Genesis Healthcare, Inc. - Quarter Report: 2008 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, 2008.

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)

Delaware		20-3934755
(State or other jurisdiction of incorporation or organization)		(IRS Employer 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 þ No o

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

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o
				(Do not check if a smaller reporting company)

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 1, 2008.

Class A common stock, $0.001 par value – 19,432,399 shares

Class B common stock, $0.001 par value – 17,632,539 shares

 

 

Skilled Healthcare Group, Inc.

Form 10-Q
For the Quarterly Period Ended June 30, 2008

Index

		Page
		Number
Part I. Financial Information			3
Item 1. Financial Statements			3
Condensed Consolidated Balance Sheets — June 30, 2008 (unaudited) and December 31, 2007			3
Condensed Consolidated Statements of Operations — Three and six months ended June 30, 2008 (unaudited) and June 30, 2007 (unaudited)			4
Condensed Consolidated Statements of Cash Flows — Six months ended June 30, 2008 (unaudited) and June 30, 2007 (unaudited)			5
Notes to Unaudited Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3. Quantitative and Qualitative Disclosures About Market Risk			34
Item 4. 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			36
Item 3. Defaults Upon Senior Securities			36
Item 4. Submission of Matters to a Vote of Security Holders			36
Item 5. Other Information			37
Item 6. Exhibits			37
Signatures			39
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

Skilled Healthcare Group, Inc.

		June 30,				December 31,
		2008				2007
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	3,713			$	5,012
Accounts receivable, less allowance for doubtful accounts of $11,552 and $9,717 at June 30, 2008 and December 31, 2007, respectively			111,215				112,919
Deferred income taxes, current			13,248				14,968
Prepaid expenses			4,113				5,708
Other current assets			13,830				11,697
Total current assets			146,119				150,304
Property and equipment, net			318,971				294,281
Other assets:
Notes receivable			5,205				5,102
Deferred financing costs, net			11,771				11,869
Goodwill			451,711				449,710
Intangible assets, net			31,941				34,092
Non-current income tax receivable			2,288				2,288
Deferred income taxes, non-current			1,153				–
Other assets			23,102				22,461
Total other assets			527,171				525,522
Total assets		$	992,261			$	970,107
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		$	49,265			$	59,218
Employee compensation and benefits			29,056				29,629
Current portion of long-term debt and capital leases			3,188				6,335
Total current liabilities			81,509				95,182
Long-term liabilities:
Insurance liability risks			32,755				24,248
Deferred income tax, non-current			—				2,297
Other long-term liabilities			23,077				21,810
Long-term debt and capital leases, less current portion			462,717				452,101
Total liabilities			600,058				595,638
Stockholders’ equity:
Preferred stock, 25,000 shares authorized, $0.001 par value per share, at June 30, 2008 and December 31, 2007, respectively; no shares issued and outstanding at June 30, 2008 and December 31, 2007, respectively			—				—
Class A common stock, 175,000 shares authorized, $0.001 par value per share; 19,432 and 19,261 issued and outstanding at June 30, 2008 and December 31, 2007, respectively			19				19
Class B common stock, 30,000 shares authorized, $0.001 par value per share; 17,633 and 17,696 issued and outstanding at June 30, 2008 and December 31, 2007, respectively			18				18
Additional paid-in-capital			365,661				365,051
Retained earnings			27,502				10,134
Accumulated other comprehensive loss			(997	)			(753	)
Total stockholders’ equity			392,203				374,469
Total liabilities and stockholders’ equity		$	992,261			$	970,107

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

Skilled Healthcare Group, Inc.

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Revenue		$	180,348			$	151,091			$	361,075			$	295,746
Expenses:
Cost of services (exclusive of rent cost of revenue and depreciation and amortization shown below) below)			142,252				119,522				284,396				233,472
Rent cost of revenue			4,478				2,527				8,962				5,221
General and administrative			5,557				4,375				11,760				9,135
Depreciation and amortization			5,073				4,239				10,233				8,200
			157,360				130,663				315,351				256,028
Other income (expenses):
Interest expense			(9,162	)			(11,926	)			(18,815	)			(24,018	)
Premium on redemption of debt and write-off of related deferred financing costs			—				(11,648	)			—				(11,648	)
Interest income			123				587				337				914
Other income			87				97				309				97
Equity in earnings of joint venture			718				353				1,109				893
Change in fair value of interest rate hedge			—				—				—				(33	)
Total other income (expenses), net			(8,234	)			(22,537	)			(17,060	)			(33,795	)
Income (loss) before provision for income taxes			14,754				(2,109	)			28,664				5,923
Provision for (benefit from) income taxes			5,830				(556	)			11,296				2,822
Net income (loss)			8,924				(1,553	)			17,368				3,101
Accretion on preferred stock			—				(2,583	)			—				(7,354	)
Net income (loss) attributable to common stockholders		$	8,924			$	(4,136	)		$	17,368			$	(4,253	)
Net income (loss) per share data:
Net income (loss) per common share, basic		$	0.24			$	(0.18	)		$	0.48			$	(0.24	)
Net income (loss) per common share, diluted		$	0.24			$	(0.18	)		$	0.47			$	(0.24	)
Weighted-average common shares outstanding, basic			36,558				23,437				36,554				17,729
Weighted-average common shares outstanding, diluted			36,871				23,437				36,877				17,729

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

Skilled Healthcare Group, Inc.

