##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

For the quarterly period ended March 31, 2007.

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



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LIFECARE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)



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|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 51-0372090                         
|(State or other jurisdiction ofincorporation or organization) |  | (IRS EmployerIdentification 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 ̈No x

Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated filer. 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

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, 2007, 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                             |  | 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 |  | 13
|           |  |                                                                                      
|ITEM 3.    |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  | 22
|           |  |                                                                                      
|ITEM 4T.   |  | CONTROLS AND PROCEDURES                                                               |  | 22
|           |  |                                                                                      
|PART II    |  | OTHER INFORMATION                                                                     |  | 22
|           |  |                                                                                      
|ITEM 1.    |  | LEGAL PROCEEDINGS                                                                     |  | 22
|           |  |                                                                                      
|ITEM 1A.   |  | RISK FACTORS                                                                          |  | 23
|           |  |                                                                                      
|ITEM 2.    |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDINGS                        |  | 23
|           |  |                                                                                      
|ITEM 3.    |  | DEFAULTS UPON SENIOR SECURITIES                                                       |  | 23
|           |  |                                                                                      
|ITEM 4.    |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   |  | 23
|           |  |                                                                                      
|ITEM 5.    |  | OTHER INFORMATION                                                                     |  | 23
|           |  |                                                                                      
|ITEM 6.    |  | EXHIBITS                                                                              |  | 23
|           | 
|SIGNATURES |  | 24                                                                                   



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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, 2007 (unaudited) and December 31, 2006

(In thousands)



|                                                                                                |  |               |          |   |                  |   |          |  
|----------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                |  | March 31,2007 |          |   | December 31,2006 |  
|Assets                                                                                          |  |               |          |   |                  |   |          |  
|Current assets:                                                                                 |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                                                                       |  | $             | 8,135    |   |                  | $ | 33,250   |  
|Accounts receivable, net of allowance for doubtful accounts of $14,907 and $14,372 respectively |  |               | 72,796   |   |                  |   | 67,464   |  
|Estimated third-party payer settlements                                                         |  |               | 74       |   |                  |   |         |  
|Income taxes                                                                                    |  |               | 7,269    |   |                  |   | 6,418    |  
|Other current assets                                                                            |  |               | 17,483   |   |                  |   | 17,662   |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Total current assets                                                                            |  |               | 105,757  |   |                  |   | 124,794  |  
|Property and equipment, net                                                                     |  |               | 82,888   |   |                  |   | 78,418   |  
|Other assets                                                                                    |  |               | 14,280   |   |                  |   | 14,461   |  
|Identifiable intangibles, net                                                                   |  |               | 19,301   |   |                  |   | 19,586   |  
|Goodwill                                                                                        |  |               | 299,159  |   |                  |   | 299,159  |  
|                                                                                                |  |               |          |   |                  |   |          |  
|                                                                                                |  | $             | 521,385  |   |                  | $ | 536,418  |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Liabilities and Stockholders Equity                                                            |  |               |          |   |                  |   |          |  
|Current liabilities:                                                                            |  |               |          |   |                  |   |          |  
|Current installments of long-term debt                                                          |  | $             | 3,188    |   |                  | $ | 3,188    |  
|Current installments of obligations under capital leases                                        |  |               | 3,385    |   |                  |   | 3,925    |  
|Estimated third party payor settlements                                                         |  |               |         |   |                  |   | 8,308    |  
|Accounts payable                                                                                |  |               | 23,888   |   |                  |   | 26,905   |  
|Accrued payroll                                                                                 |  |               | 7,905    |   |                  |   | 6,243    |  
|Accrued vacation                                                                                |  |               | 4,001    |   |                  |   | 3,475    |  
|Accrued insurance                                                                               |  |               | 1,813    |   |                  |   | 1,318    |  
|Accrued interest                                                                                |  |               | 1,853    |   |                  |   | 5,295    |  
|Accrued other                                                                                   |  |               | 2,475    |   |                  |   | 2,110    |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Total current liabilities                                                                       |  |               | 48,508   |   |                  |   | 60,767   |  
|Obligations under capital leases, excluding current installments                                |  |               | 1,360    |   |                  |   | 1,909    |  
|Long-term debt, excluding current installments                                                  |  |               | 395,624  |   |                  |   | 396,262  |  
|Accrued insurance                                                                               |  |               | 5,650    |   |                  |   | 5,902    |  
|Other noncurrent liabilities                                                                    |  |               | 21,276   |   |                  |   | 21,080   |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Total liabilities                                                                               |  |               | 472,418  |   |                  |   | 485,920  |  
|                                                                                                |  |               |          |   |                  |   |          |  
|Commitments and contingencies                                                                   |  |               |          |   |                  |   |          |  
|                                                                                                |  |              
|Stockholders equity:                                                                           |  |               |          |   |                  |   |          |  
|Common stock, $0.01 par value, 100 shares authorized, issued and outstanding in 2007 and 2006   |  |               |         |   |                  |   |         |  
|Additional paid-in capital                                                                      |  |               | 161,324  |   |                  |   | 161,160  |  
|Accumulated deficit                                                                             |  |               | (112,357 | ) |                  |   | (110,662 | )
|                                                                                                |  |               |          |   |                  |   |          |  
|Total stockholders equity                                                                      |  |               | 48,967   |   |                  |   | 50,498   |  
|                                                                                                |  |               |          |   |                  |   |          |  
|                                                                                                |  | $             | 521,385  |   |                  | $ | 536,418  |  
|                                                                                                |  |               |          |   |                  |   |          |  

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, 2007 and 2006

(In thousands)

(Unaudited)



|                                     |  |      |        |   |      |   |        |  
|------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                     |  | 2007 |        |   | 2006 |  
|Net patient service revenue          |  | $    | 82,369 |   |      | $ | 87,319 |  
|                                     |  |      |        |   |      |   |        |  
|Salaries, wages, and benefits        |  |      | 37,980 |   |      |   | 36,068 |  
|Supplies                             |  |      | 8,397  |   |      |   | 8,436  |  
|Rent                                 |  |      | 5,122  |   |      |   | 4,560  |  
|Other operating expenses             |  |      | 20,683 |   |      |   | 20,877 |  
|Provision for doubtful accounts      |  |      | 1,413  |   |      |   | 1,515  |  
|Depreciation and amortization        |  |      | 2,844  |   |      |   | 2,978  |  
|Interest expense, net                |  |      | 8,476  |   |      |   | 7,880  |  
|Gain on early extinguishment of debt |  |      |       |   |      |   | (1,329 | )
|                                     |  |      |        |   |      |   |        |  
|Total expenses                       |  |      | 84,915 |   |      |   | 80,985 |  
|                                     |  |      |        |   |      |   |        |  
|Income before income taxes           |  |      | (2,546 | ) |      |   | 6,334  |  
|                                     |  |     
|Provision for income taxes           |  |      | (851   | ) |      |   | 2,543  |  
|                                     |  |      |        |   |      |   |        |  
|Net income (loss)                    |  | $    | (1,695 | ) |      | $ | 3,791  |  
|                                     |  |      |        |   |      |   |        |  

See accompanying notes to condensed consolidated financial statements.



