | $    | (2,917 | ) |      | $ | (1,695 | )
|                                          |  |      |        |   |      |   |        |  

See accompanying notes to condensed consolidated financial statements.



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LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders Equity
(Deficit)

For the three months ended March 31, 2008

(In thousands)

(Unaudited)



|                                 |  |             |   |                          |   |                    |  |   |                                   |   |  |   |        |  
|-------------------------------- |  | ----------- | - | ------------------------ | - | ------------------ |  | - | --------------------------------- | - |  | - | ------ | -
|                                 |  | CommonStock |   | AdditionalPaid-inCapital |   | AccumulatedDeficit |  |   | TotalStockholdersEquity(Deficit) |  
|Balance, December 31, 2007       |  | $           |  |                          | $ | 171,677            |  | $ | (171,444                          | ) |  | $ | 233    |  
|Equity compensation amortization |  |             |  |                          |   | 99                 |  |   |                                  |   |  |   | 99     |  
|Net loss                         |  |             |  |                          |   |                   |  |   | (2,917                            | ) |  |   | (2,917 | )
|                                 |  |             |   |                          |   |                    |  |   |                                   |   |  |   |        |  
|Balance, March 31, 2008          |  | $           |  |                          | $ | 171,776            |  | $ | (174,361                          | ) |  | $ | (2,585 | )
|                                 |  |             |   |                          |   |                    |  |   |                                   |   |  |   |        |  

See accompanying notes to condensed consolidated financial statements.



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LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

For the three months ended March 31, 2008 and 2007

(In thousands)

(Unaudited)



|                                                                            |  |      |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                            |  | 2008 |         |   | 2007 |  
|Cash flows from operating activities:                                       |  |      |         |   |      |   |         |  
|Net loss                                                                    |  | $    | (2,917  | ) |      | $ | (1,695  | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |      |         |   |      |   |         |  
|Depreciation and amortization                                               |  |      | 3,276   |   |      |   | 3,207   |  
|Provision for doubtful accounts                                             |  |      | 1,847   |   |      |   | 1,413   |  
|Equity compensation amortization                                            |  |      | 99      |   |      |   | 164     |  
|Changes in operating assets and liabilities:                                |  |      |         |   |      |   |         |  
|Patient accounts receivable                                                 |  |      | (11,516 | ) |      |   | (6,745  | )
|Current income taxes                                                        |  |      | 200     |   |      |   | (1,389  | )
|Other current assets                                                        |  |      | (788    | ) |      |   | 717     |  
|Other assets                                                                |  |      | 61      |   |      |   | (182    | )
|Estimated third-party payor settlements                                     |  |      | (2,119  | ) |      |   | (8,382  | )
|Accounts payable and accrued expenses                                       |  |      | 3,838   |   |      |   | (3,871  | )
|Other liabilities                                                           |  |      | 352     |   |      |   | 405     |  
|                                                                            |  |      |         |   |      |   |         |  
|Net cash used in operating activities                                       |  |      | (7,667  | ) |      |   | (16,358 | )
|                                                                            |  |      |         |   |      |   |         |  
|Cash flows from investing activities:                                       |  |      |         |   |      |   |         |  
|Purchases of property and equipment                                         |  |      | (8,542  | ) |      |   | (7,030  | )
|Sale-leaseback proceeds                                                     |  |      | 2,893   |   |      |   |        |  
|                                                                            |  |      |         |   |      |   |         |  
|Net cash used in investing activities                                       |  |      | (5,649  | ) |      |   | (7,030  | )
|                                                                            |  |      |         |   |      |   |         |  
|Cash flows from financing activities:                                       |  |      |         |   |      |   |         |  
|Lease financing obligation proceeds                                         |  |      | 1,800   |   |      |   |        |  
|Payments of notes payable and long-term debt                                |  |      | (638    | ) |      |   | (638    | )
|Proceeds from capital lease financing                                       |  |      | 1,802   |   |      |   |        |  
|Payments on obligations under capital leases                                |  |      | (797    | ) |      |   | (1,089  | )
|                                                                            |  |      |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                         |  |      | 2,167   |   |      |   | (1,727  | )
|                                                                            |  |      |         |   |      |   |         |  
|Net decrease in cash and cash equivalents                                   |  |      | (11,149 | ) |      |   | (25,115 | )
|Cash and cash equivalents, beginning of period                              |  |      | 17,816  |   |      |   | 33,250  |  
|                                                                            |  |      |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                    |  | $    | 6,667   |   |      | $ | 8,135   |  
|                                                                            |  |      |         |   |      |   |         |  
|Supplemental disclosure of cash flow information:                           |  |      |         |   |      |   |         |  
|Cash:                                                                       |  |      |         |   |      |   |         |  
|Interest paid                                                               |  | $    | 13,380  |   |      | $ | 12,223  |  
|Income taxes paid                                                           |  |      |        |   |      |   |        |  
|Investing and financing activities:                                         |  |      |         |   |      |   |         |  
|Equipment purchased through capital lease financing                         |  |      | 824     |   |      |   |        |  

See accompanying notes to condensed consolidated financial statements.



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LifeCare Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(In thousands, except share and per share data)



|(1) | Basis of Presentation
|--- | ---------------------

LifeCare Holdings, Inc. (the
Company) is a wholly owned subsidiary of LCI Holdco, LLC (Holdco). Holdco is a wholly owned subsidiary of LCI Holding Company, Inc. (Holdings), which is owned by an investor group that includes affiliates of The
Carlyle Group and members of the board of directors. The investor group acquired Holdings pursuant to a merger that occurred on August 11, 2005 (the Merger).

The accompanying unaudited condensed consolidated financial statements and financial information have been prepared in accordance with generally accepted
accounting principles, and reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results of the interim periods. The accompanying financial statements for the three months ended March 31, 2008
and 2007 are not necessarily indicative of annualized financial results.

The accompanying unaudited condensed consolidated financial
statements should be read in conjunction with the consolidated audited financial statements and notes thereto for the year ended December 31, 2007 included in the Form 10-K we filed on March 28, 2008 with the Securities and Exchange
Commission. Certain information and disclosures normally included in the notes to consolidated financial statements have been condensed or omitted as permitted by the rules and regulations of the Securities and Exchange Commission, although we
believe the disclosure is adequate to make the information presented not misleading.



|(2) | Summary of Significant Accounting Policies
|--- | ------------------------------------------

Use of Estimates

The preparation of the financial statements requires us to make a number of estimates and
assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual amounts could differ from those estimates.

Goodwill

We review our goodwill annually, or more frequently if circumstances warrant a more timely review, to determine if there has been an impairment. We review
goodwill based upon one reporting unit. In calculating the fair value of the reporting unit, we use various assumptions including projected cash flows and discount rates. If projected future cash flows decline from the current amounts projected by
management, recording of impairments may be required.

Income Taxes

For the three months ended March 31, 2008, income tax expense recorded represents the estimated income tax liability for certain state income taxes.
We expected that no benefit or expense will be realized during 2008 for federal income taxes based on recent taxable loss trends and a projected taxable loss for the remainder of 2008. We anticipate that federal net operating losses generated during
2008 will be offset by an increase in the valuation allowance against net deferred tax assets.

FASB Interpretation No. 48, Accounting
for Uncertainty in Income Taxes, an interpretation of FASB Statement 109 (FIN 48) prescribes a threshold of more-likely-than-not for recognition of tax benefits of uncertain tax positions taken or expected to be taken in a tax return. We record
accrued interest and penalties associated with uncertain tax positions as income tax expense in the consolidated statement of operations.

The federal statute of limitations remains open for tax years 2004 through 2007. State jurisdictions generally have statutes of limitations ranging from three to five years. The state income tax impact of federal income tax changes remains
subject to examination by various states for a period up to one year after formal notification to the states.

Stock Compensation

We account for equity-based compensation in accordance with FASB Statement No. 123(R), Share-Based Payment, (FAS
123(R)). Pursuant to FAS 123(R), we estimate the fair value of awards on the date of grant, or the date of award modification if applicable, using the Black-Scholes option pricing model. The weighted average fair value of options granted
during the three months ended March 31, 2008 was $0 per share and was calculated based on the following assumptions: expected volatility of 40%, expected dividend yield of 0%, expected life of 6.25 years, and a risk-free interest rate of 3.00%
to 3.39%. Expected volatility was derived using data drawn from other healthcare public companies for five to seven years prior to the date of grant and award modification. The expected life was computed



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utilizing the simplified method as permitted by the Securities and Exchange Commissions Staff Accounting Bulletin No. 110, Share-Based Payment.
The expected forfeiture rates are 50% and are based upon a review of our recent history and expectations. The risk-free interest rate is based on the approximate yield on seven-year United States Treasury Bonds as of the date of grant and award
modification. There were 1,728,000 options granted during the three months ended March 31, 2008 (see note 5).

Recent Accounting
Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (Statement 157) which defines fair
value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements. The Statement does not require any new fair value measures. The Statement is effective for fair value measures already required
or permitted by other standards for fiscal years beginning after November 15, 2007. We were required to adopt Statement 157 beginning on January 1, 2008. Statement 157 is required to be applied prospectively, except for certain financial
instruments. Any transition adjustments would have been recognized as an adjustment to opening retained earnings. The adoption of Statement 157 had no impact on our financial position, results of operations or liquidity.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an Amendment to SFAS
115 (SFAS 159). SFAS 159 allows the measurement of many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis under a fair value option. SFAS 159 became effective for fiscal
years that begin after November 15, 2007. The adoption of SFAS 159 had no impact on our financial position, results of operations or liquidity.

Reclassifications

Certain reclassifications have been made to the consolidated financial
statements for prior periods to conform to the presentation of the 2008 consolidated financial statements.



|(3) | Net Patient Service Revenue
|--- | ---------------------------

We recognize in our
consolidated financial statements the impact of adjustments, if any, to Medicare reimbursement when the amounts can be reasonably determined. Net revenues for the three months ended March 31, 2008 and 2007, include a decrease of $(495) and
$(195), respectively, related to changes in estimates and settlements on prior year cost reports filed with the Medicare program.



|(4) | Long-Term Debt
|--- | --------------

Long-term debt consists of the
following:



|                                               |  |               |         |   |                  |   |         |  
|---------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                               |  | March 31,2008 |         |   | December 31,2007 |  
|Senior secured credit facilityterm loan       |  | $             | 248,625 |   |                  | $ | 249,263 |  
|91/4% senior
subordinated notes                |  |               | 147,000 |   |                  |   | 147,000 |  
|                                               |  |               |         |   |                  |   |         |  
|Total long-term debt                           |  |               | 395,625 |   |                  |   | 396,263 |  
|Current installments of long-term debt         |  |               | (2,550  | ) |                  |   | (2,550  | )
|                                               |  |               |         |   |                  |   |         |  
|Long-term debt, excluding current installments |  | $             | 393,075 |   |                  | $ | 393,713 |  
|                                               |  |               |         |   |                  |   |         |  

The senior secured credit facility consists of (i) a $60 million Revolving Credit Facility,
subject to availability, and (ii) a $248.6 million Term Loan B Facility (Facility).



|(5) | Stock Options
|--- | -------------

At March 31, 2008, there were
2,860,000 shares of common stock of Holdings available under the 2005 Equity Incentive Plan (Plan) for stock option grants and other incentive awards, including restricted stock units. Options granted generally have an exercise
price equal to the fair market value of the shares on the date of grant and expire 10 years from the date of grant. A restricted stock unit is a contractual right to receive one share of Holdings common stock in the future. Options units typically
vest one-quarter on each of the first four anniversary dates of the grant and restricted stock units vest one-quarter upon grant and one-quarter each year thereafter. Income from the three months ended March 31, 2008 and 2007 includes $99 and
$164, respectively, of pre-tax compensation costs related to our stock-based compensation arrangements.