		Six Months Ended
		June 30,
		2008				2007
Cash Flows from Operating Activities
Net income		$	17,368			$	3,101
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			10,233				8,200
Provision for doubtful accounts			3,525				2,515
Non-cash stock-based compensation			610				256
Amortization of deferred financing costs			1,481				1,421
Write-off of deferred financing costs and premium on early redemption of debt			—				11,648
Deferred income taxes			(1,216	)			(2,220	)
Change in fair value of interest rate hedge			—				33
Amortization of discount on senior subordinated notes			54				82
Changes in operating assets and liabilities:
Accounts receivable			(5,110	)			(8,480	)
Other current and non-current assets			911				(3,991	)
Accounts payable and accrued liabilities			(3,246	)			(6,991	)
Employee compensation and benefits			(422	)			(928	)
Insurance liability risks			1,650				(1,184	)
Other long-term liabilities			868				1,844
Net cash provided by operating activities			26,706				5,306
Cash Flows from Investing Activities
Principal payments on (additions to) notes receivable, net			1,157				1,413
Acquisition of healthcare facilities			(13,592	)			(36,654	)
Additions to property and equipment			(21,244	)			(12,627	)
Changes in other assets			(358	)			3,260
Cash distributed related to the Onex Transaction			—				(7,330	)
Net cash used in investing activities			(34,037	)			(51,938	)
Cash Flows from Financing Activities
Borrowings under line of credit, net			12,000				10,500
Repayments on long-term debt and capital leases			(4,585	)			(71,469	)
Fees paid for early extinguishment of debt			—				(7,700	)
Additions to deferred financing costs			(1,383	)			(1,993	)
Proceeds from IPO, net of expenses			—				116,806
Net cash provided by financing activities			6,032				46,144
Decrease in cash and cash equivalents			(1,299	)			(488	)
Cash and cash equivalents at beginning of period			5,012				2,821
Cash and cash equivalents at end of period		$	3,713			$	2,333
Supplemental cash flow information
Cash paid for:
Interest expense, net of capitalized interest		$	18,436			$	26,481
Income taxes		$	12,656			$	10,620
Non-cash financing activities:
Conversion of accounts receivable into notes receivable		$	3,289			$	2,437

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

SKILLED HEALTHCARE GROUP, INC.

1. Description of Business

   Current Business

     Skilled Healthcare Group, Inc. (“Skilled”), through its subsidiaries, is an operator of long-term care facilities and a provider of a wide range of post-acute care services, with a strategic emphasis on sub-acute specialty medical care. Skilled and its consolidated subsidiaries are collectively referred to as the “Company.” The Company currently operates facilities in California, Kansas, Missouri, Nevada, New Mexico and Texas, including 75 skilled nursing facilities (“SNFs”), which offer sub-acute care and rehabilitative and specialty medical skilled nursing care and 14 assisted living facilities (“ALFs”), which provide room and board and social services. 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 three licensed hospices that provide hospice care in its California and New Mexico markets. The Company is also a member in a joint venture located in Texas that provides institutional pharmacy services, which currently serves approximately eight of the Company’s SNFs and other facilities unaffiliated with the Company.

   Seasonality

     The Company’s business experiences slight seasonality as a result of variation in average daily census levels, with historically the highest average daily census in the first quarter of the year and the lowest average daily census in the third quarter of the year. In addition, revenue has typically increased in the fourth quarter of a year on a sequential basis due to annual increases in Medicare and Medicaid rates that typically have been fully implemented during that quarter.

   Recent Developments

          On April 1, 2008, the Company acquired the real property and assets of a 152-bed SNF and an adjacent 34-unit ALF located in Wichita, Kansas, for approximately $13.2 million.

2. Summary of Significant Accounting Policies

   Other Information

     The accompanying condensed consolidated financial statements as of June 30, 2008 and for the three- and six-month periods ended June 30, 2008 and 2007 (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, 2007, which are included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”). Management believes that the Interim Financial Statements reflect all adjustments that are of a normal and recurring nature necessary to fairly present the Company’s financial position and results of operations and cash flows in all material respects. The results of operations presented in the Interim Financial Statements are not necessarily representative of operations for the entire year.

     The accompanying Interim 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.

   Estimates and Assumptions

     The preparation of the Interim Financial Statements in conformity with U.S. generally accepted accounting principles (“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

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Company’s condensed Interim Financial Statements relate to revenue, allowance for doubtful accounts, the self-insured portion of general and professional liability and workers’ compensation claims, income taxes and impairment of long-lived assets. Actual results could differ from those estimates.

     Information regarding the Company’s significant accounting policies is contained in “Summary of Significant Accounting Policies” in Note 2 in the Company’s 2007 Annual Report on Form 10-K filed with the SEC.

   Reclassifications

     Certain prior year amounts have been reclassified to conform to current year presentation, including general and administrative expense and cost of services, as well as revenue, intercompany rent and total assets by segment. Prior to 2008, the Company reported revenue generated from services provided to a third-party-owned SNF in other revenue. Services for such SNF are performed by personnel in the Company’s Long-Term Care (“LTC”) segment. Accordingly, $0.1 million and $0.3 million of revenue have been more appropriately reclassified as LTC segment revenue in the three- and six- month period ended June 30, 2007, respectively. Indirect overhead of $6.0 million and $12.8 million related to ancillary and LTC personnel that was previously reported as a general and administrative expense has been more appropriately classified as cost of services in the three- and six-month periods ended June 30, 2007, respectively. Intercompany rent of $7.1 and $13.3 million that was previously charged to long-term care services has been eliminated in the three- and six-month periods ended June 30, 2007, respectively, for segment reporting purposes. The book value of assets in the amount of $263.5 million as of December 31, 2007 used in the operations of LTC has been reclassified to that segment. In order to reflect the conversion of trade accounts receivable to notes receivable, $2.4 million was reclassified between cash flows from operating and investing activities in the statement of cash flows.