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LIFECARE HOLDINGS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders Equity

For the three months ended March 31, 2007

(In thousands)

(Unaudited)



|                                 |  |             |   |                          |   |                    |  |   |                          |   |  |   |        |  
|-------------------------------- |  | ----------- | - | ------------------------ | - | ------------------ |  | - | ------------------------ | - |  | - | ------ | -
|                                 |  | CommonStock |   | AdditionalPaid-inCapital |   | AccumulatedDeficit |  |   | TotalStockholdersEquity |  
|Balance, December 31, 2006       |  | $           |  |                          | $ | 161,160            |  | $ | (110,662                 | ) |  | $ | 50,498 |  
|Equity compensation amortization |  |             |  |                          |   | 164                |  |   |                         |   |  |   | 164    |  
|Net loss                         |  |             |  |                          |   |                   |  |   | (1,695                   | ) |  |   | (1,695 | )
|                                 |  |             |   |                          |   |                    |  |   |                          |   |  |   |        |  
|Balance, March 31, 2007          |  | $           |  |                          | $ | 161,324            |  | $ | (112,357                 | ) |  | $ | 48,967 |  
|                                 |  |             |   |                          |   |                    |  |   |                          |   |  |   |        |  

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, 2007 and 2006

(In thousands)

(Unaudited)



|                                                                                                   |  |      |         |   |      |   |         |  
|-------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                                   |  | 2007 |         |   | 2006 |  
|Cash flows from operating activities:                                                              |  |      |         |   |      |   |         |  
|Net income (loss)                                                                                  |  | $    | (1,695  | ) |      | $ | 3,791   |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |      |         |   |      |   |         |  
|Depreciation and amortization                                                                      |  |      | 3,207   |   |      |   | 3,605   |  
|Provision for doubtful accounts                                                                    |  |      | 1,413   |   |      |   | 1,515   |  
|Gain on early extinguishment of debt                                                               |  |      |        |   |      |   | (1,329  | )
|Deferred income taxes                                                                              |  |      |        |   |      |   | (1,394  | )
|Equity compensation amortization                                                                   |  |      | 164     |   |      |   | 92      |  
|Changes in operating assets and liabilities:                                                       |  |      |         |   |      |   |         |  
|Patient accounts receivable                                                                        |  |      | (6,745  | ) |      |   | (3,434  | )
|Current income taxes                                                                               |  |      | (1,389  | ) |      |   | 16,333  |  
|Insurance proceeds receivable                                                                      |  |      |        |   |      |   | 7,000   |  
|Other current assets                                                                               |  |      | 717     |   |      |   | (2,869  | )
|Other assets                                                                                       |  |      | (182    | ) |      |   | 584     |  
|Estimated third-party payor settlements                                                            |  |      | (8,382  | ) |      |   | 2,326   |  
|Accounts payable and accrued expenses                                                              |  |      | (3,871  | ) |      |   | (2,773  | )
|Other liabilities                                                                                  |  |      | 405     |   |      |   | 759     |  
|                                                                                                   |  |      |         |   |      |   |         |  
|Net cash (used in) provided by operating activities                                                |  |      | (16,358 | ) |      |   | 24,206  |  
|                                                                                                   |  |      |         |   |      |   |         |  
|Cash used in investing activities:                                                                 |  |      |         |   |      |   |         |  
|Purchases of property and equipment                                                                |  |      | (7,030  | ) |      |   | (2,414  | )
|                                                                                                   |  |      |         |   |      |   |         |  
|Net cash used in investing activities                                                              |  |      | (7,030  | ) |      |   | (2,414  | )
|                                                                                                   |  |      |         |   |      |   |         |  
|Cash flows used in financing activities:                                                           |  |      |         |   |      |   |         |  
|Payments of notes payable and long-term debt                                                       |  |      | (638    | ) |      |   | (2,169  | )
|Payments on obligations under capital leases                                                       |  |      | (1,089  | ) |      |   | (1,507  | )
|                                                                                                   |  |      |         |   |      |   |         |  
|Net cash used in financing activities                                                              |  |      | (1,727  | ) |      |   | (3,676  | )
|                                                                                                   |  |      |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                               |  |      | (25,115 | ) |      |   | 18,116  |  
|Cash and cash equivalents, beginning of period                                                     |  |      | 33,250  |   |      |   | 19,843  |  
|                                                                                                   |  |      |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                                           |  | $    | 8,135   |   |      | $ | 37,959  |  
|                                                                                                   |  |      |         |   |      |   |         |  
|Supplemental disclosure of cash flow information:                                                  |  |      |         |   |      |   |         |  
|Cash:                                                                                              |  |      |         |   |      |   |         |  
|Interest paid                                                                                      |  | $    | 12,223  |   |      | $ | 12,783  |  
|Income taxes paid                                                                                  |  |      |        |   |      |   | (12,397 | )

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 Companys senior management and 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, 2007
and 2006 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, 2006 included in the Form 10-K filed by the Company on April 2, 2007 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
the Company believes 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 management of the Company 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, impairments may be required.

We are assessing the financial impact that the CMS regulations issued on May 1, 2007 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.

Income Taxes

For the three
months ended March 31, 2007, the income tax benefit recorded is based on actual expected taxes for the quarter as the Company is not able to reasonably estimate an annual effective rate due to the interaction of the level of profitability and
the Texas gross margin tax, which is not based on pre tax net income. Based on recent taxable income trends during the three months ended March 31, 2007, along with revised projections through December 31, 2007, we now expect a federal and
state income tax effective rate of 38.5% exclusive of Texas gross margin tax. The Texas gross margin tax is calculated on gross margin, as defined, and was approximately $129 for the quarter.

Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation no. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprises financial statements and 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. FIN 48 also provides related guidance on measurement,
derecognition, classification, interest and penalties, and disclosure. The provisions of FIN 48 became effective for the Company on January 1, 2007. The Company records accrued interest and penalties associated with uncertain tax positions as
income tax expense in the consolidated statement of operations. The adoption of FIN 48 had no impact on the Companys results of operations and financial position.

The federal statute of limitations remains open for tax years 2003 through 2006. 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.

Reclassifications

Certain reclassifications have been made to the consolidated financial statements for prior
periods to conform to the presentation of the 2007 consolidated financial statements.



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##### Table of Contents

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

The Company recognizes
in its 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, 2007 included a decrease of $(195) related to
changes in estimates and settlements on prior year cost reports filed with the Medicare program, while there were no changes related to the three months ended March 31, 2006.



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

Long-term debt consists of the
following:



|                                               |  |               |         |   |                  |   |         |  
|---------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                               |  | March 31,2007 |         |   | December 31,2006 |  
|Senior secured credit facilityterm loan       |  | $             | 251,812 |   |                  | $ | 252,450 |  
|91/4% senior
subordinated notes                |  |               | 147,000 |   |                  |   | 147,000 |  
|                                               |  |               |         |   |                  |   |         |  
|Total long-term debt                           |  |               | 398,812 |   |                  |   | 399,450 |  
|Current installments of long-term debt         |  |               | (3,188  | ) |                  |   | (3,188  | )
|                                               |  |               |         |   |                  |   |         |  
|Long-term debt, excluding current installments |  | $             | 395,624 |   |                  | $ | 396,262 |  
|                                               |  |               |         |   |                  |   |         |  

Amendment to Credit Agreement

On May 2, 2007, the Company entered into Amendment No. 1 to the Companys $326.8 million senior secured credit facility (Amendment
No. 1). Amendment No. 1 modifies certain financial covenants effective March 31, 2007 and increases the spread on the variable interest rate to be paid by the Company. The applicable margins on the loans as amended are currently
(1) 2.25% for alternate base rate revolving loans, (2) 3.25% for adjusted LIBOR revolving loans, (3) 2.25% for alternate base rate term loans and (4) 3.25% 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 No. 1 to the credit agreement). The senior secured credit facility consists of (i) a $75
million Revolving Credit Facility and (ii) a $251.8 million Term Loan B Facility. The Company is currently in compliance with the covenants of the Credit Agreement as amended. The Companys operating results for the quarter ended March 31,
2007 were not in compliance with the financial covenants as set forth in the original agreement however, there has been no default under the senior secured credit agreement. The Company incurred $1.1 million in fees to obtain Amendment No. 1,
which will be capitalized and amortized over the remaining life of the senior secured credit facility.



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

At March 31, 2007, there were
2,860,000 million 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, 2007 and 2006 includes
$164 and $92, respectively, of pre-tax compensation costs related to our stock-based compensation arrangements.

The following table
summarizes stock option activity during the three months ended March 31, 2007:



|                             |  |                 |   |  |                              |     
|---------------------------- |  | --------------- | - |  | ---------------------------- | ----
|                             |  | Number ofShares |   |  | Weightedaverageexerciseprice
|Balance at December 31, 2006 |  | 1,011,000       |   |  | $                            | 6.00
|Granted                      |  |                |   |  |                              |    
|Exercised                    |  |                |   |  |                              |    
|Forfeited                    |  | (21,000         | ) |  |                              | 6.00
|Expired                      |  | (4,000          | ) |  |                              | 6.00
|                             |  |                 |   |  |                              |     
|Balance at March 31, 2007    |  | 986,000         |   |  | $                            | 6.00
|                             |  |                 |   |  |                              |     

At March 31, 2007, the weighted average remaining contractual life of outstanding options was
9.0 years. There were 103,250 stock options exercisable at March 31, 2007. At March 31, 2007, the weighted average exercise price of the vested stock options was $6.00, the remaining weighted average contractual life was 8.4 years and the
aggregate intrinsic value of the vested stock options shares was $41.

As of March 31, 2007, there was approximately $1,348 of total
unrecognized compensation costs related to stock options. These costs are expected to be recognized over a period of approximately four years.



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##### Table of Contents

Restricted Stock Awards

The following table summarizes restricted stock award activity during the three months ended March 31, 2007:



|                             |  |                 |  
|---------------------------- |  | --------------- | -
|                             |  | Number ofShares |  
|Balance at December 31, 2006 |  | 130,000         |  
|Granted                      |  |                |  
|Exercised                    |  |                |  
|Forfeited                    |  |                |  
|Repurchased                  |  | (10,000         | )
|                             |  |                 |  
|Balance at March 31, 2007    |  | 120,000         |  
|                             |  |                 |  

One of the holders of restricted stock resigned from the Company during 2006 resulting in the
forfeiture of 10,000 shares of restricted stock awards that were not vested. 10,000 restricted shares held by the holder had vested prior to his resignation. During the three months ended March 31, 2007, Holdings purchased the 10,000 shares
that had previously vested for $3.11 per share pursuant to the restricted stock award agreement.

As of March 31, 2007, there was
approximately $300 of total unrecognized compensation costs related to restricted stock awards. These costs are expected to be recognized over a remaining period of approximately two and a half years.



|(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 extremely 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 in the normal course of conducting their business. 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, the Company is 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. The Company endeavors to conduct its business in compliance with applicable laws and regulations, including
healthcare fraud and abuse laws.

The Company undertakes various procedures to assure that its annual cost reports are correctly prepared
and filed in accordance with applicable Medicare regulations governing provider reimbursement. During 2004 and 2003, the Company conducted an internal review of its previously filed cost reports. As a result of this review, which covered the years
1997 through 2001, the Company made certain adjustments in 2003 to its 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 the Companys findings. On June 12, 2006, the Company 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 the Company continue to maintain its 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 corporate compliance and internal audit activities.



