Genesis Healthcare, Inc. - Quarter Report: 2007 June (Form 10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2007.

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     .

Skilled Healthcare Group, Inc.

(Exact name of registrant as specified in its charter)

SEE TABLE OF ADDITIONAL REGISTRANTS BELOW

Delaware		20-3934755
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)
27442 Portola Parkway, Suite 200
Foothill Ranch, California		92610
(Address of principal executive offices)		(Zip Code)

(949) 282-5800
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes o No þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o       Accelerated filer o      Non-accelerated filer þ

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the close of business on August 7, 2007.

Class A common stock, $0.001 par value – 19,166,666 shares
Class B common stock, $0.001 par value – 17,730,928 shares

 

 

 

TABLE OF ADDITIONAL REGISTRANTS

 

     The address, including zip code, and telephone number, including area code, of each additional registrant’s principal executive office is 27442 Portola Parkway, Suite 200, Foothill Ranch, California 92610.

     These companies are listed as guarantors of the 11.0% senior subordinated notes of the registrant. All of the equity securities of each of the guarantors set forth in the table above are owned, either directly or indirectly, by the registrant.

Skilled Healthcare Group, Inc.

Form 10-Q
For the Quarterly Period Ended June 30, 2007

Index

				Page
				Number
Part I.		Financial Information			2
Item 1.		Financial Statements			2
		Condensed Consolidated Balance Sheets — June 30, 2007 (unaudited) and December 31, 2006			2
		Condensed Consolidated Statements of Operations — Three months ended June 30, 2007 (unaudited) and June 30, 2006 (unaudited)			3
		Condensed Consolidated Statements of Operations — Six months ended June 30, 2007 (unaudited) and June 30, 2006 (unaudited)			4
		Condensed Consolidated Statements of Cash Flows – Six months ended June 30, 2007 (unaudited) and June 30, 2006 (unaudited)			5
		Notes to Unaudited Condensed Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			34
Item 4.		Controls and Procedures			35
Item 4T.		Controls and Procedures			35
Part II.		Other Information			36
Item 1.		Legal Proceedings			36
Item 1A.		Risk Factors			36
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			54
Item 3.		Defaults Upon Senior Securities			54
Item 4.		Submission of Matters to a Vote of Security Holders			54
Item 5.		Other Information			55
Item 6.		Exhibits			55
Signature.					58
EXHIBIT 2.6
EXHIBIT 3.2
EXHIBIT 10.3
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

Skilled Healthcare Group, Inc.

		June 30,				December 31,
		2007				2006
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	2,333			$	2,821
Accounts receivable, less allowance for doubtful accounts of $8,472 and $7,889 at June 30, 2007 and December 31, 2006, respectively			89,696				86,168
Deferred income taxes, net			14,060				13,248
Prepaid expenses			2,858				2,101
Other current assets			14,527				10,296
Total current assets			123,474				114,634
Property and equipment, net			267,456				230,904
Other assets:
Notes receivable			5,992				4,968
Deferred financing costs, net			12,768				15,764
Goodwill			418,857				411,349
Intangible assets, net			32,565				33,843
Non-current income tax receivable			1,882				1,882
Deferred income taxes, net			1,367				1,504
Other assets			20,431				23,847
Total other assets			493,862				493,157
Total assets		$	884,792			$	838,695
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		$	46,752			$	69,136
Employee compensation and benefits			21,734				22,693
Current portion of long-term debt and capital leases			2,957				3,177
Total current liabilities			71,443				95,006
Long-term liabilities:
Insurance liability risks			26,779				28,306
Other long-term liabilities			20,168				8,857
Long-term debt and capital leases, less current portion			405,591				465,878
Total liabilities			523,981				598,047
Stockholders’ equity:
Preferred stock, 50,000 shares authorized, 25,000 Class A convertible shares and 25,000 Class B shares.			—				—
Class A, $0.001 par value per share; no shares and 22,312 shares issued and outstanding at June 30, 2007 (unaudited) and December 31, 2006, respectively, liquidation preference of $0 and $18,652 at June 30, 2007 (unaudited) and December 31, 2006, respectively			—				18,652
Class B, $0.001 par value per share; no shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively			—				—
Preferred stock, 25,000,000 shares authorized, $0.001 par value per share; no shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively			—				—
Common stock, 25,350,000 shares authorized, $0.001 par value per share; no and 12,636,079 shares issued and outstanding at June 30, 2007 (unaudited) and December 31, 2006, respectively			—				13
Class A common stock, 175,000,000 shares authorized, $0.001 par value per share; 19,166,666 and no shares issued and outstanding at June 30, 2007 (unaudited) and December 31, 2006, respectively			19				—
Class B common stock, 30,000,000 shares authorized, $0.001 par value per share; 17,730,928 and no shares issued and outstanding at June 30, 2007 (unaudited) and December 31, 2006, respectively			18				—
Additional paid-in-capital			364,688				221,983
Retained deficit			(3,914	)			—
Total stockholders’ equity			360,811				240,648
Total liabilities and stockholders’ equity		$	884,792			$	838,695

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

Skilled Healthcare Group, Inc.