   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 health insurance programs, the continuation of which are dependent upon governmental policies, and are subject to audit risk and potential recoupment.

   Goodwill and Intangible Assets

     Goodwill is accounted for under Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations (“SFAS 141”), and represents the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), goodwill is subject to periodic testing for impairment. Goodwill of a reporting unit is tested for impairment on an annual basis, or, if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount, between annual testing.

   Recent Accounting Pronouncements

     Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS 157”). In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which provides a one-year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except for those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of SFAS 157 only with respect to financial assets and liabilities, as well as any other assets and liabilities carried at fair value. SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes how to measure fair value

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

based on a three-level hierarchy of inputs, of which the first two are considered observable and the last unobservable.

	•		Level 1 — Quoted prices in active markets for identical assets or liabilities.
	•		Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
	•		Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

     The adoption of this statement did not have a material impact on the Company’s consolidated results of operations or financial condition (see Note 10).

     Effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect to adopt the fair value option on any assets or liabilities not previously carried at fair value under SFAS 159.

     In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations the Company engages in will be recorded and disclosed following existing GAAP until January 1, 2009. The Company expects SFAS 141R will have an impact on its consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions consummated by the Company.

     In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (“SFAS 160”), which establishes accounting and reporting standards to improve the relevance, comparability, and transparency of financial information in a company’s consolidated financial statements. SFAS 160 requires all entities, except not-for-profit organizations, that prepare consolidated financial statements to (a) clearly identify, label, and present ownership interests in subsidiaries held by parties other than the parent in the consolidated statement of financial position within equity, but separate from the parent’s equity; (b) clearly identify and present both the parent’s and the noncontrolling interest’s attributable consolidated net income on the face of the consolidated statement of income; (c) consistently account for changes in the parent’s ownership interest while the parent retains its controlling financial interest in a subsidiary and for all transactions that are economically similar to be accounted for similarly; (d) measure any gain, loss or retained noncontrolling equity at fair value after a subsidiary is deconsolidated; and (e) provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 also clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in a company’s interim financial statements. SFAS 160 is effective for fiscal years and interim periods on or after December 15, 2008. The Company is currently evaluating the impact, if any, that SFAS 160 may have on its consolidated financial statements.

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

     The Company computes net 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

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

each share of class B common stock is convertible into one share of class A common stock under certain circumstances. Therefore, net income is allocated on a proportionate basis.

     Basic net income (loss) per share was computed by dividing net income (loss) attributable to common stockholders by the weighted average number of outstanding shares for the period. Dilutive net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders plus the effect of assumed conversions (if applicable) by the weighted average number of outstanding shares after giving effect to all potential dilutive common stock, including options, warrants, common stock subject to repurchase and convertible preferred stock, if any.

     The following table sets forth the computation of basic and diluted net income (loss) per share of class A common stock and class B common stock for the three- and six-month periods ended June 30, 2008 (amounts in thousands, except per share data):

		Three Months Ended June 30, 2008												Six Months Ended June 30, 2008
		Class A				Class B				Total				Class A				Class B				Total
Net income per share, basic
Numerator:
Allocation of income attributable to common stockholders		$	4,688			$	4,236			$	8,924			$	9,123			$	8,245			$	17,368
Denominator:
Weighted-average common shares outstanding			19,203				17,355				36,558				19,201				17,353				36,554
Net income per common share, basic		$	0.24			$	0.24			$	0.24			$	0.48			$	0.48			$	0.48
Net income per share, diluted
Numerator:
Allocation of income attributable to common stockholders		$	4,657			$	4,267			$	8,924			$	9,063			$	8,305			$	17,368
Denominator:
Weighted-average common shares outstanding			19,203				17,355				36,558				19,201				17,353				36,554
Plus: incremental shares related to dilutive effect of stock options and restricted stock, if applicable			38				275				313				42				281				323
Adjusted weighted-average common shares outstanding			19,241				17,630				36,871				19,243				17,634				36,877
Net income per common share, diluted		$	0.24			$	0.24			$	0.24			$	0.47			$	0.47			$	0.47

4. 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, 2008, long-term care services were provided by 75 SNF subsidiaries that offer post-acute, rehabilitative and specialty skilled nursing care, as well as 14 ALF subsidiaries that provide room and board and assistive 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 subsidiaries, Hallmark

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Rehabilitation GP, LLC and Hallmark Rehabilitation, LP. 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, earnings before net interest, tax, depreciation and amortization (“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, 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 (see Note 2 above) included in the Company’s 2007 Annual Report on Form 10-K filed with the SEC. Intersegment sales and transfers are recorded at cost plus standard mark-up; intersegment transactions have been eliminated in consolidation.

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

		Long-term				Ancillary
		Care Services				Services				Other				Elimination				Total
Three months ended June 30, 2008
Revenue from external customers		$	158,952			$	21,388			$	8			$	—			$	180,348
Intersegment revenue			990				16,516				—				(17,506	)			—
Total revenue		$	159,942			$	37,904			$	8				(17,506	)		$	180,348
Segment capital expenditures		$	12,528			$	611			$	(828	)		$	—			$	12,311
EBITDA(1)		$	28,884			$	4,888			$	(4,906	)		$	—			$	28,866
Three months ended June 30, 2007
Revenue from external customers		$	132,053			$	19,038			$	—			$	—			$	151,091
Intersegment revenue			—				14,892				—				(14,892	)			—
Total revenue		$	132,053			$	33,390			$	—				(14,892	)		$	151,091
Segment capital expenditures		$	5,842			$	139			$	267			$	—			$	6,248
EBITDA(1)		$	24,492			$	4,829			$	(15,852	)		$	—			$	13,469

