Genesis Healthcare, Inc. - Quarter Report: 2009 June (Form 10-Q)

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, 2009.


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

For the transition period from to .

Commission file number: 001-33459

Skilled Healthcare Group, Inc.

(Exact name of registrant as specified in its charter)


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

27442 Portola Parkway, Suite 200 Foothill Ranch, California (Address of principal executive offices)		92610 (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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o 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 þ		Non-accelerated filer o	Smaller reporting company o
		(do not check if 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 July 31, 2009.

Class A common stock, $0.001 par value – 20,307,082 shares
Class B common stock, $0.001 par value – 17,008,038 shares

Skilled Healthcare Group, Inc.

Form 10-Q
For the Quarterly Period Ended June 30, 2009
Index


	Page
	Number

Part I. Financial Information

Item 1. Financial Statements		3

Condensed Consolidated Balance Sheets — June 30, 2009 (unaudited) and December 31, 2008		3

Condensed Consolidated Statements of Operations — Three and six months ended June 30, 2009 (unaudited) and June 30, 2008 (unaudited and restated)		4

Condensed Consolidated Statements of Cash Flows — Three and six months ended June 30, 2009 (unaudited) and June 30, 2008 (unaudited and restated)		5

Notes to Unaudited Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20

Item 3. Quantitative and Qualitative Disclosures About Market Risk		39

Item 4. Controls and Procedures		40

Part II. Other Information

Item 1. Legal Proceedings		42

Item 1A. Risk Factors		42

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		43

Item 3. Defaults Upon Senior Securities		43

Item 4. Submission of Matters to a Vote of Security Holders		43

Item 5. Other Information		44

Item 6. Exhibits		44

Signatures		45

Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I — FINANCIAL INFORMATION


Item 1.		*Financial Statements.*

Skilled Healthcare Group, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except per share data)


	June 30,			December 31,
	2009			2008
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	12,174		$	2,047
Accounts receivable, less allowance for doubtful accounts of $29,670 and $26,593 at June 30, 2009 and December 31, 2008, respectively		101,124			102,954
Deferred income taxes		21,218			19,703
Prepaid expenses		4,820			9,226
Other current assets		7,115			7,483

Total current assets		146,451			141,413
Property and equipment, less accumulated depreciation of $49,448 and $40,118 at June 30, 2009 and December 31, 2008, respectively		357,669			346,466
Other assets:
Notes receivable		11,496			4,448
Deferred financing costs, net		16,268			10,184
Goodwill		449,962			449,962
Intangible assets, less accumulated amortization of $12,493 and $10,490 at June 30, 2009 and December 31, 2008, respectively		28,337			30,310
Other assets		24,111			23,797

Total other assets		530,174			518,701

Total assets	$	1,034,294		$	1,006,580

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities	$	51,605		$	55,478
Employee compensation and benefits		32,193			30,825
Current portion of long-term debt and capital leases		3,457			7,812

Total current liabilities		87,255			94,115
Long-term liabilities:
Insurance liability risks		30,223			30,654
Deferred income taxes		1,823			721
Other long-term liabilities		14,405			14,064
Long-term debt and capital leases, less current portion		475,180			462,449

Total liabilities		608,886			602,003
Stockholders’ equity:
Class A common stock, 175,000 shares authorized, $0.001 par value per share; 20,307 and 20,189 issued and outstanding at June 30, 2009 and December 31, 2008, respectively		20			20
Class B common stock, 30,000 shares authorized, $0.001 par value per share; 17,008 and 17,027 issued and outstanding at June 30, 2009 and December 31, 2008, respectively		17			17
Additional paid-in-capital		364,016			362,982
Retained earnings		62,482			43,400
Accumulated other comprehensive loss		(1,127	)		(1,842	)

Total stockholders’ equity		425,408			404,577

Total liabilities and stockholders’ equity	$	1,034,294		$	1,006,580

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

Skilled Healthcare Group, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2009			2008			2009			2008
				(As Restated,						(As Restated,
				See Note 2)						See Note 2)
Revenue	$	193,400		$	180,348		$	382,851		$	361,075
Expenses:
Cost of services (exclusive of rent cost of revenue and depreciation and amortization shown below)		154,257			143,439			304,472			286,342
Rent cost of revenue		4,568			4,478			9,107			8,943
General and administrative		6,823			5,557			13,063			11,779
Depreciation and amortization		5,867			5,073			11,344			10,233

		171,515			158,547			337,986			317,297


Other income (expenses):
Interest expense		(8,241	)		(9,162	)		(16,331	)		(18,815	)
Interest income		420			123			611			337
Other income (expense)		—			87			(60	)		309
Equity in earnings of joint venture		751			718			1,484			1,109

Total other expenses, net		(7,070	)		(8,234	)		(14,296	)		(17,060	)

Income before provision for income taxes		14,815			13,567			30,569			26,718
Provision for income taxes		5,736			5,363			11,487			10,530

Net income	$	9,079		$	8,204		$	19,082		$	16,188


Earnings per share data:
Earnings per common share, basic	$	0.25		$	0.22		$	0.52		$	0.44

Earnings per common share, diluted	$	0.25		$	0.22		$	0.52		$	0.44

Weighted-average common shares outstanding, basic		36,904			36,558			36,892			36,554

Weighted-average common shares outstanding, diluted		36,928			36,871			36,929			36,877

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

Skilled Healthcare Group, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Six Months Ended
	June 30,
	2009			2008
				(As Restated,
				See Note 2)
Cash Flows from Operating Activities
Net income	$	19,082		$	16,188
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		11,344			10,233
Provision for doubtful accounts		6,684			5,471
Non-cash stock-based compensation		1,128			610
Loss on disposal of asset		60			—
Amortization of deferred financing costs		1,868			1,481
Deferred income taxes		(890	)		(1,982	)
Amortization of discount on senior subordinated notes		53			54
Changes in operating assets and liabilities:
Accounts receivable		(15,111	)		(5,110	)
Other current and non-current assets		6,055			911
Accounts payable and accrued liabilities		(1,549	)		(3,246	)
Employee compensation and benefits		983			(422	)
Insurance liability risks		(1,272	)		1,650
Other long-term liabilities		341			868

Net cash provided by operating activities		28,776			26,706

Cash Flows from Investing Activities
Payments on notes receivable		1,584			1,157
Acquisition of healthcare facilities		(1,650	)		(13,592	)
Additions to property and equipment		(18,927	)		(21,244	)
Changes in other assets		—			(358	)

Net cash used in investing activities		(18,993	)		(34,037	)

Cash Flows from Financing Activities
Borrowings under line of credit, net		14,000			12,000
Repayments of long-term debt and capital leases		(5,704	)		(4,585	)
Additions to deferred financing costs		(7,952	)		(1,383	)

Net cash provided by financing activities		344			6,032

Increase (decrease) in cash and cash equivalents		10,127			(1,299	)
Cash and cash equivalents at beginning of period		2,047			5,012

Cash and cash equivalents at end of period	$	12,174		$	3,713


Supplemental cash flow information
Cash paid for:
Interest expense, net of capitalized interest	$	15,623		$	18,436
Income taxes, net	$	10,623		$	12,656
Non-cash activities:
Conversion of accounts receivable into notes receivable, net	$	10,257		$	3,289

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

SKILLED HEALTHCARE GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Description of Business

Current Business

Skilled Healthcare Group, Inc. (“Skilled”) companies operate long-term care facilities and provide a wide range of post-acute care services, with a strategic emphasis on sub-acute specialty medical care. Skilled and its consolidated wholly owned companies are collectively referred to as the “Company.” As of June 30, 2009, the Company currently operates facilities in California, Iowa, Kansas, Missouri, Nevada, New Mexico and Texas, including 77 skilled nursing facilities (“SNFs”), which offer sub-acute care and rehabilitative and specialty medical skilled nursing care, and 22 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 provides hospice care in the California and New Mexico markets. The Company also has an administrative service company that provides a full complement of administrative and consultative services that allows its facility operators and those unrelated facility operators, with whom the Company contracts, to better focus on delivery of healthcare services. The Company has four such agreements with unrelated facility operators. The Company is also a member in a joint venture located in Texas that provides institutional pharmacy services, which currently serves eight of the Company’s SNFs and other facilities unaffiliated with the Company.

Company History

Skilled was incorporated as SHG Holding Solutions, Inc. in Delaware in October 2005. The Company’s predecessor company acquired Summit Care, a publicly traded long-term care company with nursing facilities in California, Texas and Arizona in 1998. On October 2, 2001, the Company’s predecessor and 19 of its subsidiaries filed voluntary petitions for protection under Chapter 11 of the U.S. Bankruptcy Code and on November 28, 2001, our remaining three companies also filed voluntary petitions for protection under Chapter 11. In August 2003, we emerged from bankruptcy, paying or restructuring all debt holders in full, paying all accrued interest expenses and issuing 5.0% of our common stock to former bondholders. In connection with the Company’s emergence from bankruptcy, we engaged in a series of transactions, including the disposition in March 2005 of our California pharmacy business, selling two institutional pharmacies in southern California.

On June 30, 2009, the United States Bankruptcy Court for the Central District of California granted entry of a final decree closing the aforementioned Chapter 11 cases.

Acquisitions and Developments

The Company admitted its first patients in March 2009 to the Dallas Center of Rehabilitation, its newly constructed skilled nursing facility in Dallas, Texas, which has received its state license as well as its Medicaid and Medicare certification.

In April 2009, the Company acquired River View Care Center, a 74-bed, skilled nursing facility located in Des Moines, Iowa, for approximately $1.7 million. Concurrent with the close of this transaction, River View Care Center was renamed The Rehabilitation Center of Des Moines.

In April 2009, the Company completed construction of Vintage Park at Tonganoxie, an assisted living facility in the Kansas City market, which has 41 units and is similar to the assisted living facility that the Company opened in Ottawa, Kansas, in April 2007.

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

2. Restatement

On June 29, 2009, the Company restated its consolidated financial statements for the annual periods in fiscal years 2006 through 2008 and the quarterly periods in fiscal years 2007 and 2008 in its amended Annual Report on Form 10-K/A for the year ended December 31, 2008 and for the first quarter of 2009 in its amended Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2009.

In the opinion of management, all adjustments (which consist of normal recurring adjustments) necessary to present fairly the financial position, results of operations and change in cash flows for the interim periods presented in this Quarterly Report on Form 10-Q have been made.

The restatement related to an understatement of accounts receivable allowance for doubtful accounts for the Company’s long-term care (“LTC”) operating segment, which was caused by improper dating of accounts receivable for that segment by a former senior officer of the LTC segment (the “former employee”). Management conducted a review of the Company’s accounts receivable allowance for doubtful accounts related to the LTC segment after the former employee left the Company’s employment following a disciplinary meeting on unrelated matters. Management determined that the former employee had acted in a manner inconsistent with the Company’s accounting and disclosure policies and practices. As a result of its review, management recommended to the Audit Committee that a restatement was required. The Audit Committee initiated and directed a special investigation regarding the accounting and reporting issues raised by the former employee’s improper dating of accounts receivable. Under the oversight of the Audit Committee, internal audit personnel with the assistance of outside legal counsel and other advisors, investigated the matter and reviewed our internal controls related to accounts receivable allowance for doubtful accounts related to the LTC segment. The Company’s investigation found no evidence that anyone else within the Company knew of or participated in the improper conduct.

The condensed consolidated interim financial statements and related financial information for the three and six months ended June 30, 2008 included in this Form 10-Q should be read only in conjunction with the information contained in our Annual Report on Form 10-K/A for the year ended December 31, 2008 and our Quarterly Report on Form 10-Q/A for the three months ended March 31, 2009.

The following tables show the previously reported, restatement adjustment and restated amounts for those accounts in the Statements of Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2008 and the Statement of Condensed Consolidated Cash Flows for the six months ended June 30, 2008, affected by the restatements.