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The following table summarizes stock option activity during the three months ended March 31, 2008:



|                             |  |                 |   |  |                              |     
|---------------------------- |  | --------------- | - |  | ---------------------------- | ----
|                             |  | Number ofShares |   |  | Weightedaverageexerciseprice
|Balance at December 31, 2007 |  | 841,000         |   |  | $                            | 2.50
|Granted                      |  | 1,728,000       |   |  |                              | 2.50
|Exercised                    |  |                |   |  |                              |    
|Forfeited                    |  | (96,250         | ) |  |                              | 2.50
|Expired                      |  | (63,750         | ) |  |                              | 2.50
|                             |  |                 |   |  |                              |     
|Balance at March 31, 2008    |  | 2,409,000       |   |  | $                            | 2.50
|                             |  |                 |   |  |                              |     

At March 31, 2008, the weighted average remaining contractual life of outstanding options was
9.8 years. There were 155,500 stock options exercisable at March 31, 2008. At March 31, 2008, the weighted average exercise price of the vested stock options was $2.50, the remaining weighted average contractual life was 8.0 years and they
had no intrinsic value.

As of March 31, 2008, there was approximately $624 of total unrecognized compensation costs related to stock
options. These costs are expected to be recognized over a period of approximately three years.

Restricted Stock Awards

The following table summarizes restricted stock award activity during the three months ended March 31, 2008:



|                                 |  |                 |  
|-------------------------------- |  | --------------- | -
|                                 |  | Number ofShares |  
|Number of unvested shares:       |  |                 |  
|Outstanding at December 31, 2007 |  | 10,000          |  
|Vested                           |  | (10,000         | )
|                                 |  |                 |  
|Outstanding at March 31, 2008    |  |                |  
|                                 |  |                 |  

One of the holders of restricted stock resigned from the Company during 2008. As part of the
separation agreement, the 10,000 outstanding unvested shares were vested. Additionally, 20,000 shares were purchased from the holder for $2.50 per share.

On January 14, 2008, the Company entered into a restricted stock award agreement with its new chief executive officer whereby he will be awarded 400,000 shares if the Company meets or exceeds certain financial
goals for the year ended December 31, 2008. The grant-date per share fair value of these awards was $0.

As of March 31, 2008, there
was no unrecognized compensation costs related to restricted stock awards.



|(6) | Regulatory Matters
|--- | ------------------

All healthcare providers are
required to comply with a significant number of laws and regulations at the federal and state government levels. These laws are complex, and in many instances, providers do not have the benefit of significant regulatory or judicial interpretation as
to how to interpret and/or apply these laws and regulations. The U.S. Department of Justice and other federal agencies are increasing resources dedicated to regulatory investigations and compliance audits of healthcare providers. As a healthcare
provider, we are subject to these regulatory efforts. Healthcare providers that do not comply with these laws and regulations may be subject to civil or criminal penalties, the loss of their licenses, or restriction in their ability to participate
in various federal and state healthcare programs. We endeavor to conduct our business in compliance with applicable laws and regulations, including healthcare fraud and abuse laws.

We undertake various procedures to assure that our annual cost reports are correctly prepared and filed in accordance with applicable Medicare regulations
governing provider reimbursement. During 2004 and 2003, we conducted an internal review of our previously filed cost reports. As a result of this review, which covered the years 1997 through 2001, we made certain adjustments in 2003 to our
previously reported allowable home office expenses. The findings of this review and proposed amendments to the home office cost reports were submitted to the Office of Inspector General of the Department of Health and Human Services (OIG), which
reviewed our findings. On June 12, 2006, we entered into a Settlement Agreement and a Certification of Compliance Agreement (CCA) with the OIG that settled these matters. The amount paid in connection with this settlement was approximately $2.6
million, which was funded out of a specific escrow account established as part of the Merger that occurred on August 11, 2005. The CCA is effective for three years from the date of the CCA, and requires, among other things, that we continue to
maintain our corporate compliance program, report certain events if they occur to the OIG and file an annual report with the OIG regarding certain specified items, including our on-going corporate compliance audit findings in areas such as cost
reports, physician contracting and charge master reviews.



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|(7) | Commitments and Contingencies
|--- | -----------------------------

At the time of
Hurricane Katrina, LifeCare operated an 82-bed facility in New Orleans located in Memorial Medical Center. In the aftermath of the hurricane, an investigation was conducted by Louisiana Attorney Generals office. The investigation culminated in
a Grand Jury being convened in February of 2007 to determine if criminal charges should be filed against three individuals, who were not LifeCare employees, but who were caring for patients in Memorial Medical Center after the hurricane. Two of the
individuals were subsequently granted immunity and the Grand Jury declined to indict the third. Neither the Company nor its employees have been named in any illegal or criminal activities associated with Hurricane Katrina.

We are currently defending ourselves against a variety of Katrina related lawsuits or matters under review by the Louisiana Patient Compensation Fund. We
are vigorously defending ourselves in these lawsuits, however, we cannot predict the ultimate resolution of these matters. We maintained $15 million of general and professional liability insurance during this period, subject to a $1 million per
claim retention. We believe that under our insurance policies, only one retention is applicable to the Katrina matters since these matters all arose from a single event, process or condition. Our insurance carriers are currently paying all costs
related to these claims, but have sent reservation of rights letters which challenge, among other things, the application of one retention to the Katrina related matters. To the extent it is ultimately determined that a separate retention applies to
each of these claims, we could experience significant losses related to these Katrina matters which would negatively impact the Companys financial position, liquidity, and results of operations.

Significant reductions in the patient service revenues earned by a hospital may occur if we are unable to maintain the certification of the hospital as an
LTAC hospital in accordance with Medicare regulations. Additionally, many of the Companys hospitals operate in space leased from general acute care hospitals (host hospitals); consequently, these HIH hospitals are subject to additional
specific Medicare HIH regulations in addition to the general LTAC hospital regulations. The HIH regulations are designed to ensure that the hospitals are organizationally and functionally independent of their host hospitals. If an LTAC hospital
located in a host hospital fails to meet the HIH regulations, it may also lose its status as an LTAC hospital. The determinations are made on an annual basis.

A provider that loses its ability to receive Medicare payments pursuant to PPS must go through the same certification process as new LTAC hospital providers must go through to obtain their initial certification to be
reimbursed pursuant to PPS. During this re-certification period, which could range from six to nine months, the provider would be paid for providing services to Medicare beneficiaries at rates that are lower than rates currently paid pursuant to
PPS.

In 2007, one of our hospitals, with multiple campus locations, failed to achieve the twenty-five day length of stay requirement for
the twelve months ended December 31, 2007. The LTAC hospital regulations provide that a hospital may correct this type of deficiency in the subsequent cost report period following the period in which the twenty-five day length of stay
requirement was not achieved. This hospital will have until December 31, 2008 to demonstrate the achievement of the twenty-five day length of stay requirement. In the event this hospital fails to correct this length of stay deficiency, it would
not be eligible to receive Medicare payments pursuant to LTAC hospital regulations for discharges on or after January 1, 2009. To achieve this requirement in 2008, it is possible that the profitability of this hospital may be negatively
impacted in 2008 as compared to 2007. We believe this hospital will achieve the corrective action required in order to retain its LTAC hospital status for Medicare, and that our remaining hospitals are currently in compliance with the Medicare
regulations regarding LTAC hospitals and will maintain compliance under these regulations.

During December 2006, we entered into an
agreement to form a new joint venture with an unrelated party in the New Orleans market that will own and operate LTAC hospitals. During 2007, we contributed to the joint venture our hospital licenses, Medicare provider numbers and certain remaining
equipment from our former New Orleans operations in exchange for a 49.99% ownership in the joint venture. In connection with this joint venture, we guaranteed, via the issuance of a letter of credit, $0.75 million of a $1.5 million line of credit
established by the new joint venture. The joint ventures line of credit is secured by certain assets, including accounts receivable and moveable equipment of the joint venture, along with our letter of credit. Pursuant to FASB Interpretation
No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, we have established a carrying value of $0.4 million associated with this guarantee, which is recorded in
other noncurrent liabilities. This value was determined based upon our estimates and probabilities of the likelihood that the operations of this joint venture would result in us becoming liable under the established letter of credit.

We have certain other pending and threatened litigation and claims incurred in the ordinary course of business. We believe (based, in part, on the advice
of legal counsel) that the probable resolution of such contingencies will not exceed our insurance coverage and will not materially affect the consolidated financial position, results of operations, or liquidity of the Company.



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|(8) | Sale-Leaseback Agreement
|--- | ------------------------

On September 1,
2006, a newly formed subsidiary (Tenant) of the Company entered into a separate Master Lease Agreement (Lease) with Health Care REIT, Inc. (Landlord) to acquire and develop hospital facilities
(Facilities). The Company granted Landlord the limited right and option, for a three-year period, to acquire or develop and subsequently lease Facilities to Tenant. Tenant will sublease each Facility to a wholly-owned subsidiary of
Tenant (Subtenant) and the licensed operator of each Facility will be the Tenant or a Subtenant. In connection with this Lease, Health Care REIT, INC. has agreed to make available up to $250 million for investments in hospital
facilities, subject to certain terms and conditions. The initial term of the Lease is 15 years and the Tenant has one 15-year renewal option. Upon each addition of a Facility, the term will be extended to a date 15 years from the date of the
addition. At the end of the term, the Tenant may exercise an option to purchase the Facilities at a price equal to the greater of the investment amount (which will include acquisition costs, development costs, renovation costs, closing cost and
fees) or fair value.

The initial rent for each Facility under the Lease will be computed based on a predetermined spread over the rate of a
15-year U.S. Treasury Note and is subject to an annual inflation adjustment. Lease payments will be secured by receivables, assignment of leases and rents, assignment of management agreements, subordination of management fees and distributions, and
cross-default, as well as a second lien on personal property and equipment owned by the Tenant. The Lease contains customary covenants, representations and warranties.

The first facility to be developed under this Master Lease is our Boise, Idaho facility. Construction was completed on this facility near the end of March 2008 at a cost of approximately $21.2 million. Through
March 31, 2008, Health Care REIT, Inc. had made payments to us of approximately $16.9 million as reimbursement for these capital expenditures. This particular facility under this Master Lease will be accounted for as a lease financing
obligation with the asset remaining capitalized upon completion.

This facility opened during April 2008. In connection with this facility
and in accordance with the terms of the Lease, we have issued $4.1 million in letters of credit through December 31, 2007, payable to the Landlord utilizing capacity available for letters of credit under our revolving credit agreement.

The Tenant and any future subsidiaries established under Tenant, will not be guarantors of the Senior Secured Credit Facility or the
9 1/4% Senior Subordinated Notes.



|(9) | Financial Information for Subsidiary Guarantors and Non-guarantor Subsidiaries under the Senior Subordinated Notes
|--- | ------------------------------------------------------------------------------------------------------------------

The senior subordinated notes are fully and unconditionally guaranteed by substantially all of our wholly-owned subsidiaries (the Subsidiary
Guarantors), however, certain of our subsidiaries did not guarantee the senior subordinated notes (the Non-Guarantor Subsidiaries).