		Long-term				Ancillary
		Care Services				Services				Other				Elimination				Total
Six months ended June 30, 2008
Revenue from external customers		$	317,769			$	43,298			$	8			$	—			$	361,075
Intersegment revenue			1,798				33,124				—				(34,922	)			—
Total revenue		$	319,567			$	76,422			$	8				(34,922	)		$	361,075
Segment capital expenditures		$	19,774			$	795			$	675			$	—			$	21,244
EBITDA(1)		$	56,564			$	11,310			$	(10,499	)		$	—			$	57,375
Six months ended June 30, 2007
Revenue from external customers		$	258,176			$	37,570			$	—			$	—			$	295,746
Intersegment revenue			—				29,360				—				(29,360	)			—
Total revenue		$	258,176			$	66,930			$	—				(29,360	)		$	295,746
Segment capital expenditures		$	14,408			$	361			$	(2,142	)		$	—			$	12,627
EBITDA(1)		$	47,611			$	9,801			$	(20,185	)		$	—			$	37,227

     The following table presents the segment assets as of June 30, 2008 compared to December 31, 2007 (dollars in thousands):

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

		Long-term				Ancillary
		Care Services				Services				Other				Total
June 30, 2008:
Segment total assets		$	877,935			$	76,362			$	37,964			$	992,261
Goodwill and intangibles included in total assets		$	447,338			$	36,314			$	—			$	483,652
December 31, 2007:
Segment total assets		$	863,698			$	71,695			$	34,714			$	970,107
Goodwill and intangibles included in total assets		$	447,304			$	36,498			$	—			$	483,802

5. Income Taxes

     For the three months ended June 30, 2008 and 2007, the Company recognized income tax expense of $5.8 million and an income tax benefit of $0.6 million, respectively, which was primarily related to the Company’s effective tax rate applied to the Company’s operating income (loss).

     For the six months ended June 30, 2008 and 2007, the Company recognized income tax expense of $11.3 million and $2.8 million, respectively, which was primarily related to the Company’s effective tax rate applied to the Company’s operating income.

     The Company is subject to taxation in the United States and in various state jurisdictions. The Company’s tax years 2003 and forward are subject to examination by the US Internal Revenue Service and from 2003 forward by the Company’s material state jurisdictions.

6. Other Current Assets and Other Assets

     Other current assets consist of the following at June 30, 2008 and December 31, 2007 (dollars in thousands):

		June 30, 2008				December 31, 2007
Receivable from escrow		$	7,031			$	7,031
Current portion of notes receivable			4,085				2,056
Supply inventories			2,621				2,533
Other current assets			93				77
		$	13,830			$	11,697

     Other assets consist of the following at June 30, 2008 and December 31, 2007 (dollars in thousands):

		June 30, 2008				December 31, 2007
Equity investment in joint ventures		$	4,917			$	4,183
Restricted cash			11,450				10,697
Investments			1,883				2,666
Deposits and other assets			4,852				4,915
		$	23,102			$	22,461

7. Other Long-Term Liabilities

     Other long-term liabilities consist of the following at June 30, 2008 and December 31, 2007 (dollars in thousands):

		June 30, 2008				December 31, 2007
Deferred rent		$	4,279			$	3,569
Other long-term tax liability			11,827				11,761
Asbestos abatement liability			5,343				5,252
Interest rate swap fair value			1,628				1,228
		$	23,077			$	21,810

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

8. 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.

     On May 4, 2006, three plaintiffs filed a complaint against the Company in the Superior Court of California, Humboldt County, entitled Bates v. Skilled Healthcare Group, Inc. and twenty-three of its subsidiaries. In the complaint, the plaintiffs allege that certain California-based facilities operated by the Company’s subsidiaries failed to provide an adequate number of qualified personnel to care for its residents and misrepresented the quality of care provided in its facilities. Plaintiffs allege these failures violated the residents’ rights, the California Business and Professions Code and the Consumer Legal Remedies Act. Plaintiffs seek restitution of money paid for services allegedly promised to, but not received by, facility residents during the period from September 1, 2003 to the present. The complaint further sought class certification of in excess of 18,000 plaintiffs as well as injunctive relief, punitive damages and attorneys fees.

     In response to the complaint, the Company filed a demurrer. On November 28, 2006, the Humboldt Court denied the demurrer. On January 31, 2008, the Humboldt Court denied the Company’s motion for a protective order as to the names and addresses of residents within the facility and on April 7, 2008, the Humboldt Court granted plaintiffs’ motion to compel electronic discovery by the Company. On May 27, 2008, plaintiffs’ motion for class certification was heard. On June 12, 2008, the Company received an order granting plaintiffs’ motion for class certification. The Comapny intends to seek a writ and reversal by the California Court of Appeal, First Appellate District, of the order granting class certification. Primary professional liability insurance coverage has been exhausted for the policy year applicable to this case. The excess insurance carrier issuing the policy applicable to this case has recently issued its reservation of rights to preserve an assertion of non-coverage for this case. Given the uncertainty of the pleadings and facts at this juncture in the litigation, an assessment of potential exposure is uncertain at this time.

     In addition to the above, the Company is involved in various other 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

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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 its Condensed Consolidated Financial Statements.

     Workers’ Compensation. The Company has maintained workers’ compensation insurance where 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 each workers’ compensation claim in California, Nevada and New Mexico.

     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.

     General and Professional Liability. The Company’s skilled nursing and assisted living 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.