		Three Months Ended June 30,
		2007				2006
		(Unaudited)
Revenue		$	151,091			$	131,171
Expenses:
Cost of services (exclusive of rent cost of sales and depreciation and amortization shown below)			113,494				98,430
Rent cost of sales			2,527				2,302
General and administrative			10,403				9,298
Depreciation and amortization			4,239				3,573
			130,663				113,603
Other income (expenses):
Interest expense			(11,926	)			(11,612	)
Premium on redemption of debt and write-off of related deferred financing costs			(11,648	)			—
Interest income and other			684				242
Equity in earnings of joint venture			353				511
Change in fair value of interest rate hedge			—				77
Total other income (expenses), net			(22,537	)			(10,782	)
(Loss) income before (benefit) provision for income taxes			(2,109	)			6,786
(Benefit) provision for income taxes			(556	)			3,071
Net (loss) income			(1,553	)			3,715
Accretion on preferred stock			(2,583	)			(4,540	)
Net loss attributable to common stockholders		$	(4,136	)		$	(825	)
Net loss per share data:
Net loss per common share, basic		$	(0.18	)		$	(0.07	)
Net loss per common share, diluted		$	(0.18	)		$	(0.07	)
Weighted-average common shares outstanding, basic			23,436,598				11,634,129
Weighted-average common shares outstanding, diluted			23,436,598				11,634,129

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

Skilled Healthcare Group, Inc.

		Six Months Ended June 30,
		2007				2006
		(Unaudited)
Revenue		$	295,746			$	256,357
Expenses:
Cost of services (exclusive of rent cost of sales and depreciation and amortization shown below)			220,707				190,741
Rent cost of sales			5,221				4,753
General and administrative			21,900				18,864
Depreciation and amortization			8,200				7,247
			256,028				221,605
Other income (expenses):
Interest expense			(24,018	)			(22,839	)
Premium on redemption of debt and write-off of related deferred financing costs			(11,648	)			—
Interest income and other			1,011				628
Equity in earnings of joint venture			893				892
Change in fair value of interest rate hedge			(33	)			56
Total other income (expenses), net			(33,795	)			(21,263	)
Income before provision for income taxes			5,923				13,489
Provision for income taxes			2,822				5,672
Net income			3,101				7,817
Accretion on preferred stock			(7,354	)			(8,941	)
Net loss attributable to common stockholders		$	(4,253	)		$	(1,124	)
Net loss per share data:
Net loss per common share, basic		$	(0.24	)		$	(0.10	)
Net loss per common share, diluted		$	(0.24	)		$	(0.10	)
Weighted-average common shares outstanding, basic			17,729,314				11,626,271
Weighted-average common shares outstanding, diluted			17,729,314				11,626,271

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

Skilled Healthcare Group, Inc.

		Six Months Ended
		June 30,
		2007				2006
		(Unaudited)
Cash Flows from Operating Activities
Net income		$	3,101			$	7,817
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			8,200				7,247
Loss on disposal of property and equipment			—				251
Provision for doubtful accounts			2,515				2,431
Non-cash stock-based compensation			256				35
Amortization of deferred financing costs			1,421				1,424
Write-off of deferred financing costs and premium on early redemption of debt			11,648				—
Deferred income taxes			(2,220	)			(396	)
Change in fair value of interest rate hedge			33				(56	)
Amortization of discount on senior subordinated notes			82				82
Changes in operating assets and liabilities:
Accounts receivable			(6,043	)			(15,502	)
Other current assets			(3,991	)			1,998
Accounts payable and accrued liabilities			(16,458	)			11,143
Employee compensation and benefits			(928	)			1,437
Insurance liability risks			(1,184	)			2,183
Other long-term liabilities			11,311				131
Net cash provided by operating activities			7,743				20,225
Cash Flows from Investing Activities
(Additions) principal payments on notes receivable, net			(1,024	)			415
Acquisition of healthcare facilities			(36,654	)			(34,016	)
Additions to property and equipment			(12,627	)			(7,962	)
Changes in other assets			3,260				(4,803	)
Cash distributed related to the Onex Transaction			(7,330	)			—
Net cash used in investing activities			(54,375	)			(46,366	)
Cash Flows from Financing Activities
Borrowings under line of credit, net			10,500				—
Repayments on long-term debt and capital leases			(71,469	)			(1,457	)
Premium paid for redemption of debt			(7,700	)			—
Additions to deferred financing costs			(1,993	)			(38	)
Proceeds from initial public offering of common stock, net of expenses			116,806				—
Proceeds from the issuance of new common stock			—				100
Net cash provided by (used in) financing activities			46,144				(1,395	)
Decrease in cash and cash equivalents			(488	)			(27,536	)
Cash and cash equivalents at beginning of period			2,821				37,272
Cash and cash equivalents at end of period		$	2,333			$	9,736

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

Skilled Healthcare Group, Inc.