Three Months Ended June 30, 2008


			Restatement
Statements of Operations Line items	As Reported		Adjustments			Restated
Cost of Services	$	142,252	$	1,187		$	143,439
Income before provision for income taxes		14,754		(1,187	)		13,567
Provision for income taxes		5,830		(467	)		5,363
Net income		8,924		(720	)		8,204
Earnings per common share, basic	$	0.24	$	(0.02	)	$	0.22
Earnings per common share, diluted	$	0.24	$	(0.02	)	$	0.22

Six Months Ended June 30, 2008


			Restatement
Statements of Operations Line items	As Reported		Adjustments			Restated
Cost of Services	$	284,396	$	1,946		$	286,342
Income before provision for income taxes		28,664		(1,946	)		26,718
Provision for income taxes		11,296		(766	)		10,530
Net income		17,368		(1,180	)		16,188
Earnings per common share, basic	$	0.48	$	(0.04	)	$	0.44
Earnings per common share, diluted	$	0.47	$	(0.03	)	$	0.44


				Restatement
Consolidated Statement of Cash Flows	As Reported			Adjustments			Restated
Operating Activities
Net income	$	17,368		$	(1,180	)	$	16,188
Provision for doubtful accounts		3,525			1,946			5,471
Deferred income taxes		(1,216	)		(766	)		(1,982	)

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

3. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated interim financial statements as of June 30, 2009 and for the three and six months ended June 30, 2009 and 2008 (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 financial statements and notes thereto for the year ended December 31, 2008, which are included in the Company’s Annual Report on Form 10-K/A 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 Company evaluated subsequent events through August 4, 2009, the date on which this Quarterly Report on Form 10-Q was filed with the Securities and Exchange Commission.

The accompanying Interim Financial Statements of the Company include the accounts of the Company and the Company’s wholly owned companies. All significant intercompany transactions have been eliminated in consolidation.

Estimates and Assumptions

The preparation of the Interim Financial Statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to consolidate subsidiary financial information and 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 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 3 in the Company’s 2008 Annual Report on Form 10-K/A filed with the SEC.

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.

In the six months ended June 30, 2009, the Company converted $10.3 million of accounts receivable, net into notes receivable, net in the Company’s rehabilitation therapy services company. As of June 30, 2009, three customers had outstanding notes receivable of $14.0 million. These notes receivable as well as the trade receivables from the customers are guaranteed by the customers as well as personally guaranteed by the principal owners of the customers. As of June 30, 2009, these three customers represented 53% of the accounts receivable for the Company’s rehabilitation therapy services company. For the six months ended June 30, 2009, these three customers represented approximately 51% of the rehabilitation therapy services company external revenue.

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

Goodwill and Intangible Assets

Goodwill is accounted for under Statement of Financial Accounting Standards (“SFAS”) No. 141 (Revised 2007), Business Combinations (“SFAS 141R”), 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. We did not record any impairment charges for the three and six months ended June 30, 2009 and 2008.

Recent Accounting Pronouncements

In April 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) SFAS No. 107-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP SFAS 107-1”). FSP SFAS 107-1 requires disclosures about fair value of financial instruments in financial statements for interim reporting periods and in annual financial statements of publicly traded companies. FSP SFAS 107-1 also requires entities to disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments in financial statements on an interim and annual basis and to highlight any changes from prior periods. FSP SFAS 107-1 is currently effective. The adoption of FSP SFAS 107-1 resulted in additional disclosures by the Company about the fair value of financial instruments in interim reporting periods, but otherwise it did not have any effect on the Company’s financial condition, results of operations or liquidity.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”), which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting that date, that is, whether that date represents the date the financial statements were issued or were available to be issued. SFAS 165 is effective for interim or annual periods ending after June 15, 2009. The adoption of SFAS 165 did not have a significant impact on the Company’s financial condition, results of operations or liquidity.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative U.S. GAAP to be applied by nongovernmental entities, except for the rules and interpretive releases of the SEC under authority of federal securities laws, which are sources of authoritative U.S. GAAP for SEC registrants. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company will adopt SFAS 168 for our quarter ending September 30, 2009. The Company is currently evaluating the effect on its financial statement disclosures as all future references to authoritative accounting literature will be referenced in accordance with the Codification.

4. Earnings Per Share of Class A Common Stock and Class B Common Stock

The Company computes earnings 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. Net income is allocated on a proportionate basis to each class of common stock in the determination of earnings per share.

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

Basic earnings per share were computed by dividing net income by the weighted-average number of outstanding shares for the period. Dilutive earnings per share is computed by dividing net income 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 earnings per share of class A common stock and class B common stock for the three and six months ended June 30, 2009 and 2008 (amounts in thousands, except per share data):


	Three Months Ended						Three Months Ended						Six Months Ended						Six Months Ended
	June 30, 2009						June 30, 2008						June 30, 2009						June 30, 2008
	Class A		Class B		Total		Class A		Class B		Total		Class A		Class B		Total		Class A		Class B		Total
							(As		(As		(As								(As		(As		(As
							Restated)		Restated)		Restated)								Restated)		Restated)		Restated)
Earnings per share, basic
Numerator:
Allocation of net income	$	4,892	$	4,187	$	9,079	$	4,309	$	3,895	$	8,204	$	10,279	$	8,803	$	19,082	$	8,503	$	7,685	$	16,188

Denominator:
Weighted-average common shares outstanding		19,886		17,018		36,904		19,203		17,355		36,558		19,873		17,019		36,892		19,201		17,353		36,554

Earnings per common share, basic	$	0.25	$	0.25	$	0.25	$	0.22	$	0.22	$	0.22	$	0.52	$	0.52	$	0.52	$	0.44	$	0.44	$	0.44

Earnings per share, diluted
Numerator:
Allocation of net income	$	4,895	$	4,184	$	9,079	$	4,281	$	3,923	$	8,204	$	10,286	$	8,796	$	19,082	$	8,447	$	7,741	$	16,188

Denominator:
Weighted-average common shares outstanding		19,886		17,018		36,904		19,203		17,355		36,558		19,873		17,019		36,892		19,201		17,353		36,554
Plus: incremental shares related to dilutive effect of stock options and restricted stock, if applicable		24		—		24		38		275		313		34		3		37		42		281		323

Adjusted weighted-average common shares outstanding		19,910		17,018		36,928		19,241		17,630		36,871		19,907		17,022		36,929		19,243		17,634		36,877

Earnings per common share, diluted	$	0.25	$	0.25	$	0.25	$	0.22	$	0.22	$	0.22	$	0.52	$	0.52	$	0.52	$	0.44	$	0.44	$	0.44

5. Business Segments

The Company has two reportable operating segments — long-term care services (“LTC”), which includes the operation of SNFs and ALFs 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. 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, 2009, LTC services are provided by 77 wholly owned SNF operating companies that offer post-acute, rehabilitative and specialty skilled nursing care, as well as 22 wholly owned ALF operating companies that provide room and board and social services. Ancillary services include rehabilitative services such as physical, occupational and speech therapy provided in the Company’s facilities and in unaffiliated facilities by its wholly owned operating company, Hallmark Rehabilitation GP, LLC. Also included in the ancillary services segment is the Company’s hospice business that began providing care to patients in October 2004.

The Company evaluates performance and allocates capital 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 expenses are not allocated to any segment for purposes of determining segment profit or loss, and are 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 3 above) included in the Company’s 2008 Annual Report on Form 10-K/A filed with the SEC. 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)

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, 2009
Revenue from external customers	$	167,609	$	25,791	$	—		$	—		$	193,400
Intersegment revenue		815		16,590		—			(17,405	)		—

Total revenue	$	168,424	$	42,381	$	—		$	(17,405	)	$	193,400

Operating income		23,448		5,586		(7,149	)					21,885
Interest expense, net of interest income												(7,821	)
Equity in earnings of joint venture												751

Income before provision for income taxes											$	14,815

Segment capital expenditures	$	8,149	$	35	$	315		$	—		$	8,499

EBITDA(1)	$	28,857	$	5,806	$	(6,160	)	$	—		$	28,503


Three months ended June 30, 2008
Revenue from external customers	$	158,960	$	21,388	$	—		$	—		$	180,348
Intersegment revenue		990		16,516		—			(17,506	)		—

Total revenue	$	159,950	$	37,904	$	—		$	(17,506	)	$	180,348

Operating income, as restated		25,739		4,680		(8,618	)					21,801
Interest expense, net of interest income												(9,039	)
Other income												87
Equity in earnings of joint venture												718

Income before provision for income taxes, as restated											$	13,567

Segment capital expenditures	$	11,611	$	611	$	89		$	—		$	12,311

EBITDA(1), as restated	$	27,697	$	4,888	$	(4,906	)	$	—		$	27,679


	Long-term		Ancillary
	Care Services		Services		Other			Elimination			Total
Six months ended June 30, 2009
Revenue from external customers	$	333,145	$	49,706	$	—		$	—		$	382,851
Intersegment revenue		1,705		33,656		—			(35,361	)		—

Total revenue	$	334,850	$	83,362	$	—		$	(35,361	)	$	382,851

Operating income		46,996		11,593		(13,724	)					44,865
Interest expense, net of interest income												(15,720	)
Other expense												(60	)
Equity in earnings of joint venture												1,484

Income before provision for income taxes											$	30,569

Segment capital expenditures	$	18,252	$	173	$	502		$	—		$	18,927

EBITDA(1)	$	57,363	$	12,026	$	(11,756	)	$	—		$	57,633


Six months ended June 30, 2008
Revenue from external customers	$	317,777	$	43,298	$	—		$	—		$	361,075
Intersegment revenue		1,798		33,124		—			(34,922	)		—

Total revenue	$	319,575	$	76,422	$	—		$	(34,922	)	$	361,075

Operating income, as restated		50,531		11,026		(17,779	)					43,778
Interest expense, net of interest income												(18,478	)
Other income												309
Equity in earnings of joint venture												1,109

Income before provision for income taxes, as restated											$	26,718

Segment capital expenditures	$	20,177	$	795	$	272		$	—		$	21,244

EBITDA(1), as restated	$	54,618	$	11,310	$	(10,499	)	$	—		$	55,429


(1)		EBITDA is defined as net income before depreciation, amortization and interest expense (net of interest income) and the provision for income taxes. See reconciliation of net income to EBITDA and a discussion of its uses and limitations on Item 2 — Results of Operations of this quarterly report.

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

The following table presents the segment assets as of June 30, 2009 compared to December 31, 2008 (dollars in thousands):


	Long-term		Ancillary
	Care Services		Services		Other		Total
June 30, 2009:
Segment total assets	$	889,565	$	81,916	$	62,813	$	1,034,294
Goodwill and intangibles included in total assets	$	442,326	$	35,973	$	—	$	478,299
December 31, 2008:
Segment total assets	$	880,724	$	75,246	$	50,610	$	1,006,580
Goodwill and intangibles included in total assets	$	444,129	$	36,143	$	—	$	480,272

6. Income Taxes

For the three months ended June 30, 2009 and 2008, the Company recognized income tax expense of $5.7 million and $5.4 million, respectively, which was primarily related to the Company’s effective tax rate applied to the Company’s income before provision for income taxes.

For the six months ended June 30, 2009 and 2008, the Company recognized income tax expense of $11.5 million and $10.5 million, respectively, which was primarily related to the Company’s effective tax rate applied to the Company’s income before provision for income taxes. Tax benefits totaling $0.3 million, primarily attributable to a decrease in unrecognized tax benefits resulting from the expiration of a statute of limitations, reduced the effective tax rate below the Company’s statutory tax rate for the six months ended June 30, 2009 while the tax expense for the six months ended June 30, 2008 approximated the Company’s statutory rate.

For the six months ended June 30, 2009, total unrecognized tax benefits, including penalties and interest, decreased by $0.3 million from $2.9 million to $2.6 million as a result of the expiration of the 2003 California income tax statute of limitations. As of June 30, 2009, it is reasonably possible that unrecognized tax benefits could decrease by $2.4 million, all of which would affect the Company’s effective tax rate, due to additional statute expirations within the 12-month rolling period ending June 30, 2010.

The Company is subject to taxation in the United States and in various state jurisdictions. The Company’s tax years 2005 and forward are subject to examination by the United States Internal Revenue Service and from 2004 forward by the Company’s material state jurisdictions.