     The Company has a professional and general liability claims-made-based insurance policy with an individual claim limit of $2.0 million per loss and a $6.0 million annual aggregate limit for its California, Texas, New Mexico 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 annual 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 annual 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 $10.0 million of coverage for losses arising from claims in excess of $5.0 million in California, Texas and Nevada. Kansas and Missouri were added to this policy at the time the Company initially acquired facilities in those states in 2005 and 2006, respectively. 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. The New Mexico facilities are also covered under this policy.

     Employee Medical Insurance. Medical preferred provider option programs are offered as a component of our employee benefits. We retain a self-insured amount up to a contractual stop loss amount and we estimate our self-insured medical reserve on a quarterly basis, based upon actuarial analyses provided by external actuaries using the most recent trends of medical claims. Based upon these analyses, at June 30, 2008, we had reserved $1.5 million for incurred but not paid medical claims.

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

		June 30, 2008																December 31, 2007
		General and																General and
		Professional				Employee				Workers’								Professional				Employee				Workers’
		Liability				Medical				Compensation				Total				Liability				Medical				Compensation				Total
Current		$	9,203	(1)		$	1,529	(2)		$	3,395	(2)		$	14,127			$	15,909	(1)		$	1,070	(2)		$	3,546	(2)		$	20,525
Non-current			22,174				—				10,581				32,755				15,230				—				9,018				24,248
		$	31,377			$	1,529			$	13,976			$	46,882			$	31,139			$	1,070			$	12,564			$	44,773

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

   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. The company has no independent assets or operations.

9. Stockholders’ Equity

   Comprehensive Income

     Comprehensive income consists of two components, net income and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains, and losses that, under GAAP, are recorded as an element of stockholders’ equity but are excluded from net income. The Company’s other comprehensive income consists of net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges. Other comprehensive loss related to derivatives held by the Company for the three-month period ended June 30, 2008 was $1.2 million, net of a tax benefit of $0.7 million. Other comprehensive income related to derivates held by the Company for the six-month period ended June 30, 2008 was $0.2 million, net of taxes of $0.2 million. There was no other comprehensive income for the three- and six- month periods ended June 30, 2007.

   2007 Stock Incentive Plan

     On May 8, 2008, the stockholders of the Company approved the Company’s Amended and Restated Skilled Healthcare Group, Inc. 2007 Incentive Award Plan, increasing the number of shares of the Company’s class A common stock that may be issued under the 2007 Incentive Award Plan by 1,500,000 shares to a total of 2,623,181 shares. The Amended and Restated Plan became effective immediately upon stockholder approval.

     The fair value of the stock option grants for the six-month period ended June 30, 2008 under SFAS No. 123 (Revised 2004), Share-Based Payments (“SFAS 123R”) was estimated on the date of the grants using the Black-Scholes option pricing model with the following assumptions:

Risk-free interest rate			3.20	%
Expected life		6.25 years
Dividend yield			0	%
Volatility			40.80	%
Weighted-average fair value		$	5.76

     There were 4,000 and 129,000 new stock options granted in the three- and six- month periods ended June 30, 2008, respectively.

     There were no options exercised during the three- and six-month periods ended June 30, 2008. The total grant date fair value of stock options vested during each of the three- and six-month periods ended June 30, 2008 was $0.2 million. As of June 30, 2008, there was $1.1 million 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 3.1 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.

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

     The following table summarizes stock option activity during the six months ended June 30, 2008 under the 2007 Plan:

										Weighted-
										Average
						Weighted -				Remaining				Aggregate
						Average				Contractual				Intrinsic
		Number of				Exercise				Term				Value
		Shares				Price				(in years)				(in thousands)
Outstanding at January 1, 2008			169,000			$	15.42
Granted			129,000			$	12.78
Exercised			—			$	—
Forfeited or cancelled			(3,000	)		$	15.50
Outstanding at June 30, 2008			295,000			$	14.26				9.23			$	85
Exercisable at June 30, 2008			66,000			$	15.50				8.74			$	—

     Aggregate intrinsic value represents the value of the Company’s closing stock price on the last trading day of the fiscal period in excess of the exercise price, multiplied by the number of options outstanding or exercisable.

     Equity-related charges related to stock option grants and stock awards included in general and administrative expenses in the Company’s consolidated financial statements of operations were $0.3 million and $0.6 million in the three- and six-month periods ended June 30, 2008, respectively.

10. Fair Value Measurements

     For a discussion of recent accounting pronouncements regarding Fair Value Measures, please see “Summary of Significant Accounting Policies” in Note 2 of this report.

     As of June 30, 2008, the Company held an interest rate swap that is required to be measured at fair value on a recurring basis. The fair value of the interest rate swap contract is determined by calculating the value of the discounted cash flows of the difference between the fixed interest rate of the interest rate swap and the counterparty’s forward LIBOR curve, which is the input used in the valuation. The forward LIBOR curve is readily available in public markets or can be derived from information available in publicly quoted markets. Therefore, the Company has categorized the interest rate swap as Level 2. The Company obtained the counterparty’s calculation of the valuation of the interest rate swap as well as a forward LIBOR curve from another investment bank and recalculated the valuation of the interest rate swap without a material difference.

     The following table summarizes the valuation of the Company’s interest rate swap as of June 30, 2008 by the SFAS 157 fair value hierarchy levels detailed in Note 2 of this report (dollars in thousands):

		Level 1		Level 2				Level 3		Total
Interest rate swap		$ —		$	(1,628	)		$ —		$	(1,628	)

     In the three- and six- month periods ended June 30, 2008, there was $1.2 million of unrealized loss, net of a tax a benefit, and $0.2 million of unrealized gain, net of income tax, respectively, on the interest rate swap recognized in other comprehensive income.