Presented below is condensed consolidating financial information for LifeCare Holdings, Inc., the Subsidiary Guarantors, and the Non-Guarantor Subsidiaries for the three months ended at March 31, 2008 and 2007. The equity method has
been used with respect to investments in subsidiaries. Separate financials statement of the Subsidiary Guarantors are not presented.



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|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|---------------------------------------------------------------- |  | -------------------------------------------------------------------------- | -------- | - | --------------------- | - | -------- | ------------------------ |  | - | ------------ | - |  | ------------------ | -------- | - |  | - | -------- | -
|                                                                 |  | LifeCare Holdings, Inc.Condensed Consolidating Balance SheetMarch 31, 2008 |         
|                                                                 |  | Parent                                                                     |          |   | GuarantorSubsidiaries |   |          | NonguarantorSubsidiaries |  |   | Eliminations |   |  | ConsolidatedTotals |         
|Assets                                                           |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Current assets:                                                  |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Cash and cash equivalents                                        |  | $                                                                          |         |   |                       | $ | 6,667    |                          |  | $ |             |   |  | $                  |         |   |  | $ | 6,667    |  
|Accounts receivable, net of allowance for doubtful accounts      |  |                                                                            |         |   |                       |   | 76,580   |                          |  |   |             |   |  |                    |         |   |  |   | 76,580   |  
|Due to/from related parties                                      |  |                                                                            | 156,626  |   |                       |   | (151,510 | )                        |  |   | (5,116       | ) |  |                    |         |   |  |   |         |  
|Income taxes receivable                                          |  |                                                                            | 2,548    |   |                       |   |         |                          |  |   |             |   |  |                    | (727     | ) |  |   | 1,821    |  
|Other current assets                                             |  |                                                                            |         |   |                       |   | 9,881    |                          |  |   | 2,703        |   |  |                    |         |   |  |   | 12,584   |  
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total current assets                                             |  |                                                                            | 159,174  |   |                       |   | (58,382  | )                        |  |   | (2,413       | ) |  |                    | (727     | ) |  |   | 97,652   |  
|Investment in subsidiaries                                       |  |                                                                            | 230,288  |   |                       |   |         |                          |  |   |             |   |  |                    | (230,288 | ) |  |   |         |  
|Property and equipment, net                                      |  |                                                                            |         |   |                       |   | 65,105   |                          |  |   | 23,525       |   |  |                    |         |   |  |   | 88,630   |  
|Other assets                                                     |  |                                                                            | 10,954   |   |                       |   | 4,137    |                          |  |   |             |   |  |                    |         |   |  |   | 15,091   |  
|Other identifiable intangibles, net                              |  |                                                                            |         |   |                       |   | 18,160   |                          |  |   |             |   |  |                    |         |   |  |   | 18,160   |  
|Goodwill                                                         |  |                                                                            |         |   |                       |   | 263,970  |                          |  |   |             |   |  |                    |         |   |  |   | 263,970  |  
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|                                                                 |  | $                                                                          | 400,416  |   |                       | $ | 292,990  |                          |  | $ | 21,112       |   |  | $                  | (231,015 | ) |  | $ | 483,503  |  
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Liabilities and Stockholders Equity (Deficit)                   |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Current liabilities:                                             |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Current installments of long-term debt                           |  | $                                                                          | 2,550    |   |                       | $ |         |                          |  | $ |             |   |  | $                  |         |   |  | $ | 2,550    |  
|Current installments of obligations under capital leases         |  |                                                                            |         |   |                       |   | 1,382    |                          |  |   | 183          |   |  |                    |         |   |  |   | 1,565    |  
|Current installment of lease financing obligation                |  |                                                                            |         |   |                       |   |         |                          |  |   | 395          |   |  |                    |         |   |  |   | 395      |  
|Estimated third-party payor settlements                          |  |                                                                            |         |   |                       |   | 3,625    |                          |  |   |             |   |  |                    |         |   |  |   | 3,625    |  
|Accounts payable                                                 |  |                                                                            | 95       |   |                       |   | 22,906   |                          |  |   | 1,678        |   |  |                    |         |   |  |   | 24,679   |  
|Accrued payroll                                                  |  |                                                                            |         |   |                       |   | 9,403    |                          |  |   | 121          |   |  |                    |         |   |  |   | 9,524    |  
|Accrued vacation                                                 |  |                                                                            |         |   |                       |   | 4,258    |                          |  |   | 21           |   |  |                    |         |   |  |   | 4,279    |  
|Accrued insurance                                                |  |                                                                            |         |   |                       |   | 1,120    |                          |  |   |             |   |  |                    |         |   |  |   | 1,120    |  
|Accrued interest                                                 |  |                                                                            | 1,781    |   |                       |   |         |                          |  |   |             |   |  |                    |         |   |  |   | 1,781    |  
|Income taxes payable                                             |  |                                                                            |         |   |                       |   | 727      |                          |  |   |             |   |  |                    | (727     | ) |  |   |         |  
|Accrued other                                                    |  |                                                                            |         |   |                       |   | 3,070    |                          |  |   | 39           |   |  |                    |         |   |  |   | 3,109    |  
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total current liabilities                                        |  |                                                                            | 4,426    |   |                       |   | 46,491   |                          |  |   | 2,437        |   |  |                    | (727     | ) |  |   | 52,627   |  
|Long-term debt, excluding current installments                   |  |                                                                            | 393,075  |   |                       |   |         |                          |  |   |             |   |  |                    |         |   |  |   | 393,075  |  
|Obligations under capital leases, excluding current installments |  |                                                                            |         |   |                       |   | 2,271    |                          |  |   | 337          |   |  |                    |         |   |  |   | 2,608    |  
|Lease-financing obligation, excluding current installments       |  |                                                                            |         |   |                       |   |         |                          |  |   | 19,130       |   |  |                    |         |   |  |   | 19,130   |  
|Accrued insurance                                                |  |                                                                            |         |   |                       |   | 4,944    |                          |  |   |             |   |  |                    |         |   |  |   | 4,944    |  
|Other noncurrent liabilities                                     |  |                                                                            | 5,500    |   |                       |   | 8,204    |                          |  |   |             |   |  |                    |         |   |  |   | 13,704   |  
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total liabilities                                                |  |                                                                            | 403,001  |   |                       |   | 61,910   |                          |  |   | 21,904       |   |  |                    | (727     | ) |  |   | 486,088  |  
|Commitments and contingencies                                    |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Stockholders equity (deficit):                                  |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Common stock                                                     |  |                                                                            |         |   |                       |   |         |                          |  |   |             |   |  |                    |         |   |  |   |         |  
|Additional paid-in capital                                       |  |                                                                            | 171,776  |   |                       |   | 63       |                          |  |   |             |   |  |                    | (63      | ) |  |   | 171,776  |  
|Retained earnings (accumulated deficit)                          |  |                                                                            | (174,361 | ) |                       |   | 231,017  |                          |  |   | (792         | ) |  |                    | (230,225 | ) |  |   | (174,361 | )
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total stockholders equity (deficit)                             |  |                                                                            | (2,585   | ) |                       |   | 231,080  |                          |  |   | (792         | ) |  |                    | (230,288 | ) |  |   | (2,585   | )
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|                                                                 |  | $                                                                          | 400,416  |   |                       | $ | 292,990  |                          |  | $ | 21,112       |   |  | $                  | (231,015 | ) |  | $ | 483,503  |  
|                                                                 |  |                                                                            |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  



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|                                        |  |                                                                                                                 |         |   |                       |   |        |                          |  |   |              |   |  |                    |        |   |  |   |        |  
|--------------------------------------- |  | --------------------------------------------------------------------------------------------------------------- | ------- | - | --------------------- | - | ------ | ------------------------ |  | - | ------------ | - |  | ------------------ | ------ | - |  | - | ------ | -
|                                        |  | LifeCare Holdings, Inc.Condensed Consolidating Statement of
OperationsFor the Three Months Ended March 31, 2008 |        
|                                        |  | Parent                                                                                                          |         |   | GuarantorSubsidiaries |   |        | NonguarantorSubsidiaries |  |   | Eliminations |   |  | ConsolidatedTotals |       
|Net patient service revenue             |  | $                                                                                                               |        |   |                       | $ | 88,761 |                          |  | $ |             |   |  | $                  |       |   |  | $ | 88,761 |  
|                                        |  |                                                                                                                 |         |   |                       |   |        |                          |  |   |              |   |  |                    |        |   |  |   |        |  
|Salaries, wages and benefits            |  |                                                                                                                 | 102     |   |                       |   | 40,563 |                          |  |   | 423          |   |  |                    |       |   |  |   | 41,088 |  
|Supplies                                |  |                                                                                                                 |        |   |                       |   | 9,051  |                          |  |   |             |   |  |                    |       |   |  |   | 9,051  |  
|Rent                                    |  |                                                                                                                 |        |   |                       |   | 6,133  |                          |  |   | 37           |   |  |                    |       |   |  |   | 6,170  |  
|Other operating expenses                |  |                                                                                                                 | 245     |   |                       |   | 20,283 |                          |  |   | 207          |   |  |                    |       |   |  |   | 20,735 |  
|Provision for doubtful accounts         |  |                                                                                                                 |        |   |                       |   | 1,847  |                          |  |   |             |   |  |                    |       |   |  |   | 1,847  |  
|Depreciation and amortization           |  |                                                                                                                 |        |   |                       |   | 2,742  |                          |  |   | 11           |   |  |                    |       |   |  |   | 2,753  |  
|Intercompany (income) expenses          |  |                                                                                                                 | 1,471   |   |                       |   | (1,471 | )                        |  |   |             |   |  |                    |       |   |  |   |       |  
|Interest expense, net                   |  |                                                                                                                 | 9,749   |   |                       |   | 78     |                          |  |   | 7            |   |  |                    |       |   |  |   | 9,834  |  
|                                        |  |                                                                                                                 |         |   |                       |   |        |                          |  |   |              |   |  |                    |        |   |  |   |        |  
|Total expenses                          |  |                                                                                                                 | 11,567  |   |                       |   | 79,226 |                          |  |   | 685          |   |  |                    |       |   |  |   | 91,478 |  
|                                        |  |                                                                                                                 |         |   |                       |   |        |                          |  |   |              |   |  |                    |        |   |  |   |        |  
|Operating income (loss)                 |  |                                                                                                                 | (11,567 | ) |                       |   | 9,535  |                          |  |   | (685         | ) |  |                    |       |   |  |   | (2,717 | )
|Earnings in investments in subsidiaries |  |                                                                                                                 | (8,650  | ) |                       |   |       |                          |  |   |             |   |  |                    | 8,650  |   |  |   |       |  
|                                        |  |                                                                                                                 |         |   |                       |   |        |                          |  |   |              |   |  |                    |        |   |  |   |        |  
|Income (loss) before income taxes       |  |                                                                                                                 | (2,917  | ) |                       |   | 9,535  |                          |  |   | (685         | ) |  |                    | (8,650 | ) |  |   | (2,717 | )
|Provision for income taxes              |  |                                                                                                                 |        |   |                       |   | 200    |                          |  |   |             |   |  |                    |       |   |  |   | 200    |  
|                                        |  |                                                                                                                 |         |   |                       |   |        |                          |  |   |              |   |  |                    |        |   |  |   |        |  
|Net income (loss)                       |  | $                                                                                                               | (2,917  | ) |                       | $ | 9,335  |                          |  | $ | (685         | ) |  | $                  | (8,650 | ) |  | $ | (2,917 | )
|                                        |  |                                                                                                                 |         |   |                       |   |        |                          |  |   |              |   |  |                    |        |   |  |   |        |  