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

On
September 28, 2005, the Louisiana Attorney Generals office announced that it was conducting an investigation of 13 nursing homes and six hospitals in the New Orleans area relating to patient deaths that occurred at these facilities during
and in the aftermath of Hurricane Katrina. One of these facilities is Memorial Medical Center within which the Company operated an 82-bed licensed hospital. The Company has been fully cooperating with this investigation since its inception. On
July 18, 2006, the Attorney Generals office presented certain findings related to this investigation that resulted in the arrest of one physician and two nurses, who were not employees of the Company. At the same time, the Attorney
General referred its findings to the New Orleans District Attorney. Neither the Company nor its employees have been named to date in any illegal or criminal activities under investigation by the Attorney General. On February 14, 2007, the New
Orleans District Attorney convened a Grand Jury to determine if any of the three individuals should be indicted and formally charged with criminal acts. At this time we cannot determine what, if any, impact this investigation or the Grand Jury
proceedings ultimately may have on the Company.

The Company is currently defending itself against a variety of Katrina related lawsuits or
matters under review by the Louisiana Patient Compensation Fund. We intend to vigorously defend ourselves in these lawsuits, however, we cannot predict the ultimate resolution of these matters. The Company maintained $15 million of general and
professional liability insurance during this period, subject to a $1 million per claim retention. The Company believes 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 or rights letters which challenge, among other things, the application of one retention to the Katrina
related



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##### Table of Contents

matters. To the extent it is ultimately determined that a separate retention applies to each of these claims, the Company could experience significant losses
related to the Katrina matters which would negatively impact the Companys results of operations.

Significant reductions in the
patient service revenues earned by a hospital may occur if the Company is unable to maintain the certification of the hospital as an LTACH in accordance with Medicare regulations. Additionally, the majority 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 LTACH regulations. The HIH regulations are designed to ensure
that the hospitals are organizationally and functionally independent of their host hospitals. If an LTACH located in a host hospital fails to meet the HIH regulations, it may also lose its status as an LTACH. 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
long-term acute care 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.

The Company believes its providers
are currently in compliance with the Medicare regulations regarding HIHs and LTACHs and are expected to maintain compliance under the current Medicare regulations.

The Company has certain pending and threatened litigation and claims incurred in the ordinary course of business. Management (based, in part, on the
advise of legal counsel) believes that the probable resolution of such contingencies will not exceed the Companys insurance coverage and will not materially affect the consolidated financial position, results of operations, or liquidity of the
Company.



|(8) | Regulatory Updates
|--- | ------------------

Medicare Reimbursement
Changes for Fiscal 2008

On May 1, 2007, CMS issued changes to the Medicare hospital payment system that will become effective for
discharges occurring on or after July 1, 2007. CMS estimates these changes will reduce overall payments to LTAC hospitals by 3.8% within the first year of implementation. These changes include: (a) a 0.71% increase to the standard federal
payment rate from $38,086 to $38,356; (b) revisions to payment methodologies impacting short-stay outliers; (c) adjustments to the wage index component of the federal payment; (d) an extension of the policy known as the 25
Percent Rule, to all LTACH hospitals, including those previously exempted due to a grandfather status, with a three year phase-in, which CMS projects will not result in payment reductions for the first year of implementation but
will result in reductions of 2.4% in the second year of implementation; and (e) an increase in the high-cost outlier fixed-loss threshold amount from $14,887 to $22,954.

The proposed short-stay outlier revisions include the creation of a new payment category for discharged cases having lengths of stay less than or equal to
the geometric mean length of stay for patients with the same diagnosis in short-term acute care hospitals. Payment for these cases would be similar to that received by a short-term acute care hospital for the same diagnosis.

Currently, CMS has regulations governing payment to LTAC hospitals that are co-located with another hospital, such as HIHs. Most co-located hospitals can
admit up to 25% of its patients from its host hospital and be paid according to LTAC PPS. Admissions that exceed the 25 Percent Rule are paid using the short-term hospital payment system. Patients reaching high cost outlier status in the
short-term hospital are not counted when computing the 25% limit. CMS new rule expands this policy to all LTAC hospitals, regardless of whether they are co-located with another hospital or were previously grandfathered from this
provision. Under the new policy, all LTAC hospitals having fiscal years beginning on or after July 1, 2007 will be paid LTAC PPS rates for the lesser of admissions from a single referral source up to 75% or the percentage that the LTAC hospital
discharged from the referring hospital during the 2005 cost reporting year. Admissions beyond the threshold will be paid using the short-term hospital payment system. Patients reaching high cost outlier status in the short-term hospital are not
counted when computing the threshold. Under the new policy, the threshold will be reduced to the lesser of 50% or the percentage that the LTAC hospital discharged from the referring hospital during the 2005 cost reporting year for fiscal years
beginning on or after July 1, 2008, and will be reduced to 25% for fiscal years beginning on or after July 1, 2009.

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



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Proposed CMS Changes to DRG Weighting for Fiscal 2008

On April 13, 2007, the CMS issued a proposed rule to adopt a severity diagnosis related group (DRG) system for the fiscal year 2008, called the
Medicare-Severity DRGs (or MS-DRGs). CMS is proposing to create 745 new DRGs to replace the current 538 DRGs. The proposal will increase payments for some cases while decreasing payments for others. Hospitals treating more severely ill and costlier
patients will receive higher payments. Payments to hospitals for treating less severely ill patients will decline. This rule will be effective for Medicare discharges on or after October 1, 2007. We are not certain what impact any such proposed
changes, if adopted, could have on our operations and financial performance in future periods.



|(9) | Sale-Leaseback Agreement
|--- | ------------------------

On May 2, 2007,
LifeCare REIT 1, Inc. (Tenant), a subsidiary of the Company entered into a Master Lease Agreement (Lease) with Health Care REIT, Inc. and HCRI Texas Properties, LTD (collectively, the Landlord) in connection with
the sale and leaseback of a 62-bed long term acute care hospital being constructed by the Company in San Antonio, Texas (Facility). The Landlord paid an initial acquisition payment of $11.7 million to the Company towards the estimated
total purchase price of $15.7 million for the Facility.

The initial term of the Lease will be 15 years, and the Tenant has one 15-year
renewal option. The initial rent for the Facility under the Lease will be computed based on a predetermined spread over the rate of a 15-year U.S. Treasury Note and will be subject to an annual inflation adjustment. The Lease is an absolute
net lease and contains customary covenants, representations and warranties. The Company and its subsidiary, San Antonio Speciality Hospitals, LTD, entered into an unconditional and continuing Lease Guaranty with the Landlord.