11. Debt

     On March 31, 2008, the Company exercised its rights to increase revolving loan commitments of certain lenders under its existing second amended and restated first lien credit agreement, as amended (the “Credit Agreement”), by an aggregate amount of $35.0 million, effected pursuant to an Acknowledgement of Increasing Lenders. Following this increase, the total revolving loan commitments under the Credit Agreement equal $135.0 million in the aggregate. The revolving loan is due in full on June 15, 2010. The revolving loan bears interest, at the Company’s election, either at the prime rate plus an initial margin of 1.75% or the LIBOR plus an initial margin of 2.75%.

SKILLED HEALTHCARE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

     The Company’s long-term debt is summarized as follows (dollars in thousands):

		June 30,				December 31,
		2008				2007
Revolving Credit Facility, swing line subfacility, interest rate based on prime plus 1.75% (6.75% at June 30, 2008) collateralized by real property, due 2010		$	8,000			$	8,000
Revolving Credit Facility, interest rate based on LIBOR plus 2.75% (5.34% at June 30, 2008) collateralized by real property, due 2010			72,000				60,000
Term Loan, interest rate based on LIBOR plus 2.00% (4.89% at June 30, 2008) collateralized by real property, due 2012			252,200				253,500
2014 Notes, interest rate 11.0%, with an original issue discount of $598 and $652 at June 30, 2008 and December 31, 2007, respectively, interest payable semiannually, principal due 2014, unsecured			129,402				129,348
Notes payable, fixed interest rate 6.5%, payable in monthly installments, collateralized by a first priority deed of trust, due November 2014			1,783				1,893
Other			330				2,310
Present value of capital lease obligations at effective interest rates, collateralized by property and equipment			2,190				3,385
Total long-term debt and capital leases			465,905				458,436
Less amounts due within one year			(3,188	)			(6,335	)
Long-term debt and capital leases, net of current portion		$	462,717			$	452,101

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, which 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 our Form 10-K for the year ended December 31, 2007. 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 condensed consolidated financial statements and related notes included in this report.

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

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 focus on 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, 2008, we owned or leased 75 skilled nursing facilities and 14 assisted living facilities, together comprising approximately 10,300 licensed beds. Our facilities, approximately 71% of which we own, are located in California, Texas, Kansas, Missouri, Nevada and New Mexico, and are generally clustered in large urban or suburban markets. For the six months ended June 30, 2008, we generated approximately 85.5% of our revenue from our skilled nursing facilities, including our integrated rehabilitation therapy services at these facilities. The remainder of our revenue is generated by our other related healthcare services. Those services consist of our assisted living facilities, rehabilitation therapy services provided to third-party facilities, and hospice care.

Revenue

   Revenue by Service Offering

     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.

     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. The remainder of our long-term care segment revenue is generated by our assisted living 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 revenue and percentage of our total revenue generated by each of these segments for the periods presented (dollars in thousands):

		Three Months Ended June 30,
		2008								2007
		Revenue				Revenue				Revenue				Revenue
		Dollars				Percentage				Dollars				Percentage
Long-term care services:
Skilled nursing facilities		$	154,220				85.5	%		$	127,761				84.6	%
Assisted living facilities			4,732				2.6				4,292				2.8
Total long-term care services			158,952				88.1				132,053				87.4
Ancillary services :

		Three Months Ended June 30,
		2008								2007
		Revenue				Revenue				Revenue				Revenue
		Dollars				Percentage				Dollars				Percentage
Third-party rehabilitation therapy services			16,820				9.3				17,280				11.4
Hospice			4,568				2.6				1,758				1.2
Total ancillary services			21,388				11.9				19,038				12.6
Other			8				—				—				—
Total		$	180,348				100.0	%		$	151,091				100.0	%

		Six Months Ended June 30,
		2008								2007
		Revenue				Revenue				Revenue				Revenue
		Dollars				Percentage				Dollars				Percentage
Long-term care services:
Skilled nursing facilities		$	308,503				85.4	%		$	249,796				84.5	%
Assisted living facilities			9,266				2.6				8,380				2.8
Total long-term care services			317,769				88.0				258,176				87.3
Ancillary services :
Third-party rehabilitation therapy services			34,300				9.5				34,166				11.5
Hospice			8,998				2.5				3,404				1.2
Total ancillary services			43,298				12.0				37,570				12.7
Other			8				—				—				—
Total		$	361,075				100.0	%		$	295,746				100.0	%

   Sources of Revenue

   Long-Term Care Services Segment

     Skilled Nursing Facilities. Within our skilled nursing facilities, we generate our revenue from Medicare, Medicaid, managed care providers, insurers, private pay and other sources. We believe that our skilled mix, which we define as the number of Medicare and managed care patient days at our skilled nursing facilities divided by the total number of patient days at our skilled nursing facilities for any given period, is an important indicator of our success in attracting high-acuity patients because it represents the percentage of our patients who are reimbursed by Medicare and managed care payors, for whom we receive higher reimbursement rates. Medicare and managed care payors typically do not provide reimbursement for custodial care, which is a basic level of healthcare.

     The following table sets forth our Medicare, managed care, private pay/other and Medicaid patient days for our skilled nursing facilities as a percentage of total patient days for our skilled nursing facilities and the level of skilled mix for our skilled nursing facilities:

		Three Months Ended June 30,								Six Months Ended June 30,
		2008				2007				2008				2007
Medicare			17.6	%			18.7	%			18.0				19.1	%
Managed care			7.0				6.0				7.2				5.9
Skilled mix			24.6				24.7				25.2				25.0
Private and other			17.7				16.4				17.2				16.3
Medicaid			57.7				58.9				57.6				58.7
Total			100.0	%			100.0	%			100.0	%			100.0	%

     Skilled mix in the first six months of 2008 was consistent with the same period in the prior year as we continue to focus on high-acuity residents and expand our Express Recovery™ Unit facilities. Skilled mix of 24.6% in the second quarter of 2008 reflected a decline from 25.7% in the first quarter of 2008, which is consistent with prior-year trends based on seasonality. We expect this downward trend to continue into the third quarter and to rebound in the fourth quarter.