		Six Months Ended
		June 30,
		2007				2006
		(Unaudited)
Supplemental cash flow information
Cash paid for:
Interest expense		$	26,481			$	10,061
Income taxes		$	10,620			$	—
Details of accumulated other comprehensive loss:
Change in market value of marketable securities, net of tax		$	—			$	225

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

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Description of Business

Current Business

     Skilled Healthcare Group, Inc., through its subsidiaries (collectively the “Company”), is a provider of integrated long-term healthcare services in its skilled nursing facilities and rehabilitation therapy business. The Company also provides other related healthcare services, including assisted living care and hospice care. The Company focuses on providing high-quality care to its patients, and has a strong reputation for treating patients who require a high level of skilled nursing care and extensive rehabilitation therapy, who it refers to as high-acuity patients. As of June 30, 2007, the Company owned or leased 64 skilled nursing facilities (“SNFs”), and 13 assisted living facilities (“ALFs”), together comprising approximately 8,900 licensed beds. The Company currently owns approximately 75% of its facilities, which are located in California, Texas, Kansas, Missouri and Nevada and are generally clustered in large urban or suburban markets. In addition, the Company provides a variety of ancillary services, such as physical, occupational and speech therapy in Company-operated facilities and unaffiliated facilities. Furthermore, the Company owns and operates two licensed hospices providing palliative care in its California and Texas markets. The Company is also a member in a joint venture located in Texas providing institutional pharmacy services which currently serves approximately eight of the Company’s SNFs and other facilities unaffiliated with the Company.

Other Information

     The accompanying condensed consolidated financial statements as of June 30, 2007 and for the three and six- month periods ended June 30, 2007 and 2006 (collectively, the “Interim Financial Statements”), are unaudited. Certain information and footnote disclosures normally included in the Company’s annual consolidated financial statements have been condensed or omitted, as permitted under applicable rules and regulations. Readers of the Interim Financial Statements should refer to the Company’s audited consolidated statements and notes thereto for the year ended December 31, 2006 which are included in the Company’s Registration Statement on Form S-1, File No. 333-137897 (the “Registration Statement”) filed with the Securities and Exchange Commission (the “SEC”). Management believes that the Interim Financial Statements reflect all adjustments which are of a normal and recurring nature necessary to present fairly the Company’s financial position and results of operations in all material respects. The results of operations presented in the Interim Financial Statements are not necessarily representative of operations for the entire year.

Recent Developments

     Effective April 1, 2007, the Company purchased the owned real property, tangible assets, intellectual property and related rights and licenses of three skilled nursing facilities located in Missouri for a cash purchase price of $30.1 million, including $0.1 million of transaction expenses. The Company also assumed certain liabilities under related operating contracts. The transaction added approximately 426 beds, as well as 24 unlicensed apartments, to the Company’s operations. The acquisition was financed by draw downs of $30.1 million on the Company’s revolving credit facility.

     In April 2007, the Company’s board of directors approved the Company’s amended and restated certificate of incorporation to be effective immediately following the Company’s initial public offering (the “IPO”). The amended and restated certificate of incorporation:

	•		authorizes 25,000,000 shares of preferred stock, $0.001 par value;
	•		authorizes 175,000,000 shares of class A common stock, voting power of one vote per share, $0.001 par value;
	•		authorizes 30,000,000 shares of class B common stock, voting power of ten votes per share, $0.001 par value; and

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

•

provides for mandatory and optional conversion of the class B common stock into class A common stock on a one-for-one basis under certain circumstances.

     In April 2007, the Company’s board of directors also approved a 507-for-one split of the Company’s common stock. As a result, share numbers and per share amounts for all periods presented in the condensed consolidated financial statements throughout this Form 10-Q reflect the effects of this stock split.

     In May 2007, in connection with the Company’s IPO, the Company sold 8,333,333 shares of class A common stock and selling stockholders sold 10,833,333 shares of class A common stock, each at the IPO price of $15.50, for net proceeds to the Company of approximately $116.8 million. Concurrently with the closing of the IPO, all previously outstanding shares of class A preferred stock converted into shares of the Company’s new class B common stock.

2. Summary of Significant Accounting Policies

     Information regarding the Company’s significant accounting policies is contained in Note 2, Summary of Significant Accounting Policies, to the Company’s consolidated financial statements included in the Registration Statement. Presented below in this and the following notes is supplemental information that should be read in conjunction with Note 2 to the Company’s consolidated financial statements included in the Registration Statement.

Basis of Presentation

     The condensed consolidated financial statements of the Company include the accounts of the Company and the Company’s wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

Estimates and Assumptions

     The preparation of the condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles, or GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. The most significant estimates in the Company’s condensed consolidated financial statements relate to revenue, allowance for doubtful accounts, the self-insured portion of general and professional liability claims, and impairment of long-lived assets. Actual results could differ from those estimates.

Revenue and Accounts Receivable

     Revenue and accounts receivable are recorded on an accrual basis as services are performed at their estimated net realizable value. The Company derives a significant amount of its revenue from funds under federal Medicare and state Medicaid assistance programs, the continuation of which are dependent upon governmental policies, audit risk and potential recoupment.