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##### Table of Contents

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
hospitals (LTACHs) in the United States. As of March 31, 2007, we operated 19 hospitals located in nine states, consisting of 11 hospital within a hospital facilities (40.8% of beds) and eight freestanding facilities
(59.2% of beds). Through these 19 long-term acute care hospitals, we operate a total of 922 licensed beds and employ approximately 2,900 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 were 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

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 long-term acute
care hospitals. We anticipate that during 2007 we will contribute to the joint venture, subject to regulatory approvals, our hospitals licenses, Medicare provider numbers and certain remaining equipment from our former New Orleans operations in
exchange for a 49% ownership in the joint venture.

On September 28, 2005, the Louisiana Attorneys Generals office announced that it was
conducting an investigation of 13 nursing homes and six hospitals in the New Orleans area relating to patient deaths that occurred at these facilities during and in the aftermath of Hurricane Katrina. One of these facilities is Memorial Medical
Center within which we operated an 82-bed facility. We have been fully cooperating with this investigation since its inception. On July 18, 2006, the Attorney Generals office presented certain findings related to this investigation that
resulted in the arrest of one physician and two nurses, who were not employees of the Company. At the same time, the Attorney General referred its findings to the New Orleans District Attorney. Neither the Company nor its employees have been named
to date in any illegal or criminal activities under investigation by the Attorney General. On February 14, 2007 the New Orleans District Attorney convened a grand Jury to determine if any of the three individual should be indicted and formally
charged with criminal acts. At this time we cannot determine what, if any, impact this investigation or the Grand Jury proceedings ultimately may have on the Company. If we become a target of the investigation, it could have a material adverse
effect on our business, operating results and financial condition.

The Company is currently defending itself against a variety of Katrina related lawsuits
or matters under review by the Louisiana Patient Compensation Fund. We intend to vigorously defend ourselves in these lawsuits, however, we cannot predict the ultimate resolution of these matters. The Company maintained $15 million of general and
professional liability insurance during this period, subject to a $1 million per claim retention. The Company believes 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 or 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, the Company could experience significant losses related to these Katrina matters which would negatively impact the Companys
results of operations.

Hospital Openings and Closings

During July 2006, we closed a 40-bed hospital within a hospital in Edinburgh, Texas. We opened a 24-bed satellite hospital within a hospital in Shreveport, Louisiana during August 2006 and a 41-bed satellite hospital within a hospital in
Pittsburgh, Pennsylvania during September 2006. We expanded an existing hospital in Shreveport, Louisiana by seven beds in November 2006, and opened a satellite 32-bed freestanding hospital in McAllen, Texas during December 2006. The licensed beds
at the Shreveport locations were transferred internally among total licensed beds in the Shreveport market; therefore, there was no change in total beds as a result of these openings during 2006.



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##### Table of Contents

During the first quarter of 2007, we terminated the lease at the Doctors Hospital campus in Shreveport, Louisiana. Seven
beds were transferred to another location and the 12 beds remaining at this location were closed. Eight beds were added to our Denver, Colorado location during the same period.

The assets formerly located in our Edinburgh hospital and Doctors Hospital campus in Shreveport, Louisiana are being used at other locations or were disposed of.

Regulatory Changes

Approximately 68.9% and 71.3% of our total
net patient service revenue for the three months ended March 31, 2007 and 2006, 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. In recent years, several material changes in reimbursement regulations have been implemented including the 25%
limit on admissions from a host hospital to an HIH, and the re-weighting of LTACH diagnosis related groupings, or DRGs. In addition CMS has issued changes to fiscal 2007 Medicare reimbursement, that may significantly reduce our Medicare
reimbursement. CMS is also considering establishing new patient and facility criteria for long-term acute care hospital providers.

Medicare
Reimbursement Change in Payment Rate for Fiscal 2007

On May 2, 2006 CMS issued the final regulations for the 2007 fiscal year which began on
July 1, 2006 relating to the prospective payment system for LTACHs. The final rules, among other things, (i) changed the payment provisions related to short-stay outliers; (ii) increased the outlier fixed-loss amount from $10,501 to
$14,887; (iii) increased the labor-related share of the prospective payment system federal rate from 72.855% to 75.665%; (iv) eliminated the surgical case exception to the three-day or less interruption of stay policy; and (v)
froze the fiscal 2007 federal rate at the 2006 level.

Prior to the regulations, the payment methodology for short-stay outliers reimbursed long-term
acute care hospital providers at the lowest of (i) 120% of patient cost; (ii) 120% of the per diem amount based on the diagnosis related group; or (iii) the full diagnosis related group payment. The CMS changes to short-stay outliers
reimbursement added a fourth payment alternative, a blended amount based upon (i) the amount that would otherwise be paid under the short-term acute care inpatient: (iv) a blend of an amount comparable to what would otherwise be paid under
the short-term acute care inpatient payment system (IPPS DRG) computed as a per diem and capped at the full IPPS DRG comparable payment amount, and (ii) 120% of the per diem amount based on the DRG for long-term acute care
hospitals. An additional CMS change lowered the reimbursement under the patient cost payment alternative from 120% of patient cost to 100%.

CMS estimated
that exclusive of the freeze of the federal rate for fiscal 2007, these changes resulted in a decrease in Medicare reimbursement of 3.7% for LTACH providers.

CMS Changes to DRG Weighting for Fiscal 2007

On August 1, 2006, CMS issued changes to the Medicare hospital payment system, including
changes to the relative weights and lengths of stay for the diagnosis related groups treated by LTACHs. This final rule was effective for Medicare discharges on or after October 1, 2006. CMS estimated these changes would result in reduced
payments to LTAC providers by 1.3% based on the current reimbursement regulations that were in place. This reduction was in addition to the reduction discussed previously as a result of the fiscal 2007 rule changes. Historically, the actual impact
of regulation changes on our Medicare net patient service revenue has closely approximated CMSs estimates. The actual impact of these reimbursement changes in subsequent periods could be materially different from CMSs estimate.

The final regulations also included (1) changes in the regulations applicable to grandfathered hospitals-within-hospitals and grandfathered satellite
facilities, and (2) changes in the methodology for determining cost-to-charge ratios for LTACHs and the reconciliation of high-cost and short-stay outlier payments under the Medicare payment system for such hospitals.