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|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|-------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------- | ------ | - | --------------------- | - | ------- | ------------------------ |  | - | ------------ | - |  | ------------ | ------ | - |  | - | ------- | -
|                                                                                                   |  | LifeCare Holdings, Inc.Condensed Consolidating Statement of Cash
FlowsFor the Three Months Ended March 31, 2008 |       
|                                                                                                   |  | Parent                                                                                                          |        |   | GuarantorSubsidiaries |   |         | NonguarantorSubsidiaries |  |   | Eliminations |   |  | Consolidated |       
|Cash flows from operating activities:                                                              |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Net income (loss)                                                                                  |  | $                                                                                                               | (2,917 | ) |                       | $ | 9,335   |                          |  | $ | (685         | ) |  | $            | (8,650 | ) |  | $ | (2,917  | )
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Depreciation and amortization                                                                      |  |                                                                                                                 | 524    |   |                       |   | 2,741   |                          |  |   | 11           |   |  |              |       |   |  |   | 3,276   |  
|Provision for doubtful accounts                                                                    |  |                                                                                                                 |       |   |                       |   | 1,847   |                          |  |   |             |   |  |              |       |   |  |   | 1,847   |  
|Equity compensation amortization                                                                   |  |                                                                                                                 | 99     |   |                       |   |        |                          |  |   |             |   |  |              |       |   |  |   | 99      |  
|Changes in operating assets and liabilities:                                                       |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Patient accounts receivable                                                                        |  |                                                                                                                 |       |   |                       |   | (11,516 | )                        |  |   |             |   |  |              |       |   |  |   | (11,516 | )
|Current income taxes                                                                               |  |                                                                                                                 |       |   |                       |   | 200     |                          |  |   |             |   |  |              |       |   |  |   | 200     |  
|Other current assets                                                                               |  |                                                                                                                 | 35     |   |                       |   | (731    | )                        |  |   | (92          | ) |  |              |       |   |  |   | (788    | )
|Change in investment in subsidiaries                                                               |  |                                                                                                                 | (8,650 | ) |                       |   |        |                          |  |   |             |   |  |              | 8,650  |   |  |   |        |  
|Other assets                                                                                       |  |                                                                                                                 | (80    | ) |                       |   | 141     |                          |  |   |             |   |  |              |       |   |  |   | 61      |  
|Due to/from related parties                                                                        |  |                                                                                                                 | 15,074 |   |                       |   | (19,243 | )                        |  |   | 4,169        |   |  |              |       |   |  |   |        |  
|Estimated third-party payor settlements                                                            |  |                                                                                                                 |       |   |                       |   | (2,119  | )                        |  |   |             |   |  |              |       |   |  |   | (2,119  | )
|Accounts payable and accrued expenses                                                              |  |                                                                                                                 | (3,447 | ) |                       |   | 6,553   |                          |  |   | 732          |   |  |              |       |   |  |   | 3,838   |  
|Other noncurrent liabilities                                                                       |  |                                                                                                                 |       |   |                       |   | 352     |                          |  |   |             |   |  |              |       |   |  |   | 352     |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Net cash provided by (used in) operating activities                                                |  |                                                                                                                 | 638    |   |                       |   | (12,440 | )                        |  |   | 4,135        |   |  |              |       |   |  |   | (7,667  | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Cash from investing activities:                                                                    |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Purchases of property and equipment                                                                |  |                                                                                                                 |       |   |                       |   | (2,088  | )                        |  |   | (6,454       | ) |  |              |       |   |  |   | (8,542  | )
|Sale-leaseback proceeds                                                                            |  |                                                                                                                 |       |   |                       |   | 2,893   |                          |  |   |             |   |  |              |       |   |  |   | 2,893   |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Net cash provided by (used in) investing activities                                                |  |                                                                                                                 |       |   |                       |   | 805     |                          |  |   | (6,454       | ) |  |              |       |   |  |   | (5,649  | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Cash flows from financing activities:                                                              |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Lease financing obligation proceeds                                                                |  |                                                                                                                 |       |   |                       |   |        |                          |  |   | 1,800        |   |  |              |       |   |  |   | 1,800   |  
|Payments of notes payable and long-term debt                                                       |  |                                                                                                                 | (638   | ) |                       |   |        |                          |  |   |             |   |  |              |       |   |  |   | (638    | )
|Proceeds from capital lease financing                                                              |  |                                                                                                                 |       |   |                       |   | 1,802   |                          |  |   |             |   |  |              |       |   |  |   | 1,802   |  
|Payments on obligations under capital leases                                                       |  |                                                                                                                 |       |   |                       |   | (1,316  | )                        |  |   | 519          |   |  |              |       |   |  |   | (797    | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Net cash provided by (used in) financing activities                                                |  |                                                                                                                 | (638   | ) |                       |   | 486     |                          |  |   | 2,319        |   |  |              |       |   |  |   | 2,167   |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Net decrease in cash and cash equivalents                                                          |  |                                                                                                                 |       |   |                       |   | (11,149 | )                        |  |   |             |   |  |              |       |   |  |   | (11,149 | )
|Cash and cash equivalents, beginning of period                                                     |  |                                                                                                                 |       |   |                       |   | 17,816  |                          |  |   |             |   |  |              |       |   |  |   | 17,816  |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  
|Cash and cash equivalents, end of period                                                           |  | $                                                                                                               |       |   |                       | $ | 6,667   |                          |  | $ |             |   |  | $            |       |   |  | $ | 6,667   |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |              |        |   |  |   |         |  



14



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##### Table of Contents

|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|---------------------------------------------------------------- |  | ----------------------------------------------------------------------------- | -------- | - | --------------------- | - | -------- | ------------------------ |  | - | ------------ | - |  | ------------------ | -------- | - |  | - | -------- | -
|                                                                 |  | LifeCare Holdings, Inc.Condensed Consolidating Balance SheetDecember 31, 2007 |         
|                                                                 |  | Parent                                                                        |          |   | GuarantorSubsidiaries |   |          | NonguarantorSubsidiaries |  |   | Eliminations |   |  | ConsolidatedTotals |         
|Assets                                                           |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Current assets:                                                  |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Cash and cash equivalents                                        |  | $                                                                             |         |   |                       | $ | 17,816   |                          |  | $ |             |   |  | $                  |         |   |  | $ | 17,816   |  
|Accounts receivable, net of allowance for doubtful accounts      |  |                                                                               |         |   |                       |   | 66,911   |                          |  |   |             |   |  |                    |         |   |  |   | 66,911   |  
|Due to/from related parties                                      |  |                                                                               | 169,912  |   |                       |   | (168,963 | )                        |  |   | (949         | ) |  |                    |         |   |  |   |         |  
|Income taxes                                                     |  |                                                                               | 2,548    |   |                       |   |         |                          |  |   |             |   |  |                    | (523     | ) |  |   | 2,025    |  
|Other current assets                                             |  |                                                                               | 1,674    |   |                       |   | 10,446   |                          |  |   | 1,477        |   |  |                    |         |   |  |   | 13,597   |  
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total current assets                                             |  |                                                                               | 174,134  |   |                       |   | (73,790  | )                        |  |   | 528          |   |  |                    | (523     | ) |  |   | 100,349  |  
|Investment in subsidiaries                                       |  |                                                                               | 221,638  |   |                       |   |         |                          |  |   |             |   |  |                    | (221,638 | ) |  |   |         |  
|Property and equipment, net                                      |  |                                                                               |         |   |                       |   | 66,235   |                          |  |   | 17,082       |   |  |                    |         |   |  |   | 83,317   |  
|Other assets                                                     |  |                                                                               | 11,398   |   |                       |   | 4,277    |                          |  |   |             |   |  |                    |         |   |  |   | 15,675   |  
|Identifiable intangibles, net                                    |  |                                                                               |         |   |                       |   | 18,445   |                          |  |   |             |   |  |                    |         |   |  |   | 18,445   |  
|Goodwill                                                         |  |                                                                               |         |   |                       |   | 263,970  |                          |  |   |             |   |  |                    |         |   |  |   | 263,970  |  
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|                                                                 |  | $                                                                             | 407,170  |   |                       | $ | 279,137  |                          |  | $ | 17,610       |   |  | $                  | (222,161 | ) |  | $ | 481,756  |  
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Liabilities and Stockholders Equity (Deficit)                   |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Current liabilities:                                             |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Current installments of long-term debt                           |  | $                                                                             | 2,550    |   |                       | $ |         |                          |  | $ |             |   |  | $                  |         |   |  | $ | 2,550    |  
|Current installments of obligations under capital leases         |  |                                                                               |         |   |                       |   | 1,604    |                          |  |   |             |   |  |                    |         |   |  |   | 1,604    |  
|Estimated third-party payor settlements                          |  |                                                                               |         |   |                       |   | 5,744    |                          |  |   |             |   |  |                    |         |   |  |   | 5,744    |  
|Accounts payable and accrued expenses                            |  |                                                                               | (7       | ) |                       |   | 22,317   |                          |  |   | 1,128        |   |  |                    |         |   |  |   | 23,438   |  
|Accrued payroll                                                  |  |                                                                               |         |   |                       |   | 6,351    |                          |  |   |             |   |  |                    |         |   |  |   | 6,351    |  
|Accrued vacation                                                 |  |                                                                               |         |   |                       |   | 3,489    |                          |  |   |             |   |  |                    |         |   |  |   | 3,489    |  
|Accrued insurance                                                |  |                                                                               |         |   |                       |   | 1,087    |                          |  |   |             |   |  |                    |         |   |  |   | 1,087    |  
|Accrued interest                                                 |  |                                                                               | 5,181    |   |                       |   |         |                          |  |   |             |   |  |                    |         |   |  |   | 5,181    |  
|Income taxes payable                                             |  |                                                                               |         |   |                       |   | 523      |                          |  |   |             |   |  |                    | (523     | ) |  |   |         |  
|Accrued other                                                    |  |                                                                               |         |   |                       |   | 2,739    |                          |  |   |             |   |  |                    |         |   |  |   | 2,739    |  
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total current liabilities                                        |  |                                                                               | 7,724    |   |                       |   | 43,854   |                          |  |   | 1,128        |   |  |                    | (523     | ) |  |   | 52,183   |  
|Long-term debt, excluding current installments                   |  |                                                                               | 393,713  |   |                       |   |         |                          |  |   |             |   |  |                    |         |   |  |   | 393,713  |  
|Obligations under capital leases, excluding current installments |  |                                                                               |         |   |                       |   | 741      |                          |  |   |             |   |  |                    |         |   |  |   | 741      |  
|Lease-financing obligation                                       |  |                                                                               |         |   |                       |   |         |                          |  |   | 16,590       |   |  |                    |         |   |  |   | 16,590   |  
|Accrued insurance                                                |  |                                                                               |         |   |                       |   | 4,714    |                          |  |   |             |   |  |                    |         |   |  |   | 4,714    |  
|Other noncurrent liabilities                                     |  |                                                                               | 5,500    |   |                       |   | 8,082    |                          |  |   |             |   |  |                    |         |   |  |   | 13,582   |  
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total liabilities                                                |  |                                                                               | 406,937  |   |                       |   | 57,391   |                          |  |   | 17,718       |   |  |                    | (523     | ) |  |   | 481,523  |  
|Stockholders equity:                                            |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Common stock                                                     |  |                                                                               |         |   |                       |   |         |                          |  |   |             |   |  |                    |         |   |  |   |         |  
|Additional paid-in capital                                       |  |                                                                               | 171,677  |   |                       |   | 62       |                          |  |   |             |   |  |                    | (62      | ) |  |   | 171,677  |  
|Retained earnings (accumulated deficit)                          |  |                                                                               | (171,444 | ) |                       |   | 221,684  |                          |  |   | (108         | ) |  |                    | (221,576 | ) |  |   | (171,444 | )
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|Total stockholders equity (deficit)                             |  |                                                                               | 233      |   |                       |   | 221,746  |                          |  |   | (108         | ) |  |                    | (221,638 | ) |  |   | 233      |  
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  
|                                                                 |  | $                                                                             | 407,170  |   |                       | $ | 279,137  |                          |  | $ | 17,610       |   |  | $                  | (222,161 | ) |  | $ | 481,756  |  
|                                                                 |  |                                                                               |          |   |                       |   |          |                          |  |   |              |   |  |                    |          |   |  |   |          |  