     The following table sets forth revenue by state and revenue by state as a percentage of total long-term care revenue for the periods (dollars in thousands):

		Three Months Ended June 30,
		2008								2007
		Revenue				Percentage of				Revenue				Percentage of
		Dollars				Revenue				Dollars				Revenue
California		$	65,787				41.4	%		$	63,615				48.2	%
Kansas			12,471				7.9				9,198				7.0
Missouri			14,033				8.8				12,953				9.8
Nevada			7,488				4.7				6,230				4.7
New Mexico			17,057				10.7				—				—
Texas			42,116				26.5				40,057				30.3
Total		$	158,952				100.0	%		$	132,053				100.0	%

		Six Months Ended June 30,
		2008								2007
		Revenue				Percentage of				Revenue				Percentage of
		Dollars				Revenue				Dollars				Revenue
California		$	132,293				41.6	%		$	126,200				48.9	%
Kansas			22,949				7.2				18,393				7.1
Missouri			28,386				8.9				21,055				8.2
Nevada			14,907				4.7				12,374				4.8
New Mexico			34,426				10.8				—				—
Texas			84,808				26.8				80,154				31.0
Total		$	317,769				100.0	%		$	258,176				100.0	%

     Assisted Living Facilities. Within our assisted living facilities, we generate our revenue primarily from private pay sources, with a small portion earned from Medicaid or other state specific programs.

 Ancillary Service Segment

     Rehabilitation Therapy. As of June 30, 2008, we provided rehabilitation therapy services to a total of 189 healthcare facilities, 75 of which were our facilities and 114 of which were unaffiliated facilities, compared to 179 facilities, 64 of which were our facilities and 115 of which were unaffiliated facilities as of June 30, 2007. In addition, we have management contracts to manage the rehabilitation therapy services for our ten healthcare facilities in New Mexico. Rehabilitation therapy revenue derived from servicing our own facilities is included in our revenue from skilled nursing facilities. Our rehabilitation therapy business receives payment for services from the third-party skilled nursing facilities that it serves based on negotiated patient per diem rates or a negotiated fee schedule based on the type of service rendered.

     Hospice. We provide hospice care in California and New Mexico. We derive substantially all of the revenue from our hospice business from Medicare and Medicaid reimbursement for hospice services.

   Regulatory and Other Governmental Actions Affecting Revenue

     Our revenue is derived from services provided to patients in the following payor classes (dollars in thousands):

		Three Months Ended June 30,
		2008								2007
		Revenue				Percentage				Revenue				Percentage
		Dollars				of Revenue				Dollars				of Revenue
Medicare		$	66,804				37.0	%		$	56,134				37.1	%
Medicaid			55,399				30.7				45,746				30.3
Subtotal Medicare and Medicaid			122,203				67.7				101,880				67.4
Managed Care			17,859				10.0				12,668				8.4
Private and Other			40,286				22.3				36,543				24.2
Total		$	180,348				100.0	%		$	151,091				100.0	%

		Six Months Ended June 30,
		2008								2007
		Revenue				Percentage				Revenue				Percentage
		Dollars				of Revenue				Dollars				of Revenue
Medicare		$	134,399				37.2	%		$	111,421				37.6	%
Medicaid			110,893				30.7				88,359				29.9
Subtotal Medicare and Medicaid			245,292				67.9				199,780				67.5
Managed Care			35,997				10.0				24,418				8.3
Private and Other			79,786				22.1				71,548				24.2
Total		$	361,075				100.0	%		$	295,746				100.0	%

     We derive a substantial portion of our revenue from government Medicare and Medicaid programs. For the six months ended June 30, 2008, we derived 37.2% and 30.7% of our total revenue from the Medicare and Medicaid programs, respectively, and for the six months ended June 30, 2007, we derived 37.6% and 29.9% of our total revenue from the Medicare and Medicaid programs, respectively. In addition, our rehabilitation therapy services, for which we receive payment from private payors, are significantly dependent on Medicare and Medicaid funding, as those private payors are generally reimbursed by these programs.

     Medicare. Medicare is a federal health insurance program for people age 65 or older, people under age 65 with certain disabilities, and people of all ages with End-Stage Renal Disease. The Medicare program has Part A hospital insurance that helps to cover inpatient care in hospitals and in skilled nursing facilities (not custodial or long-term care). It also helps cover hospice care and some home health care. Skilled nursing facilities are paid on the basis of a prospective payment system, or PPS. The PPS payment rates are adjusted for case mix and geographic variation in wages and cover all costs of furnishing covered skilled nursing facilities services (routine, ancillary, and capital-related costs). The amount to be paid is determined by classifying each patient into a resource utilization group, or RUG, category, which is based upon each patient’s acuity level. Payment rates have historically increased each Federal fiscal year using a skilled nursing facilities market basket index.

     On May 7, 2008, CMS published its proposed rule on the fiscal year 2009 per diem payment rates for skilled nursing facilities, proposing a market basket increase factor of 3.1 percent, which would result in an estimated increase in aggregate payments by approximately $710 million. On July 31, 2008, CMS released its final rule on the fiscal year 2009 per diem payment rates for skilled nursing facilities. Under the final rule, CMS revised and rebased the skilled nursing facility market basket, resulting in a 3.4% market basket increase factor. Using this increase factor, the final rule increased aggregate payments to skilled nursing facilities nationwide by approximately $780.0 million. President Bush’s proposed budget for 2009 includes a provision that would establish a zero percent market basket update for fiscal years 2009 through 2011. The President’s proposed market basket increase can be implemented only through legislation passed by Congress. We cannot predict at this time whether the President’s proposal would be adopted and implemented.