Medicare Reimbursement Changes for Fiscal 2008

On May 1, 2007,
CMS issued changes to the Medicare hospital payment system that will become effective for discharges occurring on or after July 1, 2007. CMS estimates these changes will reduce overall payments to LTAC hospitals by 3.8% in the first year of
implementation. These changes include: (a) a 0.71% increase to the standard federal payment rate from $38,086 to $38,356; (b) revisions to payment methodologies impacting short-stay outliers; (c) adjustments to the wage index
component of the federal payment; (d) an extension of the policy known as the 25 Percent Rule to all LTACH hospitals, including those previously exempted due to a grandfather status, with a three year phase-in, which CMS
projects will not



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result in payment reductions for the first year of implementation but will result in reductions of 2.4% in the second year of implementation; and (e) an
increase in the high-cost outlier fixed-loss threshold amount from $14,887 to $22,954.

The proposed short-stay outlier revisions include the creation of a
new payment category for discharged cases having lengths of stay less than or equal to the geometric mean length of stay for patients with the same diagnosis in short-term acute care hospitals. Payment for these cases would be similar to that
received by a short-term acute care hospital for the same diagnosis.

Currently, CMS has regulations governing payment to LTAC hospitals that are
co-located with another hospital, such as HIHs. Most co-located hospitals can admit up to 25% of its patients from its host hospital and be paid according to LTAC PPS. Admissions that exceed the 25 Percent Rule are paid using the
short-term hospital payment system. Patients reaching high cost outlier status in the short-term hospital are not counted when computing the 25% limit. CMS new rule expands this policy to all LTAC hospitals, regardless of whether they are
co-located with another hospital or were previously grandfathered from this provision. Under the new policy, all LTAC hospitals having fiscal years beginning on or after July 1, 2007 will be paid LTAC PPS rates for the lesser of
admissions from a single referral source up to 75% or the percentage that the LTAC hospital discharged from the referring hospital during the 2005 cost reporting period. Admissions beyond the threshold will be paid using the short-term hospital
payment system. Patients reaching high cost outlier status in the short-term hospital are not counted when computing the threshold. Under the new policy, the threshold will be reduced to the lesser of 50% or the percentage that the LTAC hospital
discharged from the referring hospital during the 2005 cost reporting period for fiscal years beginning on or after July 1, 2008, and will be reduced to 25% for fiscal years beginning on or after July 1, 2009.

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

We believe that the new policy
will reduce our Medicare reimbursement, which we will attempt to mitigate. There can be no guarantee that such efforts will be successful in mitigating the effect of the rule.

Proposed CMS Changes to DRG Weighting for Fiscal 2008

On April 13, 2007, the CMS issued a proposed rule to
adopt a severity diagnosis related group (DRG) system for the fiscal year 2008, called the Medicare-Severity DRGs (or MS-DRGs). CMS is proposing to create 745 new DRGs to replace the current 538 DRGs. The proposal will increase payments for some
cases while decreasing payments for others. Hospitals treating more severely ill and costlier patients will receive higher payments. Payments to hospitals for treating less severely ill patients will decline. This rule will be effective for Medicare
discharges on or after October 1, 2007. We are not certain what impact any such proposed changes, if adopted, could have on our operations and financial performance in future periods.

CMS Study on Patient and Facility Criteria

Based upon a June 2004
report prepared by MedPAC, it was recommended that CMS study and consider new patient and facility criteria for long-term acute care hospital providers. The contractor commissioned by CMS to conduct aspects of this analysis submitted its report to
CMS in December 2006. At this time we are not certain as to what actions CMS may take as a result of this study nor of the impact any such proposed changes, if adopted, could have on our operations and financial performance in future periods.

Regulatory Matters

As discussed in note 16 to
our December 31, 2006 consolidated financial statements included in our Form 10-K filed with the SEC on April 2, 2007, 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 these matters on June 12, 2006. 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 Transactions 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 that we file an annual report with the OIG regarding certain specified items, including corporate compliance. We believe that the annual incremental costs to comply with the CCA will not be significant
since we currently maintain corporate compliance as described above.



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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 68.9% and 71.3% of total net patient service revenue for the three months ended March 31, 2007 and 2006, 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 LTACH 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.

Total Expenses

Total expenses
consists 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.

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.



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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, 2006 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, impairments may be required.

We are assessing the financial impact that the CMS regulations as issued on
May 1, 2007, 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.

Results of Operations

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



|                                     |  |                                |        |   |                                |   |        |  
|------------------------------------ |  | ------------------------------ | ------ | - | ------------------------------ | - | ------ | -
|                                     |  | Three monthsendedMarch 31,2007 |        |   | Three monthsendedMarch 31,2006 |  
|Net patient service revenue          |  | $                              | 82,369 |   |                                | $ | 87,319 |  
|                                     |  |                                |        |   |                                |   |        |  
|Salaries, wages, and benefits        |  |                                | 37,980 |   |                                |   | 36,068 |  
|Supplies                             |  |                                | 8,397  |   |                                |   | 8,436  |  
|Rent                                 |  |                                | 5,122  |   |                                |   | 4,560  |  
|Other operating expenses             |  |                                | 20,683 |   |                                |   | 20,877 |  
|Provision for doubtful accounts      |  |                                | 1,413  |   |                                |   | 1,515  |  
|Depreciation and amortization        |  |                                | 2,844  |   |                                |   | 2,978  |  
|Interest expense, net                |  |                                | 8,476  |   |                                |   | 7,880  |  
|Gain on early extinguishment of debt |  |                                |       |   |                                |   | (1,329 | )
|                                     |  |                                |        |   |                                |   |        |  
|Total expenses                       |  |                                | 84,915 |   |                                |   | 80,985 |  
|                                     |  |                                |        |   |                                |   |        |  
|Income (loss) before income taxes    |  |                                | (2,546 | ) |                                |   | 6,334  |  
|Provision for income taxes           |  |                                | (851   | ) |                                |   | 2,543  |  
|                                     |  |                                |        |   |                                |   |        |  
|Net income (loss)                    |  | $                              | (1,695 | ) |                                | $ | 3,791  |  
|                                     |  |                                |        |   |                                |   |        |  