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

7. Other Current Assets and Other Assets

Other current assets consist of the following as of June 30, 2009 and December 31, 2008 (dollars in thousands):


	June 30, 2009		December 31, 2008
Current portion of notes receivable	$	3,148	$	1,523
Supplies inventory		2,707		2,684
Income tax refund receivable		1,020		2,739
Other current assets		240		537

	$	7,115	$	7,483

Other assets consist of the following at June 30, 2009 and December 31, 2008 (dollars in thousands):


	June 30, 2009		December 31, 2008
Equity investment in joint ventures	$	5,291	$	5,082
Restricted cash		14,079		13,969
Deposits and other assets		4,741		4,746

	$	24,111	$	23,797

8. Other Long-Term Liabilities

Other long-term liabilities consist of the following at June 30, 2009 and December 31, 2008 (dollars in thousands):


	June 30, 2009		December 31, 2008
Deferred rent	$	6,349	$	5,780
Other long-term tax liability		2,605		2,912
Asbestos abatement liability		5,451		5,372

	$	14,405	$	14,064

For more information regarding other long-term tax liability, see Note 6 — “Income Taxes” in the unaudited condensed consolidated financial statements under Part I, Item 1 of this report

9. Commitments and Contingencies

Litigation

On July 24, 2009, a purported class action complaint captioned Shepardson v. Skilled Healthcare Group, Inc., et al. was filed in the U.S. District Court for the Central District of California against us, our Chairman and Chief Executive Officer, our current Chief Financial Officer, our former Chief Financial Officer, and investment banks that underwrote the Company’s initial public offering, on behalf of two classes of purchasers of our securities. One purported class consists of all persons other than defendants who purchased our Class A common stock pursuant or traceable to our Initial Public Offering from May 14, 2007 through August 5, 2008. The second purported class consists of all persons other than defendants who purchased our Class A common stock from May 14, 2007, through June 9, 2009. The complaint, which seeks an unspecified amount of damages (including rescissory damages), asserts claims under the federal securities laws relating to our June 9, 2009 announcement that we would restate our financial statements for the period from January 1, 2006, to March 31, 2009, and that the restatement was likely to require cumulative charges against after-tax earnings in the aggregate amount of between $8 million and $9 million over the affected periods. The complaint also alleges that our registration statement and prospectus, financial statements, and public statements about our results of operations contained material false and misleading statements. None of the defendants have responded to the complaint at this time.

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

On April 15, 2009, two of Skilled Healthcare Group’s wholly owned companies, Eureka Healthcare and Rehabilitation Center, LLC, which operates Eureka Healthcare and Rehabilitation Center (the “Facility”), and Skilled Healthcare, LLC, the Administrative Services provider for the Facility, were served with a search warrant that relates to an investigation of the Facility by the California Attorney General’s Bureau of Medi-Cal Fraud & Elder Abuse (“BMFEA”). The search warrant related to, among other things, records, property and information regarding certain enumerated patients of the Facility and covered the period from January 1, 2007 through the date of the search. The Facility represents less than 1% of our revenue and less than 0.3% of our EBITDA based on full year 2008. Nevertheless, although the Company is unable to assess the potential exposure, any fines or penalties that may result from the BMFEA’s investigation could be significant. The Company is committed to working cooperatively with the BMFEA on this matter.

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 companies. In the complaint, the plaintiffs allege, among other things, that certain California-based facilities operated by the Company’s wholly owned operating companies failed to provide an adequate number of qualified personnel to care for their residents and misrepresented the quality of care provided in their facilities. Plaintiffs allege these failures violated, among other things, the residents’ rights, the California Health and Safety Code, the California Business and Professions Code and the Consumer Legal Remedies Act. Plaintiffs seek, among other things, 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, and the Humboldt Court entered its order granting plaintiffs’ motion for class certification on June 19, 2008. The Company subsequently petitioned the California Court of Appeal, First Appellate District, for a writ and reversal of the order granting class certification. The Court of Appeal denied the Company’s writ on November 6, 2008 and the Company accordingly filed a petition for review with the California Supreme Court. On January 21, 2009, the California Supreme Court denied the Company’s petition for review. The order granting class certification accordingly remains in place, and the action is proceeding as a class action. 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 issued its reservation of rights to preserve an assertion of non-coverage for this case due to the lack of any allegation of injury or harm to the plaintiffs. The Humboldt Court recently set the matter to begin trial on November 30, 2009. Given the uncertainty of the pleadings and facts at this juncture in the litigation, an assessment of potential exposure is uncertain at this time.

As is typical in the healthcare industry, the Company experiences a significant number of litigation claims asserted against it. 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. 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.

Under U.S. 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.

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

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 California, Nevada and New Mexico.

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

The Company has purchased guaranteed cost policies for Kansas, Missouri and Iowa. 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 LTC patients. The Company has from time to time been subject to malpractice claims and other litigation in the ordinary course of business.

The Company had a general and professional 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, which expired on August 31, 2008, the Company retains an unaggregated $1.0 million self-insured general and professional liability retention per claim.

In September 2008, California-based skilled nursing facility companies purchased individual three-year general and professional liability insurance policies with a per occurrence and annual aggregate coverage limit of $1.0 million and $3.0 million, respectively, and an unaggregated $0.1 million per claim self-insured retention.

The Company has a three-year excess liability policy with applicable aggregate limits of $14.0 million for losses arising from claims in excess of $1.0 million for the California ALFs and the Texas, New Mexico, Nevada, Kansas and Missouri facilities. The Company retains an unaggregated self-insured retention of $1.0 million per claim for all Texas, New Mexico and Nevada facilities and its California ALFs. From September 2006 through August 2008, 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 Company’s ten New Mexico facilities were also covered under this policy after their acquisition in September 2007.

The Company’s Kansas and Iowa facilities are insured on an occurrence basis with a per occurrence and annual aggregate coverage limit of $1.0 million and $3.0 million, respectively. There are no applicable self-insurance retentions or deductibles under these contracts. The Company’s Missouri facilities are underwritten on a claims-made basis with no applicable self-insured retentions or deductibles and have a per occurrence and annual aggregate coverage limit of $1.0 million and $3.0 million, respectively.

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

Employee Medical Insurance. Medical preferred provider option programs are offered as a component of our employee benefits. The Company retains 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.

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


	As of June 30, 2009											As of December 31, 2008
	General and											General and
	Professional			Employee			Workers’					Professional			Employee			Workers’
	Liability			Medical			Compensation			Total		Liability			Medical			Compensation			Total
Current	$	6,946	⁽¹⁾	$	1,708	⁽²⁾	$	4,134	⁽²⁾	$	12,788	$	8,172	⁽¹⁾	$	1,551	⁽²⁾	$	3,906	⁽²⁾	$	13,629
Non-current		20,068			—			10,155			30,223		20,871			—			9,783			30,654

	$	27,014		$	1,708		$	14,289		$	43,011	$	29,043		$	1,551		$	13,689		$	44,283


(1)		Included in accounts payable and accrued liabilities.

(2)		Included in employee compensation and benefits.

Financial Guarantees

Substantially all of the Company’s wholly owned companies 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. These guarantees are full and unconditional and joint and several. The Company has no independent assets or operations.

10. Stockholders’ Equity

Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss) consists of two components, net income and other comprehensive income (loss). Other comprehensive income (loss) refers to revenue, expenses, gains, and losses that, under U.S. GAAP, are recorded as an element of stockholders’ equity but are excluded from net income. Currently, 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 income (loss) net of tax was $0.4 million and $(1.2) million for the three months ended June 30, 2009, and 2008 respectively. Other comprehensive income (loss) net of tax was $0.7 million and $(0.2) million for the six months ended June 30, 2009, and 2008 respectively.

2007 Stock Incentive Plan

The fair value of the stock option grants for the six months ended June 30, 2009 and 2008 under SFAS No. 123 (Revised 2004), Share-Based Payment (“SFAS 123R”), was estimated on the date of the grants using the Black-Scholes option pricing model with the following assumptions:


	2009			2008
Risk-free interest rate		2.62	%		3.20	%
Expected life	6.25 years			6.25 years
Dividend yield		0	%		0	%
Volatility		54.34	%		40.80	%
Weighted-average fair value	$	5.49		$	5.76

There were 90,000 and 4,000 new stock options granted in the three months ended June 30, 2009 and 2008, respectively. There were 328,253 and 129,000 new stock options granted in the six months ended June 30, 2009 and 2008, respectively.

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

There were no options exercised during the three and six months ended June 30, 2009. As of June 30, 2009, there was $2.2 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 3.2 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, 2009 under the 2007 Stock Incentive Plan:


						Weighted-
						Average
				Weighted-		Remaining		Aggregate
				Average		Contractual		Intrinsic
	Number of			Exercise		Term		Value
	Shares			Price		(in years)		(in thousands)
Outstanding at January 1, 2009		309,000		$	14.35
Granted		328,253		$	10.11
Exercised		—		$	—
Forfeited or cancelled		(45,204	)	$	12.17

Outstanding at June 30, 2009		592,049		$	12.16		8.94	$	—

Exercisable at June 30, 2009		131,750		$	14.81		7.76	$	—

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 to stock option grants and stock awards included in cost of services in the Company’s condensed consolidated interim financial statement of operations was $0.3 million in the three months ended June 30, 2009. There was $0.5 million included in cost of services in the six months ended June 30, 2009. There was no comparable amount in cost of services in the three and six months ended June 30, 2008. The amount in general and administrative expenses was $0.4 million and $0.3 million in the three months ended June 30, 2009 and 2008, respectively. The amount in general and administrative expenses was $0.7 million and $0.6 million in the six months ended June 30, 2009 and 2008, respectively.

11. Fair Value Measurements

The following table summarizes the valuation of the Company’s interest rate swap as of June 30, 2009 by the SFAS No. 157, Fair Value Measurements (“SFAS 157”), fair value hierarchy (dollars in thousands):


	Level 1		Level 2			Level 3		Total
Interest rate swap	$	—	$	(1,839	)	$	—	$	(1,839	)

The Company uses its existing second amended and restated first lien credit agreement, as amended (the “Credit Agreement”) and 11.0% Senior Subordinated Notes due 2014 (the “2014 Notes”) to finance its operations. The Credit Agreement exposes the Company to variability in interest payments due to changes in interest rates. In November 2007, the Company entered into a $100.0 million interest rate swap agreement in order to manage fluctuations in cash flows resulting from interest rate risk. This interest rate swap changes a portion of the Company’s variable-rate cash flow exposure to fixed-rate cash flows at an interest rate of 6.4% until December 31, 2009. The Company continues to assess its exposure to interest rate risk on an ongoing basis.

The interest rate swap 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, which agreed with the counterparty’s calculation.

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

The fair value of interest rate swap agreements designated as hedging instruments against the variability of cash flows associated with floating-rate, long-term debt obligations are reported in accumulated other comprehensive income. These amounts subsequently are reclassified into interest expense as a yield adjustment in the same period in which the related interest on the floating-rate debt obligation affects earnings. As the interest rate swap matures on December 31, 2009, $1.8 million will be reclassified to earnings into interest expense as a yield adjustment over the remainder of 2009. The Company evaluates the effectiveness of the cash flow hedge, in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, on a quarterly basis. The change in fair value is recorded as a component of other comprehensive income. Should the hedge become ineffective, the change in fair value would be recognized in the condensed consolidated statements of operations.

For the six months ended June 30, 2009, the total net loss recognized from converting from floating rate (three-month LIBOR) to fixed rate from a portion of the interest payments under the Company’s long-term debt obligations was approximately $1.5 million. As of June 30, 2009, an unrealized loss of $1.1 million (net of income tax) is included in accumulated other comprehensive loss.