15



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##### Table of Contents

|                                          |  |                                                                                                                 |         |   |                       |   |        |                          |  |              |   |  |                    |        |   |  |   |        |  
|----------------------------------------- |  | --------------------------------------------------------------------------------------------------------------- | ------- | - | --------------------- | - | ------ | ------------------------ |  | ------------ | - |  | ------------------ | ------ | - |  | - | ------ | -
|                                          |  | LifeCare Holdings, Inc.Condensed Consolidating Statement of
OperationsFor the Three Months Ended March 31, 2007 |        
|                                          |  | Parent                                                                                                          |         |   | GuarantorSubsidiaries |   |        | NonguarantorSubsidiaries |  | Eliminations |   |  | ConsolidatedTotals |       
|Net patient service revenue               |  | $                                                                                                               |        |   |                       | $ | 82,369 |                          |  | $            |  |  | $                  |       |   |  | $ | 82,369 |  
|                                          |  |                                                                                                                 |         |   |                       |   |        |                          |  |              |   |  |                    |        |   |  |   |        |  
|Salaries, wages and benefits              |  |                                                                                                                 | 167     |   |                       |   | 37,813 |                          |  |              |  |  |                    |       |   |  |   | 37,980 |  
|Supplies                                  |  |                                                                                                                 |        |   |                       |   | 8,397  |                          |  |              |  |  |                    |       |   |  |   | 8,397  |  
|Rent                                      |  |                                                                                                                 |        |   |                       |   | 5,122  |                          |  |              |  |  |                    |       |   |  |   | 5,122  |  
|Other operating expenses                  |  |                                                                                                                 | 215     |   |                       |   | 20,468 |                          |  |              |  |  |                    |       |   |  |   | 20,683 |  
|Provision for doubtful accounts           |  |                                                                                                                 |        |   |                       |   | 1,413  |                          |  |              |  |  |                    |       |   |  |   | 1,413  |  
|Depreciation and amortization             |  |                                                                                                                 |        |   |                       |   | 2,844  |                          |  |              |  |  |                    |       |   |  |   | 2,844  |  
|Intercompany (income) expenses            |  |                                                                                                                 | 1,298   |   |                       |   | (1,298 | )                        |  |              |  |  |                    |       |   |  |   |       |  
|Interest expense, net                     |  |                                                                                                                 | 8,617   |   |                       |   | (141   | )                        |  |              |  |  |                    |       |   |  |   | 8,476  |  
|                                          |  |                                                                                                                 |         |   |                       |   |        |                          |  |              |   |  |                    |        |   |  |   |        |  
|Total expenses                            |  |                                                                                                                 | 10,297  |   |                       |   | 74,618 |                          |  |              |  |  |                    |       |   |  |   | 84,915 |  
|                                          |  |                                                                                                                 |         |   |                       |   |        |                          |  |              |   |  |                    |        |   |  |   |        |  
|Operating income (loss)                   |  |                                                                                                                 | (10,297 | ) |                       |   | 7,751  |                          |  |              |  |  |                    |       |   |  |   | (2,546 | )
|Earnings in investments in subsidiaries   |  |                                                                                                                 | (7,711  | ) |                       |   |       |                          |  |              |  |  |                    | 7,711  |   |  |   |       |  
|                                          |  |                                                                                                                 |         |   |                       |   |        |                          |  |              |   |  |                    |        |   |  |   |        |  
|Income (loss) before income taxes         |  |                                                                                                                 | (2,586  | ) |                       |   | 7,751  |                          |  |              |  |  |                    | (7,711 | ) |  |   | (2,546 | )
|Provision for (benefit from) income taxes |  |                                                                                                                 | (891    | ) |                       |   | 40     |                          |  |              |  |  |                    |       |   |  |   | (851   | )
|                                          |  |                                                                                                                 |         |   |                       |   |        |                          |  |              |   |  |                    |        |   |  |   |        |  
|Net income (loss)                         |  | $                                                                                                               | (1,695  | ) |                       | $ | 7,711  |                          |  | $            |  |  | $                  | (7,711 | ) |  | $ | (1,695 | )
|                                          |  |                                                                                                                 |         |   |                       |   |        |                          |  |              |   |  |                    |        |   |  |   |        |  



16



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##### Table of Contents

|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|-------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------- | ------ | - | --------------------- | - | ------- | ------------------------ |  | - | ------------ | - |  | ------------------ | ------ | - |  | - | ------- | -
|                                                                                                   |  | LifeCare Holdings, Inc.Condensed Consolidating Statement of Cash
FlowsFor the Three Months Ended March 31, 2007 |       
|                                                                                                   |  | Parent                                                                                                          |        |   | GuarantorSubsidiaries |   |         | NonguarantorSubsidiaries |  |   | Eliminations |   |  | ConsolidatedTotals |       
|Cash flows from operating activities:                                                              |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Net income (loss)                                                                                  |  | $                                                                                                               | (1,695 | ) |                       | $ | 7,711   |                          |  | $ |             |   |  | $                  | (7,711 | ) |  | $ | (1,695  | )
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Depreciation and amortization                                                                      |  |                                                                                                                 | 363    |   |                       |   | 2,844   |                          |  |   |             |   |  |                    |       |   |  |   | 3,207   |  
|Provision for doubtful accounts                                                                    |  |                                                                                                                 |       |   |                       |   | 1,413   |                          |  |   |             |   |  |                    |       |   |  |   | 1,413   |  
|Equity compensation amortization                                                                   |  |                                                                                                                 | 164    |   |                       |   |        |                          |  |   |             |   |  |                    |       |   |  |   | 164     |  
|Changes in operating assets and liabilities:                                                       |  |                                                                                                                 |       |   |                       |   |        |                          |  |   |             |   |  |                    |       |   |  |   |        |  
|Patient accounts receivable                                                                        |  |                                                                                                                 |       |   |                       |   | (6,745  | )                        |  |   |             |   |  |                    |       |   |  |   | (6,745  | )
|Current income taxes                                                                               |  |                                                                                                                 |       |   |                       |   | (1,389  | )                        |  |   |             |   |  |                    |       |   |  |   | (1,389  | )
|Other current assets                                                                               |  |                                                                                                                 | (968   | ) |                       |   | 1,685   |                          |  |   |             |   |  |                    |       |   |  |   | 717     |  
|Change in investment in subsidiaries                                                               |  |                                                                                                                 | (7,711 | ) |                       |   |        |                          |  |   |             |   |  |                    | 7,711  |   |  |   |        |  
|Other assets                                                                                       |  |                                                                                                                 |       |   |                       |   | (182    | )                        |  |   |             |   |  |                    |       |   |  |   | (182    | )
|Due to/from related parties                                                                        |  |                                                                                                                 | 13,647 |   |                       |   | (14,199 | )                        |  |   | 552          |   |  |                    |       |   |  |   |        |  
|Estimated third-party payor settlements                                                            |  |                                                                                                                 |       |   |                       |   | (8,382  | )                        |  |   |             |   |  |                    |       |   |  |   | (8,382  | )
|Accounts payable and accrued expenses                                                              |  |                                                                                                                 | (3,357 | ) |                       |   | (514    | )                        |  |   |             |   |  |                    |       |   |  |   | (3,871  | )
|Other noncurrent liabilities                                                                       |  |                                                                                                                 | 195    |   |                       |   | 210     |                          |  |   |             |   |  |                    |       |   |  |   | 405     |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Net cash provided by (used in) operating activities                                                |  |                                                                                                                 | 638    |   |                       |   | (17,548 | )                        |  |   | 552          |   |  |                    |       |   |  |   | (16,358 | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Cash from investing activities:                                                                    |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Purchases of property and equipment                                                                |  |                                                                                                                 |       |   |                       |   | (6,478  | )                        |  |   | (552         | ) |  |                    |       |   |  |   | (7,030  | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Net cash used in investing activities                                                              |  |                                                                                                                 |       |   |                       |   | (6,478  | )                        |  |   | (552         | ) |  |                    |       |   |  |   | (7,030  | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Cash flows from financing activities:                                                              |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Payments of notes payable and long-term debt                                                       |  |                                                                                                                 | (638   | ) |                       |   |        |                          |  |   |             |   |  |                    |       |   |  |   | (638    | )
|Payments on obligations under capital leases                                                       |  |                                                                                                                 |       |   |                       |   | (1,089  | )                        |  |   |             |   |  |                    |       |   |  |   | (1,089  | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Net cash used in financing activities                                                              |  |                                                                                                                 | (638   | ) |                       |   | (1,089  | )                        |  |   |             |   |  |                    |       |   |  |   | (1,727  | )
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Net decrease in cash and cash equivalents                                                          |  |                                                                                                                 |       |   |                       |   | (25,115 | )                        |  |   |             |   |  |                    |       |   |  |   | (25,115 | )
|Cash and cash equivalents, beginning of period                                                     |  |                                                                                                                 |       |   |                       |   | 33,250  |                          |  |   |             |   |  |                    |       |   |  |   | 33,250  |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  
|Cash and cash equivalents, end of period                                                           |  | $                                                                                                               |       |   |                       | $ | 8,135   |                          |  | $ |             |   |  | $                  |       |   |  | $ | 8,135   |  
|                                                                                                   |  |                                                                                                                 |        |   |                       |   |         |                          |  |   |              |   |  |                    |        |   |  |   |         |  



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|ITEM 2: | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

You should read the following discussion and analysis in conjunction with our condensed consolidated financial statements and the accompanying notes.

Company Overview

We began operations in 1993 and have grown our
business through developing and acquiring hospitals to become a leading operator of long-term acute care (LTAC) hospitals in the United States. As of March 31, 2008, we operated 19 hospitals located in nine states, consisting of
nine hospital within a hospital facilities (31% of beds) and ten freestanding facilities (69% of beds). Through these 19 long-term acute care hospitals, we operate a total of 1,009 licensed beds and employ approximately 3,200 people, the
majority of whom are registered or licensed nurses and respiratory therapists.

We believe we have developed a reputation for excellence in providing
treatment for patients with complex medical needs requiring extended treatment. Our patients have serious medical conditions such as respiratory failure, chronic pulmonary disease, nervous system disorders, infectious diseases and severe wounds.
They generally require a high level of monitoring and specialized care, yet may not require the continued services of an intensive care unit. Due to their serious medical conditions, our patients are generally not clinically appropriate for
admission to a skilled nursing facility or inpatient rehabilitation facility. By combining general acute care services with a focus on long-term treatment, we believe that our hospitals provide medically complex patients with better and more
cost-effective outcomes.