Operating Statistics

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



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|                                                                            |  |                                |        |   |                                |   |        |  
|--------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ------------------------------ | - | ------ | -
|                                                                            |  | Three monthsendedMarch 31,2007 |        |   | Three monthsendedMarch 31,2006 |  
|Number of hospitals within hospitals (end of period)                        |  |                                | 11     |   |                                |   | 12     |  
|Number of freestanding hospitals (end of period)                            |  |                                | 8      |   |                                |   | 6      |  
|Number of total hospitals (end of period)                                   |  |                                | 19     |   |                                |   | 18     |  
|Licensed beds (end of period) (1)                                           |  |                                | 922    |   |                                |   | 893    |  
|Average licensed beds (1)                                                   |  |                                | 923    |   |                                |   | 893    |  
|Admissions                                                                  |  |                                | 2,176  |   |                                |   | 2,081  |  
|Patient days                                                                |  |                                | 58,239 |   |                                |   | 57,815 |  
|Occupancy rate                                                              |  |                                | 70.1   | % |                                |   | 71.9   | %
|Percent net patient service revenue from Medicare                           |  |                                | 68.9   | % |                                |   | 71.3   | %
|Percent net patient service revenue from commercial payors and Medicaid (2) |  |                                | 31.1   | % |                                |   | 28.7   | %
|Net patient service revenue per patient day                                 |  | $                              | 1,413  |   |                                | $ | 1,510  |  

---

|(1) | The licensed beds are only calculated on the beds at locations that were open for operations during the applicable period, and exclude beds at locations prior to openings, or
subsequent to closures.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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, 2007 Compared to Three Months Ended March 31, 2006

Overview

During July 2006, we closed a 40-bed hospital within a hospital in Edinburgh, Texas. We opened a
24-bed satellite hospital within a hospital in Shreveport, Louisiana during August 2006 and a 41-bed satellite hospital within a hospital in Pittsburgh, Pennsylvania during September 2006. We expanded an existing hospital in Shreveport, Louisiana by
seven beds in November 2006, and opened a satellite 32-bed freestanding hospital in McAllen, Texas during December 2006. The licensed beds at the Shreveport locations were transferred internally among total licensed beds in the Shreveport market;
therefore, there was no change in total beds in Shreveport.

During the first quarter of 2007, we terminated the lease at the Doctors Hospital campus in
Shreveport, Louisiana. Seven beds were transferred to another location and the 12 beds remaining at this location were closed. Eight beds were added to our Denver location during the same period.

Net Revenues

Our net patient service revenue decreased by
$4.9 million, or 5.7%, for the three months ended March 31, 2007, to $82.4 million from $87.3 million for the comparable period in 2006. Patient days in 2007 were 424 greater, or 0.7% greater, than the same period in 2006. This decrease was
comprised of a favorable benefit of $0.6 million from the increase in patient days offset by an unfavorable variance of $5.6 million as the result of lower rates on a per patient day basis.

During the three months ended March 31, 2007, our net patient service revenue per patient day was $1,413, which represented a decrease of 6.4% compared to the same
period in 2006. The decrease on a per patient day basis was primarily the result of the unfavorable reimbursement changes implemented by CMS for all discharges on or after July 1, 2006 and the unfavorable reduction to DRG weights for all
discharges on or after October 1, 2006, partially offset by an increase in the percentage of our revenues generated from commercial payors and our continued focus on treating higher acuity patients.

Total Expenses

Total expenses increased by $3.9 million to
$84.9 million for the three months ended March 31, 2007 as compared to $81.0 million for the same period in 2006. Exclusive of the gain on early extinguishment of debt of $1.3 million recognized during the three months ended March 31,
2006, expenses increased by $2.6 million from the 2006 period to the 2007 period.

Of this $2.6 million increase in total expenses, approximately $1.9
million was attributable to an increase in salaries, wages, and benefits. The remaining $0.7 million of the total $2.6 million increase was comprised of an increase in rent expense of $0.6 million and an increase of $0.6 million in interest expense,
offset by net decreases in other expense categories. The



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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 due to a higher LIBOR rate for the 2007 period as compared to the 2006 period.

Gain on early extinguishment of debt for the three
months ended March 31, 2006 was the result of our repurchasing $3 million in face of our senior subordinated notes for an amount approximating $1.5 million. Partially offsetting the gain was the write-off of capitalized financing cost of $0.1
million recorded in connection with the retirement of these senior subordinated notes.

Income Tax Expense

For the three months ended March 31, 2007, the income tax benefit recorded is based on actual expected taxes for the quarter as the Company is not able to reasonably
estimate an annual effective rate due to the interaction of the level of profitability and the Texas gross margin tax, which is not based on pre tax net income. Based on recent taxable income trends during the three months ended March 31, 2007,
along with revised projections through December 31, 2007, we now expect a federal and state income tax effective rate of 38.5% exclusive of Texas gross margin tax. The Texas gross margin tax is calculated on gross margin, as defined, and was
approximately $129 for the quarter.

Liquidity and Capital Resources

Our primary sources of liquidity are cash flow generated by operations and availability of borrowings under a revolving credit facility. 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, 2007, our debt structure consisted of $147.0 million
aggregate principal amount of senior subordinated notes, a senior secured credit facility, consisting of (i) a $251.8 million term loan facility with a maturity of seven years, (ii) capital lease obligations of $4.7 million with varying
maturities, and (iii) a $75.0 million revolving credit facility, subject to availability, including sub-facilities for letters of credit and swingline loans, with a maturity of six years. The full amount available under the term loan facility
was used in connection with the Transactions. During the three months ended March 31, 2006 we repurchased $3 million face value of our senior subordinated notes for approximately $1.5 million. Accordingly, we recorded a gain on early
extinguishment of debt of approximately $1.5 million during this period.

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. The Company is currently in compliance with the covenants of the Credit Agreement as amended. The
Companys operating results for the quarter ended March 31, 2007 were not in compliance with the financial covenants as set forth in the original agreement, however, there has been no default under the senior secured credit agreement.

On May 2, 2007, the Company entered into the Amendment No. 1 to the Companys $326.8 million senior secured credit facility
(Amendment No. 1). Amendment No 1 modifies certain financial covenants effective March 31, 2007 and increases the spread on the variable interest rate to be paid by the Company. The senior secured credit facility consists of
(i) a $75 million Revolving Credit Facility and (ii) a $251.8 million Term Loan B Facility. Based upon amounts presently outstanding under the senior credit facility and current interest rates, the Company estimates that Amendment
No. 1 will result in an increase in annual interest expense of approximately $1.9 million.

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) 2.25% for alternate base rate revolving loans, (2) 3.25% for adjusted LIBOR revolving loans, (3) 2.25% for alternate
base rate term loans and (4) 3.25% 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, 2007, the interest rate applicable to the $251.8 million under our term loan facility was 7.60%.