Below is a table listing the fair value of the interest rate swap as of June 30, 2009 and December 31, 2008 (dollars in thousands):

Derivatives designated as

June 30, 2009

December 31, 2008

hedging instruments

Fair Value

under Statement 133

Balance Sheet Location

(Pre-tax)

Balance Sheet Location

(Pre-tax)

Interest rate swap

Accounts payable and

(1,839

)

Accounts payable and

(3,007

)

accrued liabilities

Below is a table listing the amount of gain (loss) recognized in other comprehensive income (“OCI”) on the interest rate swap for the three and six months ending June 30, 2009 and 2008 (dollars in thousands):


	Amount of Gain (Loss)
Derivatives in Statement 133	Recognized in OCI on Derivative (Effective Portion)
Cash Flow Hedging	Three Months Ended June 30,				Six Months Ended June 30,
Relationships	2009		2008		2009		2008
Interest rate swap	$	614	$	1,894	$	1,168	$	(400	)

Below is a table listing the amount of gain (loss) reclassified from accumulated OCI into income (effective portion) for the three and six months ending June 30, 2009 and 2008 (dollars in thousands):


Location of Gain (Loss)	Amount of Gain (Loss)
Reclassified from	Reclassified from Accumulated OCI into Income (Effective Portion)
Accumulated OCI into Income	Three Months Ended June 30,						Six Months Ended June 30,
(Effective Portion)	2009			2008			2009			2008
Interest expense	$	(838	)	$	(348	)	$	(1,454	)	$	(489	)

12. Debt

On April 28, 2009, the Company entered into an amendment to extend the maturity of the revolving loan commitments under its second amended and restated first lien credit agreement from June 15, 2010 to June 15, 2012. The Company’s revolving line of credit has a capacity of $135.0 million through June 15, 2010, and will reduce to $124.0 million, thereafter, until its maturity on June 15, 2012. The Company’s costs for the extension included upfront fees and expenses of approximately $8.0 million. The revolving loan will maintain current interest rates at the Company’s choice of LIBOR plus 2.75% or prime plus 1.75%.

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

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


	As of			As of
	June 30, 2009			December 31, 2008

Revolving Credit Facility, base interest rate, comprised of prime plus 1.75% (5.00% at June 30, 2009) collateralized by substantially all assets of the Company, due 2012	$	13,000		$	3,000

Revolving Credit Facility, interest rate based on LIBOR plus 2.75% (3.06% at June 30, 2009) collateralized by substantially all assets of the Company, due 2012		82,000			78,000

Term Loan, interest rate based on LIBOR plus 2.00% (2.31% at June 30, 2009) collateralized by substantially all assets of the Company, due 2012		149,600			150,900

Term Loan, interest rate swapped at 6.38% collateralized by substantially all assets of the Company, due 2012		100,000			100,000

2014 Notes, interest rate 11.0%, with an original issue discount of $492 and $545 at June 30, 2009 and December 31, 2008, respectively, interest payable semiannually, principal due 2014, unsecured		129,508			129,455

Notes payable, fixed interest rate 6.5%, payable in monthly installments, collateralized by a first priority deed of trust, due November 2014		1,608			1,669

Insurance premium financing		710			5,059

Present value of capital lease obligations at effective interest rates, collateralized by property and equipment		2,211			2,178


Total long-term debt and capital leases		478,637			470,261

Less amounts due within one year		(3,457	)		(7,812	)


Long-term debt and capital leases, net of current portion	$	475,180		$	462,449

13. Subsequent Events

For a detailed discussion of the Company’s subsequent event, see Note 9 — “Commitments and Contingencies — Litigation.”

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 our Annual Report on Form 10-K/A for the year ended December 31, 2008. 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 wholly owned companies. 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.

Business Overview

We are a provider of integrated long-term healthcare services through our skilled nursing companies and rehabilitation therapy business. We also provide other related healthcare services, including assisted living care and hospice care. We have an administrative service company that provides a full complement of administrative and consultative services that allows our facility operators and third-party facility operators with whom we contract to better focus on delivery of healthcare services. We have four such service agreements with unrelated facility operators. We focus on providing high-quality care to our patients and we have a strong commitment to 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, 2009, we owned or leased 77 skilled nursing facilities and 22 assisted living facilities, together comprising approximately 10,800 licensed beds. Our facilities, approximately 73.7% of which we own, are located in California, Iowa, Texas, Kansas, Missouri, Nevada and New Mexico, and are generally clustered in large urban or suburban markets. For the six months ended June 30, 2009, we generated approximately 83.9% of our revenue from our skilled nursing facilities, including our integrated rehabilitation therapy services at these facilities. The remainder of our revenue is generated from our assisted living services, rehabilitation therapy services provided to third-party facilities, and hospice care.

Company History

Skilled Healthcare Group, Inc. was incorporated as SHG Holding Solutions, Inc. in Delaware in October 2005. Our predecessor company acquired Summit Care, a publicly traded long-term care company with nursing facilities in California, Texas and Arizona in 1998. On October 2, 2001, our predecessor and 19 of its subsidiaries filed voluntary petitions for protection under Chapter 11 of the U.S. Bankruptcy Code and on November 28, 2001, our remaining three companies also filed voluntary petitions for protection under Chapter 11. In August 2003, we emerged from bankruptcy, paying or restructuring all debt holders in full, paying all interest expense that had accrued on our debt and issuing 5.0% of our common stock to former bondholders. In connection with our emergence from bankruptcy, we engaged in a series of transactions, including the disposition in March 2005 of our California pharmacy business by selling two institutional pharmacies in southern California.

On June 30, 2009, the United States Bankruptcy Court for the Central District of California granted entry of a final decree closing the aforementioned Chapter 11 cases.

Acquisitions and Developments

We admitted our first patients in March 2009 to our newly constructed skilled nursing facility in Dallas, Texas, the Dallas Center of Rehabilitation, which has received its state license as well as Medicaid and Medicare certification

In April 2009, we acquired River View Care Center, a 74-bed, skilled nursing facility located in Des Moines, Iowa, for approximately $1.7 million. Concurrent with the close of this transaction, River View Care Center was renamed The Rehabilitation Center of Des Moines.

In April 2009, we completed construction of Vintage Park at Tonganoxie, an assisted living facility in the Kansas City market, with 41 units, which is similar to the assisted living facility that the Company opened in Ottawa, Kansas, in April 2007.

Restatement

On June 29, 2009, we restated our financial statements for the annual periods in fiscal years 2006 through 2008 and the quarterly periods in fiscal years 2007 and 2008 in our amended Annual Report on Form 10-K/A for the year ended December 31, 2008 and for the first quarter of 2009 in our amended Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2009. For more information regarding the restatement adjustments and restated amounts for those line items in the consolidated balance sheets and the consolidated statements of operations and cash flows for the three and six months ended June 30, 2008 affected by the restatement, see Note 2 — “Restatement” in Part I, Item 1 of this Quarterly Report.

The restatement related to an understatement of accounts receivable allowance for doubtful accounts for our long-term care (“LTC”) operating segment, which was caused by improper dating of accounts receivable for that segment by a former senior officer of the LTC segment (the “former employee”). Management conducted a review of the Company’s accounts receivable allowance for doubtful accounts related to the LTC segment after the former employee left the Company’s employment following a disciplinary meeting on unrelated matters. Management determined that the former employee had acted in a manner inconsistent with the Company’s accounting and disclosure policies and practices. As a result of its review, management recommended to the Audit Committee that a restatement was required. The Audit Committee initiated and directed a special investigation regarding the accounting and reporting issues raised by the former employee’s improper dating of accounts receivable. Under the oversight of the Audit Committee, internal audit personnel with the assistance of outside legal counsel and other advisors, investigated the matter and reviewed our internal controls related to accounts receivable allowance for doubtful accounts related to the LTC segment. The Company’s investigation found no evidence that anyone else within the Company knew of or participated in the improper conduct.

The condensed consolidated financial statements and related financial information for the three and six months ended June 30, 2008 included in this Form 10-Q should be read only in conjunction with the information contained in our Annual Report on Form 10-K/A for the year ended December 31, 2008 and our Quarterly Report on Form 10-Q/A for the three months ended March 31, 2009.

Throughout the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, all referenced amounts for prior periods and prior period comparisons reflect the affected balances and amounts on a restated basis.

Revenue

Revenue by Service Offering

We operate our business in two reportable segments: long-term care services and ancillary services. Long-term care services includes the operation of skilled nursing and assisted living facilities as well as an administrative service company that provides a full complement of administrative and consultative services that allows its facility operators and those unrelated facility operators, with whom we contract, to better focus on delivery of healthcare services. Long-term care services is the most significant portion of our business. Ancillary services includes our integrated and third-party 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,
	2009					2008
	Revenue		Revenue			Revenue		Revenue			Increase/(Decrease)
	Dollars		Percentage			Dollars		Percentage			Dollars		Percentage
Long-term care services:
Skilled nursing facilities	$	161,659		83.6	%	$	154,228		85.5	%	$	7,431		4.8	%
Assisted living facilities		5,950		3.1			4,732		2.6			1,218		25.7

Total long-term care services		167,609		86.7			158,960		88.1			8,649		5.4
Ancillary services:
Third-party rehabilitation therapy services		19,822		10.2			16,820		9.3			3,002		17.8
Hospice		5,969		3.1			4,568		2.6			1,401		30.7

Total ancillary services		25,791		13.3			21,388		11.9			4,403		20.6

Total	$	193,400		100.0	%	$	180,348		100.0	%	$	13,052		7.2	%


	Six Months Ended June 30,
	2009					2008
	Revenue		Revenue			Revenue		Revenue			Increase/(Decrease)
	Dollars		Percentage			Dollars		Percentage			Dollars		Percentage
Long-term care services:
Skilled nursing facilities	$	321,070		83.9	%	$	308,511		85.4	%	$	12,559		4.1	%
Assisted living facilities		12,075		3.2			9,266		2.6			2,809		30.3

Total long-term care services		333,145		87.1			317,777		88.0			15,368		4.8
Ancillary services:
Third-party rehabilitation therapy services		38,058		9.9			34,300		9.5			3,758		11.0
Hospice		11,648		3.0			8,998		2.5			2,650		29.5

Total ancillary services		49,706		12.9			43,298		12.0			6,408		14.8

Total	$	382,851		100.0	%	$	361,075		100.0	%	$	21,776		6.0	%

Sources of Revenue

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


	Three Months Ended June 30,
	2009					2008
	Revenue		Percentage of			Revenue		Percentage of
	Dollars		Revenue			Dollars		Revenue
California	$	86,233		44.5	%	$	80,524		44.6	%
Texas		48,390		25.0			46,322		25.7
New Mexico		21,626		11.2			19,183		10.6
Kansas		14,291		7.4			12,798		7.1
Missouri		13,903		7.2			14,033		7.8
Nevada		7,922		4.1			7,488		4.2
Iowa		876		0.5			—		—
Other		159		0.1					—

Total	$	193,400		100.0	%	$	180,348		100.0	%


	Six Months Ended June 30,
	2009					2008
	Revenue		Percentage of			Revenue		Percentage of
	Dollars		Revenue			Dollars		Revenue
California	$	171,089		44.7	%	$	162,127		44.9	%
Texas		95,768		25.0			93,393		25.9
New Mexico		43,378		11.3			38,611		10.7
Kansas		28,184		7.4			23,642		6.5
Missouri		27,717		7.2			28,384		7.9
Nevada		15,528		4.1			14,908		4.1
Iowa		876		0.2			—		—
Other		311		0.1			10		—

Total	$	382,851		100.0	%	$	361,075		100.0	%

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 non-Medicaid 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. Several of our skilled nursing facilities include our Express Recovery™ program. This program uses a dedicated unit within a skilled nursing facility to deliver a comprehensive rehabilitation regimen in accommodations uniquely designed to serve high-acuity patients.

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


	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
Medicare		16.6	%		17.6	%		16.9	%		18.0	%
Managed care		7.0			7.0			7.1			7.2

Skilled mix		23.6			24.6			24.0			25.2
Private pay and other		17.9			17.7			17.9			17.2
Medicaid		58.5			57.7			58.1			57.6

Total		100.0	%		100.0	%		100.0	%		100.0	%

Our skilled mix was lower in the three and six months ended June 30, 2009 compared to the three and six months ended June 30, 2008 primarily due to a reduction in Medicare census from lower acute-care hospital admissions as a result of the challenging economic environment and competitive pressures in a handful of facilities.