     The Company’s revenue is derived from services provided to patients in the following payor classes (dollars in thousands):

		Three Months Ended June 30,
		2007								2006
		(Unaudited)								(Unaudited)
		Revenue				Percentage				Revenue				Percentage
		Dollars				of Revenue				Dollars				of Revenue
Medicare		$	56,134				37.1	%		$	47,903				36.5	%
Medicaid			45,746				30.3				41,348				31.5
Subtotal Medicare and Medicaid			101,880				67.4				89,251				68.0
Managed Care			12,668				8.4				10,543				8.0
Private and Other			36,543				24.2				31,377				24.0
Total		$	151,091				100.0	%		$	131,171				100.0	%

		Six Months Ended June 30,
		2007								2006
		(Unaudited)								(Unaudited)
		Revenue				Percentage				Revenue				Percentage
		Dollars				of Revenue				Dollars				of Revenue
Medicare		$	111,421				37.6	%		$	94,074				36.7	%
Medicaid			88,359				29.9				81,110				31.6
Subtotal Medicare and Medicaid			199,780				67.5				175,184				68.3
Managed Care			24,418				8.3				20,580				8.0
Private and Other			71,548				24.2				60,593				23.7
Total		$	295,746				100.0	%		$	256,357				100.0	%

Stock Options and Equity Related Charges

     On January 1, 2006, the Company adopted Statement of Financial Accounting Standards, or SFAS, No. 123 (revised), Share-Based Payments, or SFAS No. 123R, which requires measurement and recognition of compensation expense for all share-based payment awards made to employees and directors. Under SFAS No. 123R, the fair value of share-based payment awards is estimated at grant date using an option pricing model and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period.

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

     The Company adopted SFAS No. 123R using the modified prospective application method. Under the modified prospective application method, prior periods are not revised for comparative purposes. The valuation provisions of SFAS No. 123R apply to new awards and awards that are outstanding on the adoption effective date that are subsequently modified or cancelled. The Company did not have stock options outstanding subsequent to December 27, 2005 through May 18, 2007, the date of the Company’s IPO. As the Company had no options outstanding during this period, the initial implementation of SFAS No. 123R had no impact on the Company’s financial statements.

     Equity-related charges included in general and administrative expenses in the Company’s consolidated statements of operations were $241,000 and $256,000 in the three- and six-month periods ended June 30, 2007, respectively, and $20,000 and $35,000 in the three and six month periods ended June 30, 2006, respectively.

Net Income (Loss) Per Share of Class A and Class B Common Stock

     The Company computes net (loss) income per share of class A common stock and class B common stock in accordance with SFAS No. 128, Earnings Per Share, using the two-class method. The Company’s class A common stock and class B common stock are identical in all respects, except with respect to voting rights and except that each share of class B common stock is convertible into one share of class A common stock under certain circumstances. Therefore, net (loss) income is allocated on a proportionate basis.

     The following table sets forth the computation of basic and diluted net (loss) income per share of class A common stock and class B common stock for the three- and six-month periods ended June 30, 2007 (dollars in thousands, except per share data):

		Three Months Ended June 30, 2007												Six Months Ended June 30, 2007
		(Unaudited)												(Unaudited)
		Class A				Class B				Total				Class A				Class B				Total
Net loss per share, basic
Numerator:
Allocation of loss attributable to common stockholders		$	(1,598	)		$	(2,538	)		$	(4,136	)		$	(1,092	)		$	(3,161	)		$	(4,253	)
Denominator:
Weighted-average common shares outstanding			9,056,776				14,379,822				23,436,598				4,553,407				13,175,907				17,729,314
Net loss per common share, basic		$	(0.18	)		$	(0.18	)		$	(0.18	)		$	(0.24	)		$	(0.24	)		$	(0.24	)
Net (loss) income per share, diluted
Numerator:
Allocation of loss attributable to common stockholders		$	(1,598	)		$	(2,538	)		$	(4,136	)		$	(1,092	)		$	(3,161	)		$	(4,253	)
Denominator:
Weighted-average common shares outstanding			9,056,776				14,379,822				23,436,598				4,553,407				13,175,907				17,729,314
Plus: incremental shares related to dilutive effect of stock options and restricted stock, if applicable			—				—				—				—				—				—
Adjusted weighted-average common shares outstanding			9,056,776				14,379,822				23,436,598				4,553,407				13,175,907				17,729,314
Net loss per common share, diluted		$	(0.18	)		$	(0.18	)		$	(0.18	)		$	(0.24	)		$	(0.24	)		$	(0.24	)

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

Recent Accounting Pronouncements

     In September 2006, the Financial Standards Accounting Board, or FASB, issued SFAS No. 157, Fair Value Measurements, or SFAS No. 157. SFAS No. 157 addresses differences in the definition of fair value and provides guidance in applying the definition of fair value to the many accounting pronouncements that require fair value measurements. SFAS No. 157 emphasizes that (1) fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing the asset or liability for sale or transfer and (2) fair value is not entity-specific but based on assumptions that market participants would use in pricing the asset or liability. Finally, SFAS No. 157 establishes a hierarchy of fair value assumptions that distinguishes between independent market participant assumptions and the reporting entity’s own assumptions about market participant assumptions. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect that SFAS No. 157 will have a material effect on its consolidated results of operations, financial position or liquidity.