Recent Trends and Events

Impact of Hurricane Katrina

At the time of Hurricane Katrina, LifeCare operated an 82-bed facility in New Orleans located in
Memorial Medical Center. In the aftermath of the hurricane, an investigation was conducted by Louisiana Attorney Generals office. The investigation culminated in a Grand Jury being convened in February of 2007 to determine if criminal charges
should be filed against three individuals, who were not LifeCare employees, but who were caring for patients in Memorial Medical Center after the hurricane. Two of the individuals were subsequently granted immunity and the Grand Jury declined to
indict the third. Neither the Company nor its employees have been named in any illegal or criminal activities associated with Hurricane Katrina.

We are
currently defending ourselves against a variety of Katrina related lawsuits or matters under review by the Louisiana Patient Compensation Fund. We are vigorously defending ourselves in these lawsuits, however, we cannot predict the ultimate
resolution of these matters. We maintained $15 million of general and professional liability insurance during this period, subject to a $1 million per claim retention. We believe that under our insurance policies, only one retention is applicable to
the Katrina matters since these matters all arose from a single event, process or condition. Our insurance carriers are currently paying all costs related to these claims, but have sent reservation of rights letters which challenge, among other
things, the application of one retention to the Katrina related matters. To the extent it is ultimately determined that a separate retention applies to each of these claims, we could experience significant losses related to these Katrina matters
which would negatively impact the Companys financial position, liquidity, and results of operations.

Hospital Openings and Closings

During the first quarter of 2007, we terminated the lease at the Doctors Hospital campus in Shreveport, Louisiana. Eight beds were transferred to another
location and the 11 beds remaining at this location were closed. Eight beds were added to our Denver, Colorado location during the same period. In June 2007, we opened a 62-bed freestanding hospital in San Antonio, Texas, which replaced a 34-bed HIH
in San Antonio that was closed in the same month. In August 2007, 21 additional beds were added to our Denver location. In September 2007, we opened a 62-bed freestanding hospital in Milwaukee, Wisconsin, which replaced a 35-bed HIH in Milwaukee
that was closed in the same month. Additionally, during September 2007 we added 10 ICU level beds to our hospital located in Fort Worth, Texas. In April 2008, we opened a new 60-bed freestanding facility in Boise, Idaho.

The assets formerly located in our hospitals that were closed or relocated are being used at other locations or were disposed of.

Regulatory Changes

Approximately 62.4% and 68.6% of our total
net patient service revenue for the three months ended March 31, 2008 and 2007, respectively, came from Medicare reimbursement. Our industry is subject to extensive government regulation, including regulation of the Medicare reimbursement
process. Changes in these regulations can have a material impact on the way we operate our business and on our results of operations.



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The 2008 Final Rule

On May 2, 2008, CMS issued its annual regulatory update regarding Medicare reimbursement for LTAC hospitals that will be effective for all discharges on or after July 1, 2008 (the 2008 Final Rule). The 2008 Final Rule
included, among other things, (1) an increase in the standard federal rate to $39,114, which represents a 2.7% increase, and (2) an increase in the high-cost outlier threshold of $2,222 to $22,960. Additionally, CMS is changing the
timetable for annual updates to a fiscal year schedule starting on October 1 instead of July 1, which will result in the 2009 rate year rates being in effect for 15 months beginning July 1, 2008. CMS has estimated that the proposed
changes for the 2009 rate year, taken as a whole, will result in an increase of 2.5% in Medicare reimbursement to LTAC hospitals. Individual hospitals, however, will see varying effects of this rule depending on their Medicare patient population and
their specific base rate changes due to geographical location.

CMS Changes to DRG Weighting for Fiscal 2009

On April 14, 2008, CMS issued its annual proposed regulatory updates regarding the re-weighting of MS-LTC-DRGs that will become effective for discharges on or after
October 1, 2008. CMS has indicated that these proposed changes were made in a budget-neutral manner and that aggregate LTAC hospital payments will be unaffected by these proposed changes. It is likely, however, that individual hospitals will
see varying effects of this rule depending upon the acuity levels of their Medicare patient populations. It is expected that this proposed rule will be finalized during the third quarter of 2008.

The Medicare, Medicaid and SCHIP Extension Act of 2007

On
December 29, 2007, legislation known as the Medicare, Medicaid and SCHIP Extension Act of 2007 (the SCHIP Extension Act) was signed into law and became effective for cost reporting periods beginning after December 29, 2007.
This legislation provides for, among other things:



| | 1) | enhanced medical necessity reviews of LTAC hospital cases and a mandated study by the Secretary of Health and Human Services on the establishment of LTAC hospital certification
criteria;
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2) | three-year moratoriums on the following:
| | -- | ----------------------------------------



| | a. | the establishment of a LTAC hospital or satellite facility, subject to exceptions for facilities under development;
| | -- | -------------------------------------------------------------------------------------------------------------------



| | b. | an increase in the number of beds at a LTAC hospital or satellite facility, subject to exceptions for states where there is only one LTAC hospital or upon request following the
closure or decrease in the number of beds at a LTAC hospital within the state;
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c. | the application of the so-called 25 Percent Rule to freestanding LTAC hospitals;
| | -- | ----------------------------------------------------------------------------------



| | d. | the very short-stay outlier payment reductions to LTAC hospitals initially implemented on May 11, 2007; and
| | -- | -----------------------------------------------------------------------------------------------------------



| | e. | the application of a one-time budget neutrality adjustment of payment rates to LTAC hospitals under the Long-Term Acute Care Prospective Payment System (PPS);
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3) | a three-year period during which LTAC hospitals that are co-located within another hospital may admit up to 50% of their patients from the host hospitals and still be paid according
to the LTAC hospital PPS;
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4) | a three-year period during which LTAC hospitals that are co-located with an urban single hospital or a hospital that generates more than 25% of the Medicare discharges in a
metropolitan statistical area (MSA Dominant hospital) may admit up to 75% of their patients from such urban single hospital or MSA Dominant hospital and still be paid according to the LTAC prospective payment system; and
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 5) | the elimination of the July 1, 2007 market basket increase in the standard federal payment rate of 0.71%, effective for discharges occurring on or after April 1, 2008.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Additionally, the SCHIP Extension Act expanded the definition of a LTAC hospital. Historically, for a hospital to be
certified as a LTAC hospital, the primary requirement was the average length of stay for Medicare patients, measured annually at the end of a cost report period, be in excess of 25 days. The SCHIP Extension Act modified this definition to include,
among other items, that the LTAC hospital has a patient review process that screens patients prior to admission for appropriateness of admission, validates within 48 hours of admission that patients meet admission criteria, regularly evaluates
patients during their stay, and assesses available discharge options when patients fail to continue to meet stay criteria.

We believe that the additional
certification criteria will not impact the certification status of our existing LTAC and in development hospitals.

CMS Changes to DRG Weighting for
Fiscal 2008

On August 1, 2007, CMS issued final inpatient prospective payment system regulations for fiscal year 2008. These regulations establish
a new Medicare severity-based patient classification system for fiscal year 2008, called Medicare-Severity DRGs (MS-LT-DRG) for LTAC hospitals. The MS-LT-DRG system creates additional severity-adjusted categories for most diagnoses,
resulting in an expansion of the number of DRGs from 538 to 745. CMS states that MS-LT-DRG weights were developed in a budget neutral manner and as such, the estimated aggregate payments under LTAC PPS would be unaffected by the annual recalibration
of MS-LT-DRG payment weights. CMS has provided for a two year phase-in period to mitigate the transition in payments for short-term acute and LTAC PPS providers. In fiscal 2008, provider reimbursements are based 50% on new MS-LT-DRGs and 50% on
existing DRGs. For fiscal 2009, 100% will be based on new MS-LT-DRGs.

CMS also stated that future annual updates to the DRG classifications and relative
weights will be made in a budget neutral manner, effective October 1, 2007. As such, it is expected that the estimated aggregate industry LTAC hospital PPS payments would be unaffected by the annual recalibration of DRG payment weights.

The 2007 Final Rule

On May 1, 2007, CMS issued
its annual regulatory update regarding Medicare reimbursement for LTAC hospitals (the 2007 Final Rule) that was effective for all discharges on or after July 1, 2007. This rule was amended on June 29, 2007, by revising the high
cost outlier threshold. CMS estimated that impact of the 2007 Final Rule was an overall net decrease in payments to all Medicare certified LTAC hospitals of approximately 1.2%. The 2007 final rule included, among other things, (1) an increase
to the standard federal payment rate of 0.71% (subsequently eliminated effective April 1, 2008, as provided for in the SCHIP Extension Act as previously discussed); (2) revisions to payment methodologies impacting short-stay outliers,
which reduce payments by 0.9% (also subsequently modified by the SCHIP Extension Act via three-year moratorium on this new provision); (3) adjustments to the wage index component of the federal payment resulting in projected reductions in
payment of 0.5%; (4) an increase in the high cost outlier threshold per discharge to $20,738, resulting is projected reimbursement reductions of 0.4%; and (5) an extension of the policy know as the 25 Percent Rule to all LTAC
hospitals, with a three-year phase in, which CMS projects will not result in payment reductions for the first year of implementation (also subsequently modified by the SCHIP Extension Act via a three-year moratorium on this provision).

A significant policy change contained in the 2007 Final Rule was the application of the so-called 25 Percent Rule to all LTAC hospitals. The result of
this policy change was that all LTAC hospitals were to be paid the LTAC PPS rates for admissions from a single referral source up to 25% of aggregate Medicare admissions. Admissions in excess of the 25% threshold were to be paid at a lesser amount
based upon short-term acute care hospital rates. Patients admitted who had previously reached a high cost outlier status in the referring short-term hospital were not counted when computing compliance with this limitation.

Regulatory Matters

On June 12, 2006 we entered into a
Settlement Agreement and a Certification of Compliance Agreement (CCA) with the Office of Inspector General of the Department of Health and Human Services (OIG) that settled certain cost report matters for the years 1997 to 2001. The CCA is
effective for three years from the date of the CCA, and requires, among other things, that we continue to maintain our corporate compliance program, report certain events if they occur to the OIG and that we file an annual report with the OIG
regarding certain specified items, including our on-going corporate compliance audit findings in areas such as cost reports, physician contracting and charge master reviews.



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Sources of Revenue

We are reimbursed for our services provided to patients by a number of sources, including the federal Medicare program and commercial payors. Payment arrangements include prospectively determined rates per discharge, reimbursed costs,
discounted charges and per diem rates. Our net patient service revenue consists of the amounts that we estimate to be reimbursable from each of the applicable non-governmental payors and the Medicare and Medicaid programs. We account for the
differences between the estimated reimbursement rates and our standard billing rates as contractual adjustments, which are deducted from gross revenues to arrive at net revenues. We record accounts receivable resulting from such payment arrangements
net of contractual allowances. Net patient service revenues generated directly from the Medicare program approximated 62.4% and 68.6% of total net patient service revenue for the three months ended March 31, 2008 and 2007, respectively. Net
patient service revenues generated from non-Medicare payors were substantially from commercial payors.

Laws and regulations governing provider
reimbursement pursuant to the Medicare program are complex and subject to interpretation. The Medicare reimbursement amounts reported in our financial statements are based upon estimates and, as such, are subject to adjustment until such time as our
billings and cost reports are filed and settled with the appropriate regulatory authorities. Federal regulations require that providers participating in the Medicare program submit annual cost reports associated with services provided to program
beneficiaries. In addition, payments under LTAC hospital PPS are subject to review by the regulatory authorities. These reviews primarily focus on the accuracy of the DRG assigned to each discharged patient and normally occur after the completion of
the billing process.