Assisted Living Facilities. Within our assisted living facilities, which are primarily in Kansas, we generate our revenue mostly 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, 2009, we provided rehabilitation therapy services to a total of 180 healthcare facilities, including 67 of our facilities, as compared to 179 facilities, including 65 of our facilities, as of June 30, 2008. In addition, we have contracts to manage the rehabilitation therapy services for our 10 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.

Regulatory and Other Governmental Actions Affecting Revenue

The following table summarizes the amount of revenue that we received from each of the payor classes (dollars in thousands):


	Three Months Ended June 30,
	2009					2008
	Revenue		Revenue			Revenue		Revenue
	Dollars		Percentage			Dollars		Percentage
Medicare	$	69,260		35.8	%	$	66,804		37.0	%
Medicaid		60,183		31.1			55,399		30.7

Subtotal Medicare and Medicaid		129,443		66.9			122,203		67.7
Managed Care		17,972		9.3			17,859		10.0
Private pay and other		45,985		23.8			40,286		22.3

Total	$	193,400		100.0	%	$	180,348		100.0	%


	Six Months Ended June 30,
	2009					2008
	Revenue		Revenue			Revenue		Revenue
	Dollars		Percentage			Dollars		Percentage
Medicare	$	138,086		36.0	%	$	134,399		37.2	%
Medicaid		118,650		31.0			110,893		30.7

Subtotal Medicare and Medicaid		256,736		67.0			245,292		67.9
Managed Care		36,245		9.5			35,997		10.0
Private pay and other		89,870		23.5			79,786		22.1

Total	$	382,851		100.0	%	$	361,075		100.0	%

We derive a substantial portion of our revenue from government Medicare and Medicaid programs. In addition, our rehabilitation therapy services, for which we receive payment from private payors, are indirectly dependent on Medicare and Medicaid funding, as those private payors are often 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. Part A of the Medicare program includes hospital insurance that helps to cover hospital inpatient care and skilled nursing facility inpatient care under certain circumstances (e.g., up to 100 days of inpatient skilled nursing coverage following a 3-day qualifying hospital stay, and no 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 according to a skilled nursing facilities market basket index.

On July 31, 2009, CMS released its final rule on the fiscal year 2010 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 2.2% market basket increase factor for fiscal year 2010. The fiscal year 2010 market basket adjustment will increase aggregate payments to skilled nursing facilities nationwide by approximately $660.0 million. Additionally, in the final rule, CMS recalibrated the parity adjustment to result in a reduction in payments to skilled nursing facilities by approximately 3.3%, or $1.05 billion. CMS noted that the negative $1.05 billion adjustment described in the final rule will be partially offset by the fiscal year 2010 market basket adjustment factor of 2.2%, or $660.0 million, with a net result of a reduction in payments to skilled nursing facilities of approximately $390.0 million. However, pending federal health reform legislative proposals may eliminate the market basket update provided in the final rule, which elimination could lead to a further reduction in payments to skilled nursing facilities. Given the substantial uncertainty surrounding federal health reform efforts, it is impossible to predict the likelihood of the elimination of the market basket update or any other proposed reductions in payments to skilled nursing facilities. Should federal health reform legislation or subsequent regulatory activities result in the reduction of payments to skilled nursing facilities, the loss of revenue associated with future changes in skilled nursing facility payments could, in the future, have an adverse impact on our financial condition or results of operations.

On July 30, 2009, CMS announced a final rule increasing Medicare payments to hospices in fiscal year 2010 by 1.4%, approximately $170.0 million. CMS said the final rule reflects a 2.1% increase in the market basket, offset by a 0.7% decrease in payments to hospices due to a revised phase out of the wage index budget neutrality adjustment factor, starting with a 10% reduction in fiscal year 2010 and a 15% reduction each year from fiscal year 2011 through fiscal year 2016.

On July 31, 2008, the Centers for Medicare and Medicaid Services, or 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. Additionally, in the final rule issued July 31, 2008, CMS decided to defer consideration of a possible reduction in payments to skilled nursing facilities related to a proposed readjustment to the refinement of nine new case mix groups (the so-called “parity adjustment”) until 2009, when the fiscal year 2010 per diem payment rates are set.

On July 15, 2008, the Medicare Improvement for Patients and Providers Act of 2008 (H.R. 6331) became effective and 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 occupational therapy services for each patient. These caps may result in decreased demand for rehabilitation therapy services that would be otherwise reimbursable 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, but were extended by H.R. 6331 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. H.R. 6331 now includes payment for such telehealth services if the patient is in a skilled nursing facility, and if the services provided are separately payable under the Medicare Physician Fee Schedule when furnished in a face-to-face encounter at a skilled nursing facility, effective January 1, 2009.

Beginning January 1, 2006, the Medicare Modernization Act of December 2003, or MMA, implemented a major expansion of the Medicare program through the introduction of a prescription drug benefit under Medicare Part D. Medicare beneficiaries who elect Part D coverage and are dual eligible beneficiaries, those eligible for both Medicare and Medicaid benefits, are enrolled automatically in Part D and have their outpatient prescription drug costs covered by this Medicare benefit, subject to certain limitations. Most of the skilled nursing facility residents we serve whose drug costs are currently covered by state Medicaid programs are dual eligible beneficiaries. Accordingly, Medicaid is no longer a significant payor for the prescription pharmacy services provided to these residents.

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 2008 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission and “Risk Factors —Reductions in Medicare reimbursement rates, including annual caps that limit the amounts that can be paid for outpatient therapy services rendered to any Medicare beneficiary, 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 2008 Annual Report on Form 10-K/A 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. Providers must accept the Medicaid reimbursement level as payment in full for services rendered. Medicaid programs generally make payments directly to providers, except in cases where the state has implemented a Medicaid managed care program, under which providers receive Medicaid payments from managed care organizations (MCOs) that have subcontracted with the Medicaid program. All states in which we currently do business have all, or a portion of, their Medicaid population enrolled in a Medicaid MCO.

Rapidly increasing Medicaid spending, combined with slow state revenue growth, has led many states to institute measures aimed at controlling spending growth. For example, California initially had extended its cost-based Medi-Cal long-term care reimbursement system enacted through Assembly Bill 1629 (A.B. 1629) through the 2009-2010 and 2010-2011 rate years with a growth rate of up to five percent for both years. However, due to California’s severe budget crisis, on July 24, 2009, the California Legislature passed a budget-balancing proposal that eliminated this five percent growth cap by amending current statute to provide that, for the 2009-2010 and 2010-2011 rate years, the weighted average Medi-Cal reimbursement rate paid to long-term care facilities shall not exceed the weighted average Medi-Cal reimbursement rate for the 2008-2009 rate year. In addition, the budget proposal increased the amounts that California nursing facilities will pay to Medi-Cal in quality assurance fees for the 2009-2010 and 2010-2011 rate years by including Medicare revenue in the calculation of the quality assurance fee that nursing facilities pay under A.B. 1629. California’s Governor signed the budget into law on July 28, 2009. 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 DRA 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 senior 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

During the three and six months ended June 30, 2009, there were no significant changes 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 2008 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission.

Results of Operations

The following table summarizes our key performance indicators, along with other statistics, for each of the periods indicated:


	Three Months Ended						Six Months Ended
	June 30, 2009			June 30, 2008			June 30, 2009			June 30, 2008

Occupancy statistics (skilled nursing facilities):
Available beds in service at end of period		9,123			9,091			9,123			9,091
Available patient days		830,193			827,281			1,639,183			1,642,641
Actual patient days		697,509			696,813			1,382,455			1,393,104
Occupancy percentage		84.0	%		84.2	%		84.3	%		84.8	%
Average daily number of patients		7,665			7,657			7,638			7,654

Revenue per patient day (skilled nursing facilities prior to intercompany eliminations)
LTC only Medicare (Part A)	$	499		$	471		$	498		$	466
Medicare blended rate (Part A &B)		557			518			554			511

Managed care		369			366			368			358

Medicaid		145			135			145			135

Private and other		162			155			162			154
Weighted average for all	$	232		$	222		$	233		$	222

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


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2009			2008			2009			2008
				(As Restated)						(As Restated)
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)		79.8			79.5			79.5			79.3
Rent cost of revenue		2.4			2.5			2.4			2.5
General and administrative		3.5			3.1			3.4			3.3
Depreciation and amortization		3.0			2.8			3.0			2.8

		88.7			87.9			88.3			87.9


Other income (expenses):
Interest expense		(4.3	)		(5.1	)		(4.3	)		(5.2	)
Interest income		0.2			0.1			0.2			0.1
Other income		—			—			—			0.1
Equity in earnings of joint venture		0.4			0.4			0.4			0.3

Total other expenses, net		(3.7	)		(4.6	)		(3.7	)		(4.7	)

Income before provision for income taxes		7.6			7.5			8.0			7.4
Provision for income taxes		3.0			3.0			3.0			2.9

Net income		4.6	%		4.5	%		5.0	%		4.5	%

EBITDA		14.7	%		15.3	%		15.1	%		15.4	%
Adjusted EBITDA		14.7	%		15.3	%		15.1	%		15.4	%


	Three Months Ended				Six Months Ended
Reconciliation of net income to EBITDA and	June 30,				June 30,
Adjusted EBITDA (in thousands):	2009		2008		2009		2008
			(As Restated)				(As Restated)
Net income	$	9,079	$	8,204	$	19,082	$	16,188
Interest expense, net of interest income		7,821		9,039		15,720		18,478
Provision for income taxes		5,736		5,363		11,487		10,530
Depreciation and amortization expense		5,867		5,073		11,344		10,233

EBITDA		28,503		27,679		57,633		55,429
Loss on disposal of asset		—		—		60		—

Adjusted EBITDA	$	28,503	$	27,679	$	57,693	$	55,429

We define EBITDA as net income before depreciation, amortization and interest expense (net of interest income) and the provision for income taxes. EBITDA margin is EBITDA as a percentage of revenue. We calculate Adjusted EBITDA by adjusting EBITDA (each to the extent applicable in the appropriate period) for:

•

the effect of a change in accounting principle, net of tax;

•

the change in fair value of an interest rate hedge;

•

reversal of a charge related to the decertification of a facility;

•

gains or losses on sale of assets;

•

provision for the impairment of long-lived assets; and

•

the write-off of deferred financing costs of extinguished debt.

We believe that the presentation of EBITDA and Adjusted EBITDA provides useful information regarding our operational performance because they enhance the overall understanding of the financial performance and prospects for the future of our core business activities.

Specifically, we believe that a report of EBITDA and Adjusted EBITDA provides consistency in our financial reporting and provides a basis for the comparison of results of core business operations between our current, past and future periods. EBITDA and Adjusted EBITDA are two of the primary indicators management uses for planning and forecasting in future periods, including trending and analyzing the core operating performance of our business from period-to-period without the effect of accounting principles generally accepted in the United States of America, or U.S. GAAP, expenses, revenues and gains that are unrelated to the day-to-day performance of our business. We also use EBITDA and Adjusted EBITDA to prepare operating budgets, to measure our performance against those budgets on a consolidated segment and a facility-by-facility level, analyzing year-over-year trends as described below and to compare our operating performance to that of our competitors.

We typically use Adjusted EBITDA for these purposes at the administrative level (because the adjustments to EBITDA are not generally allocable to any individual business unit) and we typically use EBITDA to compare the operating performance of each skilled nursing and assisted living facility, as well as to assess the performance of our operating segments: long-term care services, which include the operation of our skilled nursing and assisted living facilities; and ancillary services, which include our rehabilitation therapy and hospice businesses. EBITDA and Adjusted EBITDA are useful in this regard because they do not include such costs as interest expense (net of interest income), income taxes, depreciation and amortization expense and special charges, which may vary from business unit to business unit and period-to-period depending upon various factors, including the method used to finance the business, the amount of debt that we have determined to incur, whether a facility is owned or leased, the date of acquisition of a facility or business, the original purchase price of a facility or business unit or the tax law of the state in which a business unit operates. These types of charges are dependent on factors unrelated to our underlying business. As a result, we believe that the use of EBITDA and Adjusted EBITDA provide a meaningful and consistent comparison of our underlying business between periods by eliminating certain items required by U.S. GAAP which have little or no significance in our day-to-day operations.