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS No. 159. SFAS No. 159 expands opportunities to use fair value measurement in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has not determined whether it will adopt SFAS No. 159 early or if it will choose to measure any eligible financial assets and liabilities at fair value. Management is still in the process of evaluating the effect, if any, on the Company of adopting SFAS No. 159.

Reclassifications

     Certain prior year amounts have been reclassified to conform to current year presentation.

3. Business Segments

     The Company has two reportable operating segments — long-term care services, which includes the operation of skilled nursing and assisted living facilities and is the most significant portion of the Company’s business, and ancillary services, which includes the Company’s rehabilitation therapy and hospice businesses. The “other” category includes general and administrative items and eliminations. The Company’s reporting segments are business units that offer different services, and that are managed separately due to the nature of the services provided or the products sold.

     At June 30, 2007, long-term care services were provided by 64 SNF subsidiaries that offer sub-acute, rehabilitative and specialty skilled nursing care, as well as 13 ALF subsidiaries that provide room and board and social services. Ancillary services include rehabilitative therapy services such as physical, occupational and speech therapy provided in the Company’s facilities and in unaffiliated facilities by its subsidiary, Hallmark Rehabilitative Services, Inc. Also included in the ancillary services segment is the Company’s hospice business.

     The Company evaluates performance and allocates resources to each segment based on an operating model that is designed to maximize the quality of care provided and profitability. Accordingly, EBITDA is used as the primary measure of each segment’s operating results because it does not include such costs as interest expense, income taxes, and depreciation and amortization which may vary from segment to segment depending upon various factors, including the method used to finance the original purchase of a segment or the tax law of the states in which a segment operates. By excluding these items, the Company is better able to evaluate operating performance of the segment by focusing on more controllable measures. General and administrative overhead is not allocated to any segment for purposes of determining segment profit or loss, and is included in the “other” category in the selected segment financial data that follows. The accounting policies of the reporting segments are the same as those described in the accounting policies (Note 2) included in the Registration Statement. Intersegment sales and transfers are recorded at cost plus standard mark-up; intersegment transactions have been eliminated in consolidation.

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

     The following table sets forth selected financial data by business segment (dollars in thousands):

		Long-term				Ancillary
		Care Services				Services				Other				Total
Three months ended June 30, 2007 (unaudited)
Revenue from external customers		$	131,929			$	19,038			$	124			$	151,091
Intersegment revenue			—				14,892				—				14,892
Total revenue		$	131,929			$	33,930			$	124			$	165,983
Segment capital expenditures		$	5,842			$	139			$	267			$	6,248
EBITDA(1)		$	20,728			$	4,871			$	(12,227	)		$	13,372
Three months ended June 30, 2006 (unaudited)
Revenue from external customers		$	116,291			$	14,786			$	94			$	131,171
Intersegment revenue			—				12,699				—				12,699
Total revenue		$	116,291			$	27,485			$	94			$	143,870
Segment capital expenditures		$	4,508			$	94			$	168			$	4,770
EBITDA(1)		$	16,846			$	4,694			$	189			$	21,729

		Long-term				Ancillary
		Care Services				Services				Other				Total
Six months ended June 30, 2007 (unaudited)
Revenue from external customers		$	257,926			$	37,570			$	250			$	295,746
Intersegment revenue			—				29,360				—				29,360
Total revenue		$	257,926			$	66,930			$	250			$	325,106
Segment total assets (2)		$	532,631			$	71,300			$	280,861			$	884,792
Goodwill and intangibles included in total assets (2)		$	414,876			$	36,546			$	—			$	451,422
Segment capital expenditures		$	14,408			$	361			$	(2,142	)		$	12,627
EBITDA(1)		$	41,406			$	9,960			$	(14,236	)		$	37,130
Six months ended June 30, 2006 (unaudited)
Revenue from external customers		$	227,989			$	28,232			$	136			$	256,357
Intersegment revenue			—				24,533				—				24,533
Total revenue		$	227,989			$	52,765			$	136			$	280,890
Segment total assets (3)		$	682,018			$	117,400			$	33,684			$	833,102
Goodwill and intangibles included in total assets (3)		$	378,949			$	64,123			$	—			$	443,072
Segment capital expenditures		$	7,102			$	213			$	647			$	7,962
EBITDA(1)		$	35,328			$	8,113			$	(494	)		$	42,947

4. Income Taxes

     For the three months ended June 30, 2007 and 2006, the Company recognized an income tax benefit of $0.6 million and income tax expense of $3.1 million, respectively, which was primarily related to the Company’s effective tax rate applied to the Company’s operating (loss) income.

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

     For the six months ended June 30, 2007 and 2006, the Company recognized income tax expense of $2.8 million and $5.7 million, respectively, which primarily was related to the Company’s effective tax rate applied to the Company’s operating income.

     The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109, or FIN No. 48, on January 1, 2007. FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the adoption of FIN No. 48, the Company recorded a $1.5 million increase in goodwill and taxes payable as of January 1, 2007. As of January 1, 2007, the total amount of unrecognized tax benefit was $11.1 million. If reversed, the entire decrease in the unrecognized benefit amount would result in a reduction to the balance of goodwill recorded in connection with the acquisition of the Company by Onex Partners LP, Onex American Holdings II LLC and Onex U.S. Principals LP, collectively referred to as “Onex.”