     CMS also proposed on May 7, 2008 to adjust the refinements to nine new case-mix groups recently developed under the prospective payment system, or PPS, for treating beneficiaries requiring extensive medical and rehabilitation services. These new case-mix groups were designed to reflect the variability in the use of non-therapy ancillary services, and under the proposed adjustment, would result in a negative $770 million in payments to skilled nursing facilities. In the final rule issued July 31, 2008, CMS decided to defer consideration of the $770 million reduction in payments to skilled nursing facilities until 2009 when the fiscal year 2010 per diem payment rates are set.

     Recent legislation, effective July 15, 2008, known as the Medicare Improvement for Patients and Providers Act of 2008 (H.R. 6331), extended certain therapy cap exceptions. These caps, effective January 1, 2006, imposed a limit to the annual amount that Medicare Part B (covering outpatient services) will pay for outpatient physical, speech language and occupation therapy services for each patient. These caps may result in decreased demand for rehabilitation therapy services reimbursed under Part B but for the caps. The Deficit Reduction Act of 2005, or DRA, established exceptions to the therapy caps for a variety of circumstances. These exceptions were scheduled to expire on June 30, 2008 and the recently enacted H.R. 6331 now extends the exception process through December 31, 2009.

     Medicare Part B also provides payment for certain professional services, including professional consultations, office visits and office psychiatry services, provided by a physician or practitioner located at a distant site. Such telehealth services previously were reimbursed only if the patient was located in the office of a physician or

practitioner, a critical access hospital, a rural health clinic, a federally qualified health center or a hospital. The new H.R. 6331 now includes payment for such telehealth services if the patient is in a skilled nursing facility. We are unable to predict the impact of this aspect of the new legislation on our revenues and business at this time.

     Historically, adjustments to reimbursement levels under Medicare have had a significant effect on our revenue. For a discussion of historic adjustments and recent changes to the Medicare program and related reimbursement rates see “Business — Sources of Reimbursement” in Part 1, Item 1 in our 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission and “Risk Factors — Reductions in Medicare reimbursement rates or changes in the rules governing the Medicare program could have a material adverse effect on our revenue, financial condition and results of operations” in Part 1, Item 1A of our 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

     Medicaid. Medicaid is a state-administered medical assistance program for the indigent, operated by the individual states with the financial participation of the federal government. Each state has relatively broad discretion in establishing its Medicaid reimbursement formulas and coverage of service, which must be approved by the federal government in accordance with federal guidelines. All states in which we operate cover long-term care services for individuals who are Medicaid eligible and qualify for institutional care. Generally, Medicaid payments are made directly to providers, who must accept the Medicaid reimbursement level as payment in full for services rendered, except in New Mexico, which has implemented a managed Medicaid program where providers receive Medicaid payments from insurance companies. Rapidly increasing Medicaid spending, combined with slow state revenue growth, has led many states to institute measures aimed at controlling spending growth. Given that Medicaid outlays are a significant component of state budgets, we expect continuing cost containment pressures on Medicaid outlays for skilled nursing facilities in the states in which we operate. In addition, the Deficit Reduction Act of 2005 limited the circumstances under which an individual may become financially eligible for Medicaid and nursing home services paid for by Medicaid.

     Managed Care. Our managed care patients consist of individuals who are insured by a third-party entity, typically called a senior Health Maintenance Organization, or HMO, plan, or are Medicare beneficiaries who assign their Medicare benefits to a senior HMO plan.

     Private Pay and Other. Private pay and other sources consist primarily of individuals or parties who directly pay for their services or are beneficiaries of the Department of Veterans Affairs or hospice beneficiaries.

Critical Accounting Policies and Estimates Update

     There have been no significant changes during the three- and six-month periods ended June 30, 2008 to the items that we disclosed as our critical accounting policies and estimates in our discussion and analysis of financial condition and results of operations in our 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Results of Operations

     The following table sets forth details of our revenue and earnings as a percentage of total revenue for the periods indicated:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Revenue			100.0	%			100.0	%			100.0	%			100.0	%
Expenses:
Cost of services (exclusive of rent cost of revenue and depreciation and amortization shown below)			78.9				79.1				78.8				78.9
Rent cost of revenue			2.5				1.7				2.5				1.8
General and administrative			3.1				2.9				3.3				3.1
Depreciation and amortization			2.8				2.8				2.8				2.8
			87.3				86.5				87.4				86.6
Other income (expenses):
Interest expense			(5.1	)			(7.9	)			(5.2	)			(8.1	)
Interest income			0.1				0.4				0.1				0.3
Other income			—				0.1				0.1				—
Equity in earnings of joint venture			0.4				0.2				0.3				0.3
Debt retirement costs			—				(7.7	)			—				(3.9	)
Change in fair value of interest rate hedge			—				—				—				—
Total other income (expenses), net			(4.6	)			(14.9	)			(4.7	)			(11.4	)
Income (loss) before provision for income taxes			8.1				(1.4	)			7.9				2.0
Provision for (benefit from) income taxes			3.2				(0.4	)			3.1				1.0
Net income (loss)			4.9	%			(1.0	)%			4.8	%			1.0	%
EBITDA margin			16.0	%			8.9	%			15.9	%			12.6	%
Adjusted EBITDA margin			16.0	%			16.6	%			15.9	%			16.5	%