We also make capital allocations to each of our facilities based on expected EBITDA returns and establish compensation programs and bonuses for our facility-level employees that are based upon the achievement of pre-established EBITDA and Adjusted EBITDA targets.

Finally, we use Adjusted EBITDA to determine compliance with our debt covenants and assess our ability to borrow additional funds and to finance or expand operations. The credit agreement governing our first lien term loan uses a measure substantially similar to Adjusted EBITDA as the basis for determining compliance with our financial covenants, specifically our minimum interest coverage ratio and our maximum total leverage ratio, and for determining the interest rate of our first lien term loan. The indenture governing our 11% senior subordinated notes also uses a substantially similar measurement for determining the amount of additional debt we may incur. For example, both our credit facility and the indenture governing our 11% senior subordinated notes include adjustments for (i) gain or losses on disposal of assets, (ii) the write-off of deferred financing costs of extinguished debt; (iii) reorganization expenses; and (iv) fees and expenses related to our transaction with Onex Corporation affiliates in December 2005. Our noncompliance with these financial covenants could lead to acceleration of amounts due under our credit facility. In addition, if we cannot satisfy certain financial covenants under the indenture for our 11% senior subordinated notes, we cannot engage in certain specified activities, such as incurring additional indebtedness or making certain payments.

Despite the importance of these measures in analyzing our underlying business, maintaining our financial requirements, designing incentive compensation and for our goal setting both on an aggregate and facility level basis, EBITDA and Adjusted EBITDA are non- U.S. GAAP financial measures that have no standardized meaning defined by U.S. GAAP. Therefore, our EBITDA and Adjusted EBITDA measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. Some of these limitations are:

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they do not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;

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they do not reflect changes in, or cash requirements for, our working capital needs;

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they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

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they do not reflect any income tax payments we may be required to make;

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although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements;

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they are not adjusted for all non-cash income or expense items that are reflected in our condensed consolidated statements of cash flows;

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they do not reflect the impact on earnings of charges resulting from certain matters we consider not to be indicative of our ongoing operations; and

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other companies in our industry may calculate these measures differently than we do, which may limit their usefulness as comparative measures.

We compensate for these limitations by using them only to supplement net income on a basis prepared in conformance with U.S. GAAP in order to provide a more complete understanding of the factors and trends affecting our business. We strongly encourage investors to consider net income determined under U.S. GAAP as compared to EBITDA and Adjusted EBITDA, and to perform their own analysis, as appropriate.

Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008

Revenue. Revenue increased $13.1 million, or 7.2%, to $193.4 million in the three months ended June 30, 2009, from $180.3 million in the three months ended June 30, 2008.

Revenue in our long-term care services segment increased $8.6 million, or 5.4%, to $167.6 million in the three months ended June 30, 2009, from $159.0 million in the three months ended June 30, 2008. The increase in long-term care services segment revenue resulted primarily from a $7.4 million, or 4.8%, increase in our skilled nursing facilities revenue and a $1.2 million, or 25.7%, increase in our assisted living facilities revenue. The increase in skilled nursing facilities revenue resulted from a $2.3 million increase due to the opening of the Dallas Center of Rehabilitation and acquisition of The Rehabilitation Center of Des Moines and a $9.7 million increase due to higher rates from Medicare, Medicaid and managed care pay sources offset by a $5.1 million decrease due to a decline in occupancy rates. Our average daily number of skilled nursing patients increased by 8, or 0.1%, to 7,665 in the three months ended June 30, 2009, from 7,657 in the three months ended June 30, 2008. Our average daily Part A Medicare rate increased 5.9% to $499 in the three months ended June 30, 2009, from $471 in the three months ended June 30, 2008 as a result of market basket increases provided under the Medicare program, as well as a higher patient acuity mix from the expansion of our Express Recovery™ Unit services. Our average daily Medicaid rate increased 7.4% to $145 in the three months ended June 30, 2009, from $135 per day in the three months ended June 30, 2008, primarily due to increased Medicaid rates in Texas, California and Missouri. The $1.2 million increase in assisted living facilities revenue is primarily attributed to the acquisition of the Kansas assisted living facilities in September 2008. Our skilled mix declined to 23.6% in the three months ended June 30, 2009, from 24.6% in the three months ended June 30, 2008.

Revenue in our ancillary services segment, excluding intersegment revenue, increased $4.4 million, or 20.6%, to $25.8 million in the three months ended June 30, 2009, from $21.4 million in the three months ended June 30, 2008. This increase in our ancillary services segment revenue resulted from a $3.0 million, or 17.8%, increase in rehabilitation therapy services and a $1.4 million, or 30.7%, increase in revenue from our hospice business. The increase in rehabilitation therapy services revenue resulted primarily from a $2.6 million, or 18.7%, increase in therapy services under existing third party facility contracts due to higher rates, increased census and improved Medicare Part A RUG distribution. Hospice revenue primarily increased due to an increase in our average daily census.

Cost of Services Expenses. Our cost of services expenses increased $10.9 million, or 7.6%, to $154.3 million, or 79.8% of revenue, in the three months ended June 30, 2009, from $143.4 million, or 79.5% of revenue, in the three months ended June 30, 2008.

Cost of services expenses in our long-term care services segment, prior to intersegment eliminations, increased $7.3 million, or 5.7%, to $135.0 million, or 80.5%, of our long-term care services segment revenue in the three months ended June 30, 2009, from $127.7 million, or 80.4%, of our long-term care services segment revenue in the three months ended June 30, 2008.

The increase in long-term care services segment cost of services expenses resulted from a $5.2 million, or 4.3%, increase in cost of services expenses at our skilled nursing facilities, a $1.2 million, or 38.7%, increase in cost of services expenses at our assisted living facilities and a $0.9 million, or 22.5%, increase in our regional operations overhead expense.

Cost of services expenses at our skilled nursing facilities increased $2.2 million due to the opening of our newly constructed building in Texas and acquisition of The Rehabilitation Center of Des Moines, and $3.0 million resulted from operating costs increasing at facilities acquired or developed on or prior to April 1, 2008 by $6 per patient day, or 3.5%, to $179 per patient day in the three months ended June 30, 2009, from $173 per patient day in the three months ended June 30, 2008. The $3.0 million increase in operating costs resulted from a $2.7 million increase in labor costs as a result of a 5.1% increase in average hourly rates and increased staffing, primarily in the nursing area to respond to the increased mix of high-acuity patients, a $0.3 million increase in other expenses such as supplies, taxes, and licenses, due to increased purchasing costs.

Cost of services expenses in our ancillary services segment, prior to intersegment eliminations, increased $3.4 million, or 10.3%, to $36.5 million in the three months ended June 30, 2009, from $33.1 million in the three months ended June 30, 2008. Cost of services expenses were 86.1% of total ancillary services segment revenue of $42.4 million in the three months ended June 30, 2009, as compared to 87.3% of total ancillary services segment revenue of $37.9 million in the three months ended June 30, 2008. The increase in our ancillary services segment cost of services expenses resulted from $2.1 million, or 7.3%, increase in operating expenses related to our rehabilitation therapy services to $30.8 million in the three months ended June 30, 2009, from $28.7 million in the three months ended June 30, 2008, and a $1.3 million, or 29.5%, increase in operating expenses related to our hospice business. Prior to intersegment eliminations, cost of services expenses related to our rehabilitation therapy services were 84.6% of total rehabilitation therapy revenue of $36.4 million in the three months ended June 30, 2009, as compared to 86.2%, of total rehabilitation therapy revenue of $33.3 million in the three months ended June 30, 2008. The increase in rehabilitation therapy margin was primarily due to increased labor productivity. Cost of services expenses related to our hospice services were 95.0% of total hospice revenue of $6.0 million in the three months ended June 30, 2009, as compared to 95.7% of total hospice revenue of $4.6 million in the three months ended June 30, 2008. Cost of services expense in our hospice business continues to be challenged by labor inefficiencies in our California operations.

Rent Cost of Revenue. Rent cost of revenue increased by $0.1 million, or 2.2% to $4.6 million, or 2.4% of revenue, in the three months ended June 30, 2009, from $4.5 million, or 2.5% of revenue, in the three months ended June 30, 2008.

General and Administrative Services Expenses. Our general and administrative services expenses increased $1.2 million, or 21.4%, to $6.8 million, or 3.5% of revenue, in the three months ended June 30, 2009 from $5.6 million, or 3.1% of revenue, in the three months ended June 30, 2008. The increase in our general and administrative expenses was primarily the result of $0.9 million of expense incurred related to the restatement of our financial results.

Depreciation and Amortization. Depreciation and amortization increased by $0.8 million, or 15.7%, to $5.9 million, or 3.0% of revenue, in the three months ended June 30, 2009, from $5.1 million, or 2.8% of revenue, in the three months ended June 30, 2008. This increase primarily resulted from increased depreciation and amortization related to the opening of the Dallas Center of Rehabilitation skilled nursing facility as well as new assets placed in service during 2008 and 2009. We expect that depreciation costs will continue to increase with the opening of our Dallas, Texas, skilled nursing facility and as we place additional Express Recovery™ units in service over the remainder of 2009.

Interest Expense. Interest expense decreased by $1.0 million, or 10.9%, to $8.2 million in the three months ended June 30, 2009, from $9.2 million in the three months ended June 30, 2008. The decrease in our interest expense was primarily due to a decrease in the average interest rate on our debt from 7.0% for the three months ended June 30, 2008, to 5.8% for the three months ended June 30, 2009, which resulted in a $1.4 million savings. Average debt outstanding increased by $14.2 million, from $465.8 million for the three months ended June 30, 2008 to $480.0 million for the three months ended June 30, 2009, which resulted in additional interest expense of $0.2 million. The remainder of the variance in interest expense was due to an increase of $0.3 million in deferred financing fee amortization as a result of fees paid to extend the maturity date of our revolving credit facility in April 2009.

Interest Income. Interest income increased by $0.3 million to $0.4 million in the three months ended June 30, 2009 from $0.1 million in the three months ended June 30, 2008 due to an increase in outstanding notes receivable.

Provision for Income Taxes. Our provision for income taxes for the three months ended June 30, 2009 was $5.7 million, or 38.7% of pre-tax earnings, as compared to $5.4 million and 39.5% of pre-tax earnings for the three months ended June 30, 2008. The increase in tax expense during the three months ended June 30, 2009 was due to a $1.2 million increase in pre-tax earnings as compared to the prior period.

EBITDA. EBITDA increased by $0.8 million, or 2.9%, to $28.5 million in the three months ended June 30, 2009, from $27.7 million in the three months ended June 30, 2008. The $0.8 million increase was primarily related to the $13.1 million increase in revenue for the period offset by the $10.9 million increase in cost of services expenses, $0.1 million increase in rent cost of revenue and $1.2 million increase in general and administrative service expenses, all discussed above.

Net Income. Net income increased by $0.9 million, or 11.0%, to $9.1 million in the three months ended June 30, 2009, from $8.2 million in the three months ended June 30, 2008. The $0.9 million increase was related primarily to the $0.8 million increase in EBITDA, the $0.3 million increase in interest income, and the $1.0 million decrease in interest expense, offset by the $0.3 million increase in income tax expense, and the $0.8 million increase in depreciation and amortization, all discussed above.

Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008

Revenue. Revenue increased $21.8 million, or 6.0%, to $382.9 million in the six months ended June 30, 2009, from $361.1 million in the six months ended June 30, 2008.