     The Company recognizes interest and penalties associated with unrecognized tax benefits in the “(Benefit) Provision for income taxes” line item of the condensed consolidated statements of operations. As of January 1, 2007, the Company had accrued approximately $2.7 million in interest and penalties, net of approximately $0.6 million of tax benefit, related to unrecognized tax benefits. A substantial portion of the accrued interest and penalties relate to periods prior to the acquisition of the Company by Onex. If reversed, approximately $2.1 million of the reversal of interest and penalties would result in a reduction to goodwill.

     The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years before 2002. During the first quarter of 2007, the Company agreed to an adjustment related to depreciation claimed on its 2003 federal tax return and is awaiting assessment. As a result, the Company anticipates that there is a reasonable possibility that the amount of unrecognized tax benefits will decrease by $1.8 million due to the settlement of the 2003 federal tax depreciation matters during 2007. In addition, due to normal closures of the statute of limitations, the Company anticipates that there is a reasonable possibility that the amount of unrecognized state tax benefits will decrease by approximately $0.4 million within the next 12 months.

5. Other Current Assets and Other Assets

Other current assets consist of the following at June 30, 2007 and December 31, 2006 (dollars in thousands):

		June 30, 2007				December 31, 2006
		(Unaudited)
Receivable from escrow		$	7,031			$	6,000
Income tax refund receivable			2,512				—
Supply inventories			2,093				2,152
Other notes receivable			2,891				2,144
		$	14,527			$	10,296

     Other assets consist of the following at June 30, 2007 and December 31, 2006 (dollars in thousands):

		June 30, 2007				December 31, 2006
		(Unaudited)
Equity investment in pharmacy joint venture		$	4,113			$	4,170
Restricted cash			7,721				8,448
Investments			3,421				4,856
Deposits and other assets			5,176				4,695
Expenses related to initial public offering			—				1,678
		$	20,431			$	23,847

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

6. Commitments and Contingencies

Litigation

     As is typical in the health care industry, the Company has experienced an increasing trend in the number and severity of litigation claims asserted against it. While the Company believes that it provides quality care to its patients and is in substantial compliance with regulatory requirements, a legal judgment or adverse governmental investigation could have a material negative effect on the Company’s financial position, results of operations or cash flows.

     The Company is involved in various lawsuits and claims arising in the ordinary course of business. These matters are, in the opinion of management, immaterial both individually and in the aggregate with respect to the Company’s condensed consolidated financial position, results of operations and cash flows.

     Under GAAP, the Company establishes an accrual for an estimated loss contingency when it is both probable that an asset has been impaired or that a liability has been incurred and the amount of the loss can be reasonably estimated. Given the uncertain nature of litigation generally, and the uncertainties related to the incurrence, amount and range of loss on any pending litigation, investigation or claim, the Company is currently unable to predict the ultimate outcome of any litigation, investigation or claim, determine whether a liability has been incurred or make a reasonable estimate of the liability that could result from an unfavorable outcome. While the Company believes that the liability, if any, resulting from the aggregate amount of uninsured damages for any outstanding litigation, investigation or claim will not have a material adverse effect on its condensed consolidated financial position, results of operations or cash flows, in view of the uncertainties discussed above, it could incur charges in excess of any currently established accruals and, to the extent available, excess liability insurance. In view of the unpredictable nature of such matters, the Company cannot provide any assurances regarding the outcome of any litigation, investigation or claim to which it is a party or the effect on the Company of an adverse ruling in such matters. As additional information becomes available, the Company will assess its potential liability and revise its estimates.

Insurance

     The Company maintains insurance for general and professional liability, workers’ compensation, employee benefits liability, property, casualty, directors and officers liability, inland marine, crime, boiler and machinery, automobile, employment practices liability and earthquake and flood. The Company believes that its insurance programs are adequate and where there has been a direct transfer of risk to the insurance carrier, the Company does not recognize a liability in the condensed consolidated financial statements.

     Workers’ Compensation. The Company has maintained workers’ compensation insurance as statutorily required. Most of its commercial workers’ compensation insurance purchased is loss sensitive in nature. As a result, the Company is responsible for adverse loss development. Additionally, the Company self-insures the first unaggregated $1.0 million per workers’ compensation claim in both California and Nevada.

     The Company has elected to not carry workers’ compensation insurance in Texas and it may be liable for negligence claims that are asserted against it by its employees.

     The Company has purchased guaranteed cost policies for Kansas and Missouri. There are no deductibles associated with these programs. The Company recognizes a liability in its condensed consolidated financial statements for its estimated self-insured workers’ compensation risks. Historically, estimated liabilities have been sufficient to cover actual claims.

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

     General and Professional Liability. The Company’s skilled nursing services subject it to certain liability risks. Malpractice claims may be asserted against the Company if its services are alleged to have resulted in patient injury or other adverse effects, the risk of which may be greater for higher-acuity patients, such as those receiving specialty and sub-acute services, than for traditional long-term care patients. The Company has from time to time been subject to malpractice claims and other litigation in the ordinary course of business.