The annual cost reports are also subject to review and adjustment by CMS through its fiscal intermediaries. These reviews may not
occur until several years after a provider files its cost reports and often results in adjustments to amounts reported by providers in their cost reports as a result of the complexity of the regulations and the inherent judgment that is required in
the application of certain provisions of provider reimbursement regulations. Since these reviews of filed cost reports occur periodically, there is a possibility that recorded estimated Medicare reimbursement reflected in our consolidated financial
statements and previously filed cost reports may change by a material amount in future periods. We recognize in our consolidated financial statements the impact of adjustments, if any, to estimated Medicare reimbursement when the amounts can be
reasonably determined.

In 2007, one of our hospitals, with multiple campus locations, failed to achieve the twenty-five day length of stay requirement for
the twelve months ended December 31, 2007. The LTAC hospital regulations provide that a hospital may correct this type deficiency in the subsequent cost report period following the period in which the twenty-five day length of stay requirement
was not achieved. This hospital will have until December 31, 2008 to demonstrate the achievement of the twenty-five day length of stay requirement. In the event this hospital fails to correct this length of stay deficiency, it would not be
eligible to receive Medicare payments pursuant to LTAC hospital regulations for discharges on or after January 1, 2009. To achieve this requirement in 2008, it is possible that the profitability of this hospital may be negatively impacted in
2008 as compared to 2007. We believe this hospital will achieve the corrective action required in order to retain its LTAC hospital status for Medicare, and that our remaining hospitals are currently in compliance with the Medicare regulations
regarding LTAC hospitals and will maintain compliance under these regulations.

Total Expenses

Total expenses consist of salaries, wages and benefits, supplies, which includes expenses related to drug and medical supplies, rent, other operating expenses, provision
for doubtful accounts, depreciation and amortization and interest expense. Other operating expenses include expenses such as contract labor, legal and accounting fees, insurance and contracted services purchased from host hospitals.

Other Operating Metrics

We use certain operating metrics in the
management of our facility operations. These include:

Licensed beds. Licensed beds represent beds for which a facility has been granted approval to
operate from the applicable state licensing agency. These licensed beds are used in the determination of average licensed beds and occupancy rates.

Average licensed beds. We compute average licensed beds by computing a weighted average based upon the number of licensed beds in place for each month within the reporting period.

Admissions. Admissions are the total number of patients admitted to our facilities during the reporting period.

Patient days. Patient days are the cumulative number of days that licensed beds are occupied in our facilities for the entire reporting period. We also refer to
patient days as our census.



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Average length of stay (days).We compute average length of stay in days by dividing patient days for discharged
patients by discharges.

Occupancy rates. We compute our occupancy rate by determining the percentage of average licensed beds that are
occupied for a 24-hour period during a reporting period. The occupancy rate provides a measure of the utilization of inpatient rooms.

Net patient
service revenue per patient day. This measure is determined by dividing our total net patient service revenue by the number of patient days in a reporting period. We use this metric to provide a measure of the net patient service revenue
generated for each patient day.

Critical Accounting Matters

This discussion and analysis of our financial condition and results of operation is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.
The preparation of those financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures. We rely on historical experience and other assumptions that we believe are reasonable at the time in
forming the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual amounts may differ from these estimates.

We believe that the following critical accounting policies as more fully described in our annual financial statements as of December 31, 2007 as filed in the Form
10-K, affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.



| |  |  | Revenue recognition
| | - |  | -------------------



| |  |  | Accounts receivable and allowance for doubtful accounts
| | - |  | -------------------------------------------------------



| |  |  | Insurance Risks
| | - |  | ---------------



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



| |  |  | Accounting for income taxes
| | - |  | ---------------------------



| |  |  | Accounting for stock-based compensation
| | - |  | ---------------------------------------

Goodwill

We review our goodwill annually, or more frequently if circumstances warrant a more timely review, to determine if there
has been an impairment. We review goodwill based upon one reporting unit. In calculating the fair value of the reporting unit, we use various assumptions including projected cash flows and discount rates. If projected future cash flows decline from
the current amounts projected by management, recording of impairments may be required.

We are assessing the financial impact that the CMS regulations
issued on May 1, 2008, as discussed previously, will have on our operations. It is possible that the impact may result in recording impairment charges in future periods as it relates to the carrying value of goodwill and identifiable intangible
assets.



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##### Table of Contents

Results of Operations

The following table sets forth operating results for each of the periods presented.



|                                     |  |                                |        |   |                                |   |        |  
|------------------------------------ |  | ------------------------------ | ------ | - | ------------------------------ | - | ------ | -
|                                     |  | Three monthsendedMarch 31,2008 |        |   | Three monthsendedMarch 31,2007 |  
|Net patient service revenue          |  | $                              | 88,761 |   |                                | $ | 82,369 |  
|                                     |  |                                |        |   |                                |   |        |  
|Salaries, wages, and benefits        |  |                                | 41,088 |   |                                |   | 37,980 |  
|Supplies                             |  |                                | 9,051  |   |                                |   | 8,397  |  
|Rent                                 |  |                                | 6,170  |   |                                |   | 5,122  |  
|Other operating expenses             |  |                                | 20,735 |   |                                |   | 20,683 |  
|Provision for doubtful accounts      |  |                                | 1,847  |   |                                |   | 1,413  |  
|Depreciation and amortization        |  |                                | 2,753  |   |                                |   | 2,844  |  
|Interest expense, net                |  |                                | 9,834  |   |                                |   | 8,476  |  
|                                     |  |                                |        |   |                                |   |        |  
|Total expenses                       |  |                                | 91,478 |   |                                |   | 84,915 |  
|                                     |  |                                |        |   |                                |   |        |  
|Loss before income taxes             |  |                                | (2,717 | ) |                                |   | (2,546 | )
|Provision (benefit) for income taxes |  |                                | 200    |   |                                |   | (851   | )
|                                     |  |                                |        |   |                                |   |        |  
|Net loss                             |  | $                              | (2,917 | ) |                                | $ | (1,695 | )
|                                     |  |                                |        |   |                                |   |        |  

Operating Statistics

The following table sets forth operating statistics for each of the periods presented.



|                                                                            |  |                                |        |   |                                |   |        |  
|--------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ------------------------------ | - | ------ | -
|                                                                            |  | Three monthsendedMarch 31,2008 |        |   | Three monthsendedMarch 31,2007 |  
|Number of hospitals within hospitals (end of period)                        |  |                                | 9      |   |                                |   | 11     |  
|Number of freestanding hospitals (end of period)                            |  |                                | 10     |   |                                |   | 8      |  
|Number of total hospitals (end of period)                                   |  |                                | 19     |   |                                |   | 19     |  
|Licensed beds (end of period) (1)                                           |  |                                | 1,009  |   |                                |   | 922    |  
|Average licensed beds (1)                                                   |  |                                | 1,009  |   |                                |   | 923    |  
|Admissions                                                                  |  |                                | 2,266  |   |                                |   | 1,990  |  
|Patient days                                                                |  |                                | 61,719 |   |                                |   | 58,239 |  
|Occupancy rate                                                              |  |                                | 67.2   | % |                                |   | 70.1   | %
|Percent net patient service revenue from Medicare                           |  |                                | 62.4   | % |                                |   | 68.6   | %
|Percent net patient service revenue from commercial payors and Medicaid (2) |  |                                | 37.6   | % |                                |   | 31.4   | %
|Net patient service revenue per patient day                                 |  | $                              | 1,438  |   |                                | $ | 1,413  |  



|(1) | The average licensed beds are only calculated on the beds at locations that were open for operations during the applicable periods.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

|(2) | The percentage of net patient service revenue from Medicaid is less than one percent for each of the periods presented.
|--- | -----------------------------------------------------------------------------------------------------------------------

Three Months Ended March 31, 2008 Compared to Three Months Ended March 31, 2007

Net Revenues

Our net patient service revenue increased by $6.4 million, or 7.8%, for the three months ended
March 31, 2008, to $88.8 million from $82.4 million for the comparable period in 2007. Patient days in the 2008 period were 3,480, or 6.0%, greater than the same period in 2007.

The increase in our net patient service revenue was comprised of a favorable benefit of $4.9 million from the increase in patient days and $1.5 million as the result of higher rates on a per patient day basis. During
the three months ended March 31, 2008, our net patient service revenue per patient day was $1,438, which represented an increase of 1.7% compared to the



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same period in 2007. The increase in net patient service revenue on a per patient day basis during the 2008 period was primarily the result of annual
inflationary increases in our standard charge rates and certain of our contracts with commercial payors, our continued focus on treating higher acuity patients and an increase in the percentage of our revenues generated from commercial payors. These
favorable items were partially offset by the unfavorable annual regulatory updates implemented by Medicare in the 2007 Final Rule.

Total Expenses

Total expenses increased by $6.6 million to $91.5 million for the three months ended March 31, 2008 as compared to $84.9 million for the same
period in 2007. Of this $6.6 million increase in total expenses, approximately $3.1 million was attributable to an increase in salaries, wages, and benefits. This increase was due primarily to our increase in operating capacity, patient days and
annual inflationary increases.

The remaining $3.5 million of the total $6.6 million increase was comprised of an increase in rent expense of $1.0 million
and an increase of $1.4 million in interest expense, in addition to net increases in other expense categories. The increase in rent expense was the result of the overall increase in the number of operating locations and beds as discussed previously.
The increase in interest expense was the result of a higher margin spread on our senior secured credit facility during the 2008 period as compared to the 2007 period as the result of the amendments to our senior secured credit facility during 2007.

Income Tax Expense

For the three months ended
March 31, 2008, income tax expense recorded represents the estimated income tax liability for certain state income taxes. We expected that no benefit or expense will be realized during 2008 for federal income taxes based on recent taxable loss
trends and a projected taxable loss for the remainder of 2008. We anticipate that federal net operating losses generated during 2008 will be offset by an increase in the valuation allowance against net deferred tax assets.

Liquidity and Capital Resources

Our primary sources of liquidity are
cash on hand, availability of borrowings under a revolving credit facility, funds available under the Master Lease and expected cash flows generated by operations, although operating cash flows for the 3 months ending March 31, 2008 were
negative. Our primary liquidity requirements will be for debt service on our senior secured credit facilities and the notes, capital expenditures and working capital.

At March 31, 2008, our debt structure consisted of $147.0 million aggregate principal amount of senior subordinated notes, a senior secured credit facility, consisting of (i) a $248.6 million term loan
facility which matures on August 11, 2012, (ii) capital lease obligations of $4.2 million with varying maturities, and (iii) a $60.0 million revolving credit facility, subject to availability, including sub-facilities for letters of
credit and swingline loans, which matures on August 11, 2011. The full amount available under the term loan facility was used in connection with the Transactions.

The senior secured credit facility requires us to comply on a quarterly basis with certain financial covenants, including an interest coverage ratio test and a maximum leverage ratio test, which financial covenants
will become more restrictive over time. In addition, the senior secured credit facility includes various negative covenants, including limitations on indebtedness, liens, investments, permitted businesses and transaction and other matters, as well
as certain customary representations and warranties, affirmative covenants and events of default including payment defaults, breach of representations and warranties, covenant defaults, cross defaults to certain indebtedness, certain events of
bankruptcy, certain events under ERISA, material judgments , actual or asserted failure of any guaranty or security document supporting the senior secured credit facility to be in full force and effect, change of control, and certain subjective
provisions. We believe we are currently in compliance with the covenants of the Credit Agreement as amended.