Revenue in our long-term care services segment increased $15.4 million, or 4.8%, to $333.1 million in the six months ended June 30, 2009, from $317.8 million in the six months ended June 30, 2008. The increase in long-term care services segment revenue resulted primarily from a $12.6 million, or 4.1%, increase in our skilled nursing facilities revenue and a $2.8 million, or 30.3%, increase in our assisted living facilities revenue. The increase in skilled nursing facilities revenue resulted from a $3.8 million increase due to our April 2008 acquisition of a skilled nursing facility in Kansas, opening of the Dallas Center of Rehabilitation in April 2009, and acquisition of The Rehabilitation Center of Des Moines and a $21.0 million increase due to higher rates from Medicare, Medicaid and managed care pay sources offset by a $13.1 million decrease due to a decline in occupancy rates. Our average daily number of skilled nursing patients decreased by 16, or 0.2%, to 7,638 in the six months ended June 30, 2009, from 7,654 in the six months ended June 30, 2008. Our average daily Part A Medicare rate increased 6.9% to $498 in the six months ended June 30, 2009, from $466 in the six months ended June 30, 2008 as a result of market basket increases provided under the Medicare program, as well as a higher patient acuity mix from the expansion of our Express Recovery™ Unit services. Our average daily Medicaid rate increased 7.4% to $145 in the six months ended June 30, 2009, from $135 per day in the six months ended June 30, 2008, primarily due to increased Medicaid rates in Texas, California and Missouri. The $2.8 million increase in assisted living facilities revenue is primarily attributed to the acquisition of the Kansas assisted living facilities in September 2008. Our skilled mix declined to 24.0% in the six months ended June 30, 2009, from 25.2% in the six months ended June 30, 2008.

Revenue in our ancillary services segment, excluding intersegment revenue, increased $6.4 million, or 14.8%, to $49.7 million in the six months ended June 30, 2009, from $43.3 million in the six months ended June 30, 2008. This increase in our ancillary services segment revenue resulted from a $3.8 million, or 11.0%, increase in rehabilitation therapy services and a $2.7 million, or 29.5%, increase in revenue from our hospice business. The increase in rehabilitation therapy revenue resulted primarily from a $4.0 million increase in therapy services under existing third party facility contracts due to higher rates, increased census and improved Medicare Part A RUG distribution. Hospice revenue primarily increased due to an increase in our average daily census.

Cost of Services Expenses. Our cost of services expenses increased $18.2 million, or 6.4%, to $304.5 million, or 79.5% of revenue, in the six months ended June 30, 2009, from $286.3 million, or 79.3% of revenue, in the six months ended June 30, 2008.

Cost of services expenses in our long-term care services segment, prior to intersegment eliminations, increased $12.5 million, or 4.9%, to $268.3 million, or 80.5%, of our long-term care services segment revenue in the six months ended June 30, 2009, from $255.8 million, or 80.5%, of our long-term care services segment revenue in the six months ended June 30, 2008. The cost of services expenses recorded in the six months ended June 30, 2009 and June 30, 2008, were 80.8% and 80.4% of revenue respectively, excluding the respective $0.9 million decrease and $0.3 million increase in required self-insured general and professional liability and workers’ compensation insurance reserves.

The increase in long-term care services segment cost of services expenses resulted from a $7.1 million, or 2.9%, increase in cost of services expenses at our skilled nursing facilities, a $2.4 million, or 39.3%, increase in cost of services expenses at our assisted living facilities, and a $3.0 million, or 39.0%, increase in our regional operations overhead expense.

Cost of services expenses at our skilled nursing facilities increased $4.1 million due to the acquisition of a Kansas facility in April 2008, opening of the Dallas Center of Rehabilitation and acquisition of The Rehabilitation Center of Des Moines, and $2.9 million resulted from operating costs increasing at facilities acquired or developed prior to January 1, 2008 by $6 per patient day, or 3.4%, to $180 per patient day in the six months ended June 30, 2009, from $174 per patient day in the six months ended June 30, 2008. The $2.9 million increase in operating costs resulted from a $4.5 million increase in labor costs as a result of a 5.6% increase in average hourly rates and increased staffing, primarily in the nursing area to respond to the increased mix of high-acuity patients, offset by a $2.1 million decrease in ancillary costs, and a $0.5 million increase in other expenses such as food, taxes, licenses, and utilities, due to increased purchasing costs.

Cost of services expenses in our ancillary services segment, prior to intersegment eliminations, increased $6.2 million, or 9.5%, to $71.3 million in the six months ended June 30, 2009, from $65.1 million in the six months ended June 30, 2008. Cost of services expenses were 85.5% of total ancillary services segment revenue of $83.4 million in the six months ended June 30, 2009, as compared to 85.2% of total ancillary services segment revenue of $76.4 million in the six months ended June 30, 2008. The increase in our ancillary services segment cost of services expenses resulted from a $3.4 million, or 6.0%, increase in operating expenses related to our rehabilitation therapy services to $60.4 million in the six months ended June 30, 2009, from $57.0 million in the six months ended June 30, 2008, and a $2.8 million, or 34.6%, increase in operating expenses related to our hospice business. Prior to intersegment eliminations, cost of services expenses related to our rehabilitation therapy services were 84.1% of total rehabilitation therapy revenue of $71.8 million in the six months ended June 30, 2009, as compared to 84.6%, of total rehabilitation therapy revenue of $67.4 million in the six months ended June 30, 2008. The increase in rehabilitation therapy margin was primarily due to increased labor productivity. Cost of services expenses related to our hospice services were 94.0% of total hospice revenue of $11.6 million in the six months ended June 30, 2009, as compared to 90.0% of total hospice revenue of $9.0 million in the six months ended June 30, 2008. Cost of services expense in our hospice business continues to be challenged by labor inefficiencies in our California operations.

Rent Cost of Revenue. Rent cost of revenue increased by $0.2 million, or 2.2%, to $9.1 million, or 2.4% of revenue, in the six months ended June 30, 2009, from $8.9 million, or 2.5% of revenue, in the six months ended June 30, 2008.

General and Administrative Services Expenses. Our general and administrative services expenses increased $1.3 million, or 11.0%, to $13.1 million, or 3.4% of revenue, in the six months ended June 30, 2009 from $11.8 million, or 3.3% of revenue, in the six months ended June 30, 2008. The increase in our general and administrative expenses was primarily the result of $0.9 million of expense incurred related to the restatement of our financial results.

Depreciation and Amortization. Depreciation and amortization increased by $1.1 million, or 10.8%, to $11.3 million, or 3.0% of revenue, in the six months ended June 30, 2009, from $10.2 million, or 2.8% of revenue, in the six months ended June 30, 2008. This increase primarily resulted from increased depreciation and amortization related to the opening of the Dallas Center of Rehabilitation skilled nursing facility as well as new assets placed in service during 2008 and 2009. We expect that depreciation costs will continue to increase with the opening of our Dallas, Texas, skilled nursing facility and as we place additional Express Recovery™ units in service over the remainder of 2009.

Interest Expense. Interest expense decreased by $2.5 million, or 13.3%, to $16.3 million in the six months ended June 30, 2009, from $18.8 million in the six months ended June 30, 2008. The decrease in our interest expense was primarily due to a decrease in the average interest rate on our debt from 7.2% for the six months ended June 30, 2008, to 6.0% for the six months ended June 30, 2009, which resulted in a $2.9 million savings. Average debt outstanding increased by $12.1 million, from $466.9 million for the six months ended June 30, 2008 to $479.0 million for the six months ended June 30, 2009, which resulted in additional interest expense of $0.4 million. The remainder of the variance in interest expense was due to a $0.3 million increase in capitalized interest expense related to the development of long-term care facilities and a $0.4 million increase in deferred financing fee amortization as a result of fees paid to extend the maturity date of our revolving credit facility in April 2009.

Interest Income. Interest income increased by $0.3 million, or 100.0%, to $0.6 million in the six months ended June 30, 2009 from $0.3 million in the six months ended June 30, 2008 due to an increase in outstanding notes receivable.

Provision for Income Taxes. Our provision for income taxes for the six months ended June 30, 2009 was $11.5 million, or 37.6% of pre-tax earnings, as compared to $10.5 million and 39.4% of pre-tax earnings for the six months ended June 30, 2008. The increase in tax expense during the six months ended June 30, 2009 was due to a $3.9 million increase in pre-tax earnings as compared to the prior period. The effective rate for the six months ended June 30, 2009 was below our statutory rate as a result of a $0.3 million reduction in our accrual for unrecognized tax benefits due to the expiration of a statute of limitations.

EBITDA. EBITDA increased by $2.2 million, or 4.0%, to $57.6 million in the six months ended June 30, 2009, from $55.4 million in the six months ended June 30, 2008. The $2.2 million increase was primarily related to the $21.8 million increase in revenue for the period offset by the $18.2 million increase in cost of services expenses, $0.2 million increase in rent cost of revenue and $1.3 million increase in general and administrative service expenses, all discussed above.

Net Income. Net income increased by $2.9 million, or 17.9%, to $19.1 million in the six months ended June 30, 2009, from $16.2 million in the six months ended June 30, 2008. The $2.9 million increase was related primarily to the $2.2 million increase in EBITDA, the $0.3 million increase in interest income, and the $2.5 million decrease in interest expense offset by the increase in income tax expense of $1.0 million, and the increase in depreciation and amortization of $1.1 million, all discussed above.

Liquidity and Capital Resources

The following table presents selected data from our condensed consolidated statements of cash flows (in thousands):


	Six Months Ended
	June 30,
	2009			2008
Net cash provided by operating activities	$	28,776		$	26,706
Net cash used in investing activities		(18,993	)		(34,037	)
Net cash provided by financing activities		344			6,032

Net increase (decrease) in cash and equivalents		10,127			(1,299	)
Cash and equivalents at beginning of period		2,047			5,012

Cash and equivalents at end of period	$	12,174		$	3,713

Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008

Our principal sources of liquidity are cash generated by our operating activities and borrowings under our first lien revolving credit facility.

At June 30, 2009, we had cash of $12.2 million. Our available cash is held in accounts at third-party financial institutions. We have periodically invested in AAA money market funds. To date, we have experienced no loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurances that access to our invested cash or cash equivalents will not be impacted by adverse conditions in the financial markets.

Net cash provided by operating activities primarily consists of net income adjusted for certain non-cash items including depreciation and amortization, stock-based compensation, as well as the effect of changes in working capital and other activities. Cash provided by operating activities for the six months ended June 30, 2009 was $28.8 million and consisted of net income of $19.1 million, and adjustments for non-cash items of $20.2 million, offset by $10.5 million used for working capital and other activities. Working capital and other activities primarily consisted of an increase in accounts receivable of $15.1 million, a $1.3 million increase in insurance liability risks and a $1.5 million decrease in accounts payable and accrued liabilities, offset by a $6.1 million decrease in other current and non-current assets, a $0.3 million increase in other long-term liabilities and a $1.0 million increase in employee compensation benefits. The increase in accounts receivable offset by collections was due primarily to an increase in revenue for the six months ended June 30, 2009, as compared to the year ago comparable period. Days sales outstanding decreased slightly from 49.9 for the three months ended December 31, 2008 to 47.6 for the three months ended June 30, 2009. The decrease in accounts payable and accrued liabilities was primarily due to the timing of trade payables.

Net cash provided by operating activities in the six months ended June 30, 2008 was $26.7 million and consisted of net income of $16.2 million and adjustments for non-cash items of $15.9 million, offset by $5.4 million used for working capital and other activities. Working capital and other activities primarily consisted of an increase in accounts receivable of $5.1 million, a $3.2 million increase in accounts payable and accrued liabilities and a $0.4 million decrease in employee compensation benefits, offset by a $1.7 million increase in insurance liability risks, a $0.9 million increase in other long-term liabilities and $0.9 million increase of other current and non-current assets.

Net cash used in investing activities for the six months ended June 30, 2009 of $19.0 million was primarily attributable to capital expenditures of $18.9 million and acquisitions of healthcare facilities of $1.7 million, offset by changes in notes receivable of $1.6 million. The capital expenditures consisted of $5.8 million for construction of new healthcare facilities, $4.2 million for expansion of our Express Recovery™ unit program and $8.9 million of routine capital expenditures.