     From April 10, 2001 to August 31, 2006, the Company maintained a retrospectively rated claims-made policy with a self-insured retention of $0.3 million for its California and Nevada facilities and $1.0 million for its Texas facilities. This policy had an occurrence and annual aggregate limit of $5.0 million each for professional liability and general liability losses.

     Effective September 1, 2006, the Company obtained professional and general liability insurance with an individual claim limit of $2.0 million per loss and a $6.0 million annual aggregate limit for its California, Texas and Nevada facilities. Under this program, the Company retains an unaggregated $1.0 million self-insured professional and general liability retention per claim.

     The Company’s Kansas facilities are insured on an occurrence basis with an occurrence and aggregate coverage limit of $1.0 million and $3.0 million, respectively, and there are no self-insurance retentions under these contracts. The Company’s Missouri facilities are underwritten on a claims-made basis with no self-insured retention and have an individual claim and aggregate coverage limit of $1.0 million and $3.0 million, respectively.

     In September 2004, the Company purchased a multi-year aggregate excess professional and general liability insurance policy providing an additional $10.0 million of coverage for losses arising from claims in excess of $5.0 million in California, Texas, Nevada, Kansas or Missouri. As of September 1, 2006, this excess coverage was modified to increase the coverage to $12.0 million for losses arising from claims in excess of $3.0 million which are reported after the September 1, 2006 change.

A summary of the liabilities related to insurance risks are as follows (dollars in thousands):

		June 30, 2007												December 31, 2006
		(Unaudited)
		General and												General and
		Professional				Workers’								Professional				Workers’
		Liability				Compensation				Total				Liability				Compensation				Total
Current		$	16,430	(1)		$	3,033	(2)		$	19,463			$	16,056	(1)		$	3,064	(2)		$	19,120
Non current			18,422				8,357				26,779				20,591				7,715				28,306
		$	34,852			$	11,390			$	46,242			$	36,647			$	10,779			$	47,426

Financial Guarantees

     Substantially all of the Company’s subsidiaries guarantee the 11.0% senior subordinated notes maturing on January 15, 2014, the Company’s first lien senior secured term loan and the Company’s revolving credit facility. The guarantees provided by the subsidiaries are full and unconditional and joint and several. Other subsidiaries of the Company that are not guarantors are considered minor.

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

7. Stockholders’ Equity

     In April 2007, the Company’s board of directors approved the Company’s amended and restated certificate of incorporation, which became effective on May 18, 2007. The amended and restated certificate of incorporation:

	•		authorizes 25,000,000 shares of preferred stock, $0.001 par value;
	•		authorizes 175,000,000 shares of class A common stock, voting power of one vote per share, $0.001 par value;
	•		authorizes 30,000,000 shares of class B common stock, voting power of ten votes per share, $0.001 par value; and
	•		provides for mandatory and optional conversion of the class B common stock into class A common stock on a one-for-one basis under certain circumstances.

     In April 2007, the Company’s board of directors also approved a 507-for-one split of the Company’s common stock. As a result, share numbers and per share amounts for all periods presented in the condensed consolidated financial statements throughout this Form 10-Q reflect the effects of this stock split.

     In May 2007, in connection with the Company’s IPO, the Company sold 8,333,333 shares of class A common stock and the selling stockholders sold 10,833,333 shares of class A common stock, each at the IPO price of $15.50, for net proceeds to the Company of approximately $116.8 million. Concurrently with the closing of the IPO, all outstanding shares of class A preferred stock converted into the Company’s new class B common stock.

2007 Incentive Award Plan

     The Company adopted the Skilled Healthcare Group, Inc. 2007 Incentive Award Plan (the “2007 Plan”) in April 2007. Under the 2007 Plan, incentive and nonqualified stock options or rights to purchase common stock and various other equity awards may be granted to eligible participants. The Company granted 134,000 options to purchase shares of class A common stock effective on the date of its IPO in May 2007, with no additional grants made through June 30, 2007.

Determining Fair Value

     Valuation and Amortization Method. The Company estimated the fair value of stock options granted using the Black-Scholes-option-pricing formula and a single option award approach. This fair value is then amortized ratably over the requisite service periods of the awards, which is generally the vesting period.

     Expected Term. The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was estimated based upon the mid-point of the estimated weighted-average vesting term and the contractual term of ten years.

     Expected Volatility. Expected volatility was estimated based upon the implied and historical volatilities of publicly-traded comparable companies over the expected term.

     Expected Dividend. The Black-Scholes valuation model calls for a single expected dividend yield as an input and the Company has no plans to pay dividends.

     Risk-Free Interest Rate. The risk-free interest rate was estimated based upon the spot rates for U.S. treasury strips at the time of the grant for periods corresponding with the expected terms of the options.

     Estimated Forfeitures. The estimated forfeiture rate was based on the Company’s historical turnover in the employee groups for which the options were granted.