The interest rates per annum applicable to
loans, other than swingline loans, under our senior secured credit facility are, at our option, equal to either an alternate base rate or an adjusted LIBOR rate for a one-, two-, three- or six-month interest period, or a nine- or twelve-month period
if available, in each case, plus an applicable margin. The applicable margins on the loans as amended are currently (1) 3.25% for alternate base rate revolving loans, (2) 4.25% for adjusted LIBOR revolving loans, (3) 3.25% for
alternate base rate term loans and (4) 4.25% for adjusted LIBOR term loans. These margins are subject to reduction based upon the ratio of our total indebtedness to our consolidated adjusted EBITDA (as defined in the credit agreement governing
our senior secured credit facility and amendment number 1 to the credit agreement). At March 31, 2008, the interest rate applicable to the $248.6 million under our term loan facility was 9.08%.

We may not be able to continue to satisfy the covenant requirements in subsequent periods. If we are unable to maintain compliance with the covenants contained in our
senior secured credit facility, an event of default would occur. During the continuation of an event of default, the lenders under the senior secured credit facility are entitled to take various actions, including accelerating amounts due under the
senior secured credit facility, terminating our access to our revolving credit facility and all other actions generally available to a secured creditor. An uncured event of default would have a material adverse effect on our financial position,
results of operations and cash flow.



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We believe that our cash on hand, expected cash flows from operations, potential availability of borrowings under the
revolving portion of our senior secured credit facilities, and funds available under the Master Lease will be sufficient to finance our operations, and meet our scheduled debt service requirements for at least the next twelve months.

On September 1, 2006, a newly formed subsidiary of the Company entered into a Master Lease Agreement (Lease) with Health Care REIT, Inc. In connection
with this Lease, Health Care REIT, Inc. agreed to make available up to $250 million for investments in hospital facilities, subject to certain terms and conditions. The first facility to be developed under this Master Lease is our Boise, Idaho
facility. Construction was completed on this facility near the end of March 2008 at a cost of approximately $21.2 million. Through March 31, 2008, Health Care REIT, Inc. had made payment to us of approximately $16.9 million as reimbursement for
these capital expenditures. This facility opened in April 2008. This particular facility under this Master Lease will be accounted for as a lease financing obligation with the asset remaining capitalized upon completion. See note 8 in our condensed
consolidated financial statements for additional discussion regarding this Lease.

We actively seek to identify and evaluate potential acquisition
candidates and, from time to time, we review potential acquisitions of businesses. Any acquisitions may require us to issue additional equity or incur additional indebtedness, subject to the limitations contained in our senior secured credit
facility.

Capital Expenditures

We anticipate that we
may incur capital expenditures of approximately $4.0 million during the remainder of 2008 based on our current plans, which includes remaining equipment needs at our Boise, Idaho facility and our ongoing capital maintenance expenditure requirements
at our existing facilities. We may enter into lease arrangements to finance a portion of these equipment expenditures.

Historical Cash Flow

Three Months Ended March 31, 2008 and 2007



|                                                    |  |                                      |        |   |                                      |   |         |  
|--------------------------------------------------- |  | ------------------------------------ | ------ | - | ------------------------------------ | - | ------- | -
|                                                    |  | Three MonthPeriod EndedMarch 31,2008 |        |   | Three MonthPeriod EndedMarch 31,2007 |  
|Net cash used in operating activities               |  | $                                    | (7,667 | ) |                                      | $ | (16,358 | )
|Net cash used in investing activities               |  |                                      | (5,649 | ) |                                      |   | (7,030  | )
|Net cash provided by (used in) financing activities |  |                                      | 2,167  |   |                                      |   | (1,727  | )

For the three months ended March 31, 2008, operating activities used $7.7 million of cash as compared to
using $16.4 million in cash for the comparable period in 2007. For the three-months ended March 31, 2008, we had a net loss of $2.9 million as compared to net loss of $1.7 million for the same period in 2007.

Accounts receivable increased by $11.5 million for the three months ended March 31, 2008 as compared to an increase of $6.7 million for the same period during 2007.
Days of net patient service revenue in accounts receivable at March 31, 2008 had increased to 78.8 as compared to 77.6 at December 31, 2007. The increase in accounts receivable during the three months ended March 31, 2008 was
principally due to an increase in net patient service revenue during this period.

Estimated third party payor settlements resulted in a net use of cash of
$2.1 million as compared to a net use of cash of $8.4 million for the three months ended March 31, 2007. The use of cash during the 2008 period was principally due to the repayment to Medicare of amounts received as interim payments during 2007
in excess of revenues ultimately recognized.

Cash used in investing activities was $5.6 million for the three months ended March 31, 2008 as compared
to $7.0 million in 2007. Cash used during the 2008 period was principally for the construction of our hospital in Boise, Idaho. This was offset by $2.9 million received in the 2008 period pursuant to our lease agreement with Healthcare REIT, Inc.
attributable to our Milwaukee, Wisconsin facility. Cash used in investing activities during the 2007 period was principally for our San Antonio, Texas and Milwaukee, Wisconsin hospital projects.

Cash provided by financing activities for the three months ended March 31, 2008 was $2.2 million as compared to cash used of $1.7 million for the same period in
2007. During the 2008 period, we received $1.8 million pursuant to the Master Lease associated with our capital expenditures on our Boise, Idaho hospital project, and received $1.8 million in proceeds by entering a capital lease on various
equipment.



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##### Table of Contents

Seasonality

Our
business experiences seasonality resulting in variation in census levels, with the highest census historically occurring in the first quarter of the year and the lowest census occurring in the third quarter of the year.

Inflation

We derive a substantial portion of our revenue from the
Medicare program. LTAC hospital PPS payments are subject to fixed payments that generally are adjusted annually for inflation. However, there can be no assurance that these adjustments, if received, will reflect the actual increase in our costs for
providing healthcare services.

Labor and supply expenses make up a substantial portion of our operating expense structure. The expenses can be subject to
increase in periods of rising inflation.

Forward Looking Statements

This quarterly report contains forward-looking statements regarding, among other things, our financial condition, results of operations, plans, objectives, future performance and business. All statements contained in
this document other than historical information are forward-looking statements. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other
developments, and contain words and phrases such as may, expects, believes, anticipates, estimates, should, or similar expressions. Because these forward-looking statements are
based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Although we believe
that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are
inherently subject to risks, uncertainties and assumptions. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:



| |  |  | changes in government reimbursement for our services may have an adverse effect on our future revenues and profitability including, for example, the changes
described under Regulatory Changes;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the failure to maintain compliance with our financial covenants could be costly or have a material adverse effect on us;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | the amount of outstanding indebtedness and the restrictive covenants in the agreements governing our indebtedness may limit our operating and financial flexibility;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a government investigation or assertion that we have violated applicable regulations may result in increased costs or sanctions that reduce our revenues and
profitability;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | private third-party payors for our services may undertake future cost containment initiatives that limit our future revenues and profitability;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | actions that may be brought by individuals on the governments behalf under the False Claims Acts qui tam or whistleblower provisions may
expose us to unforeseen liabilities;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the failure of our long-term acute care hospitals to maintain their qualification could cause our revenues and profitability to decline;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the failure of our satellite facilities to qualify for provider-based status with the applicable main facilities may adversely affect our
results of operations;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | development of new facilities may prove difficult or unsuccessful, use significant resources or expose us to unforeseen liabilities;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an increase in uninsured and underinsured patients in our hospitals or the deterioration in the collectibility of the accounts of such patients could harm our
results of operations;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the failure to maintain established relationships with the physicians in our markets could reduce our revenues and profitability;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | shortages in qualified nurses or therapists could increase our operating costs significantly;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | competition may limit our ability to grow and result in a decrease in our revenues and profitability;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | the loss of key members of our management team could significantly disrupt our operations;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | the geographic concentration of our facilities in Texas make us sensitive to economic, regulatory, environmental and other developments in this state;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adverse changes in individual markets could significantly affect operating results;
| | - |  | -----------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | the effect of legal actions or other claims associated with the circumstances arising from Hurricane Katrina could subject us to substantial liabilities;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of legal actions asserted against us or lack of adequate available insurance could subject us to substantial uninsured liabilities;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ability to ensure and maintain an effective system of internal controls over financial reporting; and,
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | the failure to comply with the provisions of any of our Master Lease Agreements could materially adversely affect our financial position, results of operations and
liquidity.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs. We do
not intend, and do not undertake, any obligation to update any forward-looking statements to reflect future events or circumstances after the date of this report.



|ITEM 3: | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

At
March 31, 2008, we had $248.6 million in senior term loans outstanding and a borrowing availability of $54.3 million under our revolving credit facility, each bearing interest at variable rates. Each 0.125% point change in interest rates would
result in a $0.4 million annual change in interest expense on our term loans and revolving credit facility loans, assuming that our revolving credit facility is fully drawn. Pursuant to our senior term loan credit agreement we were required to enter
into an interest rate Swap Agreement that would provide protection against fluctuations in interest rates on a notional amount of $12 million. On November 9, 2005, we entered into such an agreement for a three year period. This agreement will
cap the LIBOR rate used to compute interest on the notional amount of our senior term loan at six percent per annum. In the future, we may enter into additional interest rate swaps, involving exchange of floating for fixed rate interest payments, to
reduce interest rate volatility.



|ITEM 4: | CONTROLS AND PROCEDURES
|------- | -----------------------

We carried out an evaluation, under the
supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities
Exchange Act of 1934) as of the end of the period covered in this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures provide reasonable assurance
that material information required to be included in our periodic SEC reports is recorded accurately, processed, summarized and reported within the time periods specified in the relevant SEC rules and forms.

In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect
those controls in the first quarter.



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##### Table of Contents

PART II: OTHER INFORMATION



|ITEM 1: | LEGAL PROCEEDINGS
|------- | -----------------

The Company is a party to various legal actions
that arise in the ordinary course of business, as well as other litigation described elsewhere in this report. These actions are primarily related to malpractice claims covered under insurance policies; however, there may be some legal actions which
are not insured. The Company is unable to predict the ultimate outcome of pending litigation and regulatory and other government investigations, nor can there be any assurance that the resolution of any litigation or investigation, either
individually or in the aggregate, would not have a material adverse effect on the Companys financial position, results of operations or liquidity.



|ITEM 1A: | RISK FACTORS
|-------- | ------------

No changes.



|ITEM 2: | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

None



|ITEM 3: | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

Not applicable.



|ITEM 4: | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

Not
applicable.



|ITEM 5: | OTHER INFORMATION
|------- | -----------------

None



|ITEM 6: | EXHIBITS
|------- | --------

The exhibits to this report are listed in the Exhibit
Index.



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##### Table of Contents

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.



LifeCare Holdings, Inc.By:

/s/ G. Wayne McAlisterG. Wayne McAlisterChief Executive OfficerBy:

/s/ Chris A. WalkerChris A. WalkerChief Financial Officer


Dated: May 15, 2008



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##### Table of Contents

EXHIBIT INDEX



|        |  |                                                                                                                                                                               
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                   
|31.1    |  | Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|        | 
|31.2    |  | Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|        | 
|32.1    |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                            
|        | 
|32.2    |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                            



30