Net cash used in investing activities for the six months ended June 30, 2008 of $34.0 million was primarily attributable to capital expenditures of $21.2 million, $7.9 million of which related to the development of a skilled nursing facility in Texas and $5.4 million of which related to Express Recovery™ Units being put in place at our existing skilled nursing facilities. The balance of the cash used in investing activities consisted primarily of $13.6 million used to acquire healthcare facilities, $13.2 million of which was used to acquire the real property and assets of a 152-bed skilled nursing facility and an adjacent 34-unit assisted living facility located in Wichita, Kansas.

Net cash provided by financing activities for the six months ended June 30, 2009 of $0.3 million primarily reflects net borrowings under our line of credit of $14.0 million, offset by scheduled debt repayments of $5.7 million and additions to deferred financing fees of $8.0 million.

Net cash provided by financing activities for the six months ended June 30, 2008 of $6.0 million primarily reflects net borrowings under our line of credit of $12.0 million, offset by scheduled debt repayments of $4.6 million and a $1.4 million increase in deferred financing fees.

Principal Debt Obligations and Capital Expenditures

We are significantly leveraged. As of June 30, 2009, we had $478.6 million in aggregate indebtedness outstanding, consisting of $129.5 million principal amount of our 11.0% senior subordinated notes (net of the unamortized portion of the original issue discount of $0.5 million), a $249.6 million first lien senior secured term loan that matures on June 15, 2012, $95.0 million principal amount outstanding under our $135.0 million revolving credit facility, and capital leases and other debt of approximately $4.5 million. Furthermore, we had $4.6 million in outstanding letters of credit against our $135.0 million revolving credit facility, leaving approximately $35.4 million of additional borrowing capacity under our amended senior secured credit facility as of June 30, 2009.

On April 28, 2009, we extended the maturity of the revolving loan commitments under our second amended and restated first lien credit agreement to June 15, 2012. The revolving line of credit has a capacity of $135.0 million through June 15, 2010, and will reduce to $124.0 million thereafter, until its maturity on June 15, 2012. Our costs for the extension include up-front fees and expenses of approximately $8.0 million. The revolving loan will continue to charge interest at our choice of LIBOR plus 2.75% or prime plus 1.75%. The revolving credit facility was previously scheduled to mature on June 15, 2010.

Under the terms of our amended senior secured credit facility, we must maintain compliance with specified financial covenants measured on a quarterly basis, including a minimum interest coverage minimum ratio as well as a maximum leverage ratio. The covenants also include annual and lifetime limitations, including the incurrence of additional indebtedness, liens, investments in other businesses and capital expenditures. Furthermore, in addition to a $2.6 million annual permanent reduction requirement, we must permanently reduce the principal amount of debt outstanding by applying the proceeds from any asset sale, insurance or condemnation payments, issuance of additional indebtedness or equity, and 25% to 50% of excess cash flows from operations based on the leverage ratio then in effect. We believe that we were in compliance with our debt covenants as of June 30, 2009.

Substantially all of our companies guarantee our 11.0% senior subordinated notes, the first lien senior secured term loan and our revolving credit facility. We have no independent assets or operations and the guarantees provided by our companies are both full and unconditional and joint and several.

We intend to invest in the maintenance and general upkeep of our facilities on an ongoing basis. We also expect to perform renovations of our existing facilities every five to ten years to remain competitive. Combined, we expect that these activities will amount to approximately $1,550 per bed, or approximately $16.0 million in capital expenditures in 2009 on our existing facilities. In addition, we are continuing with the expansion of our Express Recovery™ units. These units cost, on average, between $0.4 million and $0.6 million each. We completed 5 Express Recovery™ units as of June 30, 2009. We are in the process of developing an additional 4 Express Recovery™ units that are scheduled to be completed by December 31, 2009.

Our relationship with Baylor Healthcare System offers us the ability to build long-term care facilities selectively on Baylor acute campuses. In the first quarter of 2009, we completed a 136-bed skilled nursing facility in downtown Dallas. We currently have two facilities we are planning and/or developing at or near Baylor Hospitals; one to be located in downtown Fort Worth, on which we broke ground in the first quarter of 2009, and another in a northern suburb of Dallas that is in the design phase.

As of June 30, 2009, we had outstanding purchase commitments of $12.5 million related to our skilled nursing facility currently under development in Forth Worth, Texas, which we expect to complete by the end of 2010. Finally, we may also invest in expansions of our existing facilities and the acquisition or development of new facilities. We currently anticipate that we will incur total capital expenditures in 2009 of approximately $35.0 million to 38.0 million. Due to the proposed slowdown in the growth of Medicare and Medicaid spending, we will continue to assess our capital spending plans going forward. For more detailed information regarding the slowdown in growth of Medicare and Medicaid spending, see “Sources of Revenue—Medicare” in Part I, Item 2 and “Risk Factors” in Part II, Item 1A of this Quarterly Report.

Based upon our current level of operations, we believe that cash generated from operations, cash on hand and borrowings available to us will be adequate to meet our anticipated debt service requirements, capital expenditures and working capital needs for at least the next 12 months. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available under our senior secured credit facilities, or otherwise, to enable us to grow our business, service our indebtedness, including our amended senior secured credit agreement and our 11.0% senior subordinated notes, or make anticipated capital expenditures. One element of our business strategy is to selectively pursue acquisitions and strategic alliances. Any acquisitions or strategic alliances may result in the incurrence of, or assumption by us, of additional indebtedness. We continually assess our capital needs and may seek additional financing through a variety of methods including through an extension of our revolving credit facility or by accessing available debt and equity markets, as considered necessary to fund capital expenditures and potential acquisitions or for other purposes. Our future operating performance, ability to service or refinance our 11.0% senior subordinated notes and ability to service and extend or refinance our senior secured credit facilities and our 11.0% senior subordinated notes will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. For additional discussion, see “Other Factors Affecting Liquidity and Capital Resources—Global Market and Economic Conditions” below in Part 1, Item 2 of this Quarterly Report.

In October 2007, we entered into an interest rate swap agreement in the notional amount of $100.0 million, maturing on December 31, 2009. Under the terms of the swap agreement, we will be required to pay a fixed interest rate of 4.4%, plus a 2.0% margin, or 6.4% in total. In exchange for the payment of the fixed rate amounts, we will receive floating rate amounts equal to the three-month LIBOR rate in effect on the effective date of the swap agreement and the subsequent reset dates, which are the quarterly anniversaries of the effective date. The effect of the swap agreement is to convert $100.0 million of variable rate debt into fixed rate debt, with an effective interest rate of 6.4%.

Other Factors Affecting Liquidity and Capital Resources

Medical and Professional Malpractice and Workers’ Compensation Insurance. Skilled nursing facilities, like physicians, hospitals and other healthcare providers, are subject to a significant number of legal actions alleging malpractice, product liability or related legal theories. Many of these actions involve large claims and significant defense costs. To protect ourselves from the cost of these claims, we maintain professional liability and general liability as well as workers’ compensation insurance in amounts and with deductibles that we believe to be sufficient for our operations. Historically, unfavorable pricing and availability trends emerged in the professional liability and workers’ compensation insurance market and the insurance market in general that caused the cost of these liability coverages to generally increase dramatically. Many insurance underwriters became more selective in the insurance limits and types of coverage they would provide as a result of rising settlement costs and the significant failures of some nationally known insurance underwriters. As a result, we experienced substantial changes in our professional insurance program beginning in 2001. Specifically, we were required to assume substantial self-insured retentions for our professional liability claims. A self-insured retention is a minimum amount of damages and expenses (including legal fees) that we must pay for each claim. We use actuarial methods to estimate the value of the losses that may occur within this self-insured retention level and we are required under our workers’ compensation insurance agreements to post a letter of credit or set aside cash in trust funds to securitize the estimated losses that we may incur. Because of the high retention levels, we cannot predict with absolute certainty the actual amount of the losses we will assume and pay.

We estimate our general and professional liability reserves on a quarterly basis and our workers’ compensation reserve on a semiannual basis, based upon actuarial analyses using the most recent trends of claims, settlements and other relevant data from our own and our industry’s loss history. Based upon these analyses, at June 30, 2009, we had reserved $27.0 million for known or unknown or potential uninsured general and professional liability claims and $14.3 million for workers’ compensation claims. We have estimated that we may incur approximately $7.0 million for general and professional liability claims and $4.1 million for workers’ compensation claims for a total of $11.1 million to be payable within 12 months; however, there are no set payment schedules and we cannot assure you that the payment amount in 2009 will not be significantly larger or smaller. To the extent that subsequent claims information varies from loss estimates, the liabilities will be adjusted to reflect current loss data. There can be no assurance that in the future general and professional liability or workers’ compensation insurance will be available at a reasonable price or that we will not have to further increase our levels of self-insurance. For a detailed discussion of our general and professional liability and workers’ compensation reserve, see “Business — Insurance” in Part 1, Item 1 in our 2008 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission.

Inflation. We derive a substantial portion of our revenue from the Medicare program. We also derive revenue from state Medicaid and similar reimbursement programs. Payments under these programs generally provide for reimbursement levels that are adjusted for inflation annually based upon the state’s fiscal year for the Medicaid programs and in each October for the Medicare program. However, we cannot assure you that these adjustments will continue in the future and, if received, will reflect the actual increase in our costs for providing healthcare services.

Labor and supply expenses make up a substantial portion of our operating expenses. Those expenses can be subject to increase in periods of rising inflation and when labor shortages occur in the marketplace. To date, we have generally been able to implement cost control measures or obtain increases in reimbursement sufficient to offset increases in these expenses. We cannot assure you that we will be successful in offsetting future cost increases.

Global Market and Economic Conditions. Recent global market and economic conditions have been unprecedented and challenging with tight credit conditions and recession in most major economies expected to continue throughout the remainder of 2009 and possibly longer.

As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide credit to borrowers. These factors have led to a decrease in spending by businesses and consumers alike, and a corresponding decrease in global infrastructure spending. Continued turbulence in the U.S. and international markets and economies and prolonged declines in business and consumer spending may adversely affect our liquidity and financial condition. Although we recently were able to extend the maturity of our revolving loan commitments and maintain existing interest rate spreads on that credit facility (see — “Principal Debt Obligations and Capital Expenditures” above), if these market conditions continue, they may impact our ability in the future to timely replace maturing liabilities, access the capital markets to meet liquidity needs, and service or refinance our 11.0% senior subordinated notes and our senior secured credit facilities, resulting in an adverse effect on our financial condition, including liquidity, capital resources and results of operations.

Medicare and Medicaid Reimbursement Climate. Recently proposed slowdowns in the growth of Medicare and Medicaid spending may result in an increase in our costs for providing healthcare services and have an adverse impact on our financial condition, including results of operations. For more detailed information regarding the slowdown in growth of Medicare and Medicaid spending, see “Sources of Revenue—Medicare” in Part I, Item 2 and “Risk Factors” in Part II, Item 1A of this Quarterly Report.

Recent Accounting Standards

See Item 2 of Part I, “Financial Statements — Note 3 — Summary of Significant Accounting Policies — Recent Accounting Pronouncements.”

Off-Balance Sheet Arrangements

We have outstanding letters of credit of $4.6 million under our $135.0 million revolving credit facility as of June 30, 2009.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

In the normal course of business, our operations are exposed to risks associated with fluctuations in interest rates. To the extent these interest rates increase, our interest expense will increase, in which event we may have difficulties making interest payments and funding our other fixed costs, and our available cash flow for general corporate requirements may be adversely affected. We routinely monitor our risks associated with fluctuations in interest rates and consider the use of derivative financial instruments to hedge these exposures. We do not enter into derivative financial instruments for trading or speculative purposes nor do we enter into energy or commodity contracts.

Interest Rate Exposure — Interest Rate Risk Management

We use our senior secured credit facility and 11.0% senior subordinated notes to finance our operations. Our first lien credit agreement exposes us to variability in interest payments due to changes in interest rates. In November 2007, we entered into a $100.0 million interest rate swap agreement in order to manage fluctuations in cash flows resulting from interest rate risk. This interest rate swap changes a portion