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

     The fair value of the stock option grants for each of the three- and six-month periods ended June 30, 2007 under SFAS No. 123R was estimated on the date of the grants using the Black-Scholes option pricing model with the following assumptions:

Risk-free interest rate			4.62	%
Expected life		5.75 years
Dividend yield			0	%
Volatility			32.00	%
Estimated forfeitures			9.00	%
Weighted-average fair value		$	6.09

     There were no options exercised during the three- and six-month periods ended June 30, 2007. The total grant date fair value of stock options vested during each of the three- and six-month periods ended June 30, 2007 was $204,000. As of June 30, 2007, there was $461,000 of unrecognized compensation cost related to outstanding stock options, net of forecasted forfeitures. This amount is expected to be recognized over a weighted-average period of 3.0 years. To the extent the forfeiture rate is different than the Company has anticipated, stock-based compensation related to these awards will be different from the Company’s expectations.

     The following table summarizes stock option activity during the six months ended June 30, 2007 under the 2007 Plan:

										Weighted-
										Average
						Weighted -				Remaining
						Average				Contractual				Aggregate
		Number of				Exercise				Term				Intrinsic
		Shares				Price				(in years)				Value
Outstanding at January 1, 2007			—			$	—
Granted			134,000			$	15.50
Exercised			—			$	—
Forfeited or cancelled			—			$	—
Outstanding at June 30, 2007			134,000			$	15.50				9.83			$	816
Exercisable at June 30, 2007			33,500			$	15.50				9.83			$	204

8. Subsequent Events

      On July 31, 2007, the Company and certain affiliates of Laurel Healthcare Providers, LLC, entered into definitive agreements, pursuant to which the Company will acquire substantially all the assets and assume the operations of several inter-related companies related to ten skilled nursing facilities and a hospice company, all of which are located in or around Albuquerque, New Mexico, for approximately $51.5 million. The acquired facilities will add 1,180 beds to the Company’s operations.

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

     This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding and assessing the trends and significant changes in our results of operations and financial condition. Historical results may not indicate future performance. Our forward-looking statements reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those contemplated by these statements. Factors that may cause differences between actual results and those contemplated by forward-looking statements include, but are not limited to, those discussed in Part II, Item 1A, “Risk Factors,” of this quarterly report. As used in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the words, “we,” “our” and “us” refer to Skilled Healthcare Group, Inc. and its consolidated subsidiaries. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and related notes included in this report.

Business Overview

     We are a provider of integrated long-term healthcare services through our skilled nursing facilities and rehabilitation therapy business. We also provide other related healthcare services, including assisted living care and hospice care. We focus on providing high quality care to our patients, and we have a strong reputation for treating patients who require a high level of skilled nursing care and extensive rehabilitation therapy, whom we refer to as high-acuity patients. As of June 30, 2007, we owned or leased 64 skilled nursing facilities and 13 assisted living facilities, together comprising approximately 8,900 licensed beds. We currently own approximately 75% of our facilities, which are located in California, Texas, Kansas, Missouri and Nevada, and are generally clustered in large urban or suburban markets. For the six months ended June 30, 2007, our skilled nursing facilities, including our integrated rehabilitation therapy services at these facilities, generated approximately 84.5% of our revenue, compared to 85.9% of our revenue for the six months ended June 30, 2006, with the remainder generated by our other related healthcare services.

     We operate our business in two reportable segments: long-term care services, which include the operation of skilled nursing and assisted living facilities and is the most significant portion of our business, and ancillary services, which include our rehabilitation therapy and hospice businesses. The “other” category includes general and administrative items and eliminations.

     On July 31, 2007, the Company and certain affiliates at Laurel Healthcare Providers, LLC, entered into definitive agreements, pursuant to which the Company will acquire substantially all the assets and assume the operations of several inter-related companies related to ten skilled nursing facilities and a hospice company, all of which are located in or around Albuquerque, New Mexico, for approximately $51.5 million. The acquired facilities will add 1,180 beds to the Company’s operations.

Revenue

Revenue by Service Offering

     In our long-term care services segment, we derive the majority of our revenue by providing skilled nursing care and integrated rehabilitation therapy services to residents in our network of skilled nursing facilities. In our ancillary services segment, we derive revenue by providing related healthcare services, including our rehabilitation therapy services provided to third-party facilities and hospice care.

     The following table shows the percentage of our total revenue generated by each of these segments for the periods presented:

		Percentage Total Revenue								Percentage Total Revenue
		Three Months Ended June 30,							Six Months Ended June 30,
		2007				2006				2007				2006
		(Unaudited)								(Unaudited)
Long-term care services segment:
Skilled nursing facilities			84.7	%			85.7	%			84.5	%			85.9	%
Assisted living facilities			2.6				2.9				2.7				3.0
Total long-term care services segment			87.3				88.6				87.2				88.9
Ancillary services segment:
Third-party rehabilitation therapy services			11.4				10.5				11.5				10.3
Hospice			1.2				0.8				1.2				0.7
Total ancillary services segment			12.6				11.3				12.7				11.0
Other:			0.1				0.1				0.1				0.1
Total			100.0	%			100.0	%			100.0	%			100.0	%