We cannot guarantee that we will be able to continue to satisfy these covenant requirements in the future. If we are unable to maintain compliance with the covenants
contained in our senior secured credit facility, an event of default could occur. In the event of a 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 permitted to be taken by a secured creditor. An event of default could 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, internally generated cash flows and potential availability of borrowings under the
revolving portion of our senior secured credit facilities will be sufficient to finance our operations and meet our debt service requirements for the next twelve months.

On May 2, 2007, LifeCare REIT 1, Inc. (Tenant), a subsidiary of the Company entered into a Master Lease Agreement (Lease) with Health Care REIT, Inc. and HCRI Texas Properties, LTD
(collectively, the Landlord) in connection with the sale and leaseback of a 62-bed long term acute care hospital being constructed by the Company in San Antonio, Texas (Facility). The Landlord paid an initial acquisition
payment of $11.7 million to the Company towards the estimated total purchase price of $15.7 million for the Facility.

The initial term of the Lease will
be 15 years, and the Tenant has one 15-year renewal option. The initial rent for the 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. The Lease is an absolute net lease and contains customary covenants, representations and warranties. The Company and its subsidiary, San Antonio Specialty Hospitals, LTD, entered into an unconditional and continuing Lease
Guaranty with the Landlord.

Capital Expenditures

We
anticipate that we may incur capital expenditures of approximately $29.0 million during the remainder of 2007 based on our current plans. Capital expenditures for our new San Antonio, Texas location will be provided by the Landlord. We anticipate
entering another sale-leaseback agreement to provide for the capital expenditures for our Milwaukee, Wisconsin location. These expenditures will relate market expansion opportunities, investment in information technology enhancements, and facility
maintenance requirements.

Historical Cash Flow

Three Months Ended March 31, 2007 and 2006



|                                                    |  |                                      |         |   |                                      |   |        |  
|--------------------------------------------------- |  | ------------------------------------ | ------- | - | ------------------------------------ | - | ------ | -
|                                                    |  | Three MonthPeriod EndedMarch 31,2007 |         |   | Three MonthPeriod EndedMarch 31,2006 |  
|Net cash provided by (used in) operating activities |  | $                                    | (16,358 | ) |                                      | $ | 24,206 |  
|Net cash used in investing activities               |  |                                      | (7,030  | ) |                                      |   | (2,414 | )
|Net cash used in financing activities               |  |                                      | (1,727  | ) |                                      |   | (3,676 | )

For the three months ended March 31, 2007, operating activities used $16.4 million of cash as compared to
providing $24.2 million in cash for the comparable period in 2006. For the three-months ended March 31, 2007, we had a net loss of $1.7 million as compared to net income of $3.8 million for the same period in 2006. Cash provided from operations
for the three months ended March 31, 2006 included the receipt of $12.4 million related to a refund of 2005 federal income payments. This tax benefit was the result of expenses recorded during the year ended December 31, 2005.
Additionally, during the three months ended March 31, 2006, we received $7.0 million in business interruption proceeds that were recorded as a receivable at December 31, 2005 as a result of the impact of Hurricane Katrina on our New
Orleans operations.

Accounts receivable increased by $6.7 million for the three months ended March 31, 2007 as compared to an increase of $3.4
million for the same period during 2006. Days of net patient service revenue in accounts receivable at March 31, 2007 had increased to 79.4 as compared to 77.1 at December 31, 2006. The increase in accounts receivable, in total and in days
outstanding, during the three months ended March 31, 2007 was principally due to an increase in net patient service revenue during the three months ended March 31, 2007 as compared to the three months ended December 31, 2006, and the continued focus
by the Company during the three months ended March 31, 2007 on the remaining aspects of the conversion to a new patient accounting system that was undertaken during the final quarter of 2006.

Estimated third party payor settlements resulted in a net use of cash of $8.4 million as compared to a net source of cash of $2.3 million for the three months ended
March 31, 2006. The use of cash during the 2007 period was principally due to the repayment to Medicare of amounts received as interim payments during 2006 in excess of revenues ultimately recognized.

A decrease in accounts payable and accrued expense resulted in a net use of cash of $3.9 million for three months
ended March 31, 2007 as compared to use of cash of $2.8 million in the comparable period in 2006. The uses of cash during the three months ended March 31, 2007 and 2006 are primarily attributable to the timing of our semi-annual interest
payments associated with our 91/4% senior subordinated notes.

Cash used in investing activities was $7.0 million for the three months ended March 31, 2007 as compared to $2.4 million in 2006. Of the $7.0 million, $2.0 million
and $2.2 million related to the new facilities in San Antonio, Texas and Milwaukee, Wisconsin, respectively. During the three months ended March 31, 2007 and 2006, we funded all equipment purchases using our available cash on hand.



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Cash used by financing activities for the three months ended March 31, 2007 was $1.7 million as compared to cash
used of $3.7 million for the same period in 2006. Included in the $3.7 million for the 2006 period was $1.5 million that was used to repurchase $3 million in face value of our senior subordinated notes.

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. LTACH 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. As discussed previously,
the final rules issued by CMS for LTACHs for the 2007 fiscal year did not provide for an inflation update, while the 2008 fiscal year rates were increased by 0.71% to $38,356.

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 covenants could be costly or have a material adverse effect on our Company;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | 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;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 adoption by Medicare of new restrictive criteria regarding the types of patients that may be admitted to our facilities or new payment methods for long-term
acute care hospitals may 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;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | implementation of new information systems to comply with federal and state initiatives relating to patient privacy, security of medical information and electronic
transactions may result in increased costs;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | integration of recently acquired operations and future acquisitions may prove difficult or unsuccessful, use significant resources or expose us to unforeseen
liabilities;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | 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 may make us sensitive to economic, regulatory, environmental and other developments in this state;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of legal actions or other claims associated with the Louisiana Attorney Generals investigation or other circumstances arising from Hurricane
Katrina could subject us to substantial liabilities, and;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

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, 2007, we had $251.8 million in senior
term loans outstanding and a borrowing availability of $75 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 4T: 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, 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.

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.



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##### Table of Contents

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/ W. EARL REED, IIIW. Earl Reed, III Chief Executive
Officer


By:

/s/ PHILLIP B. DOUGLASPhillip B. Douglas Chief Financial
Officer


Dated: May 15, 2007



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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.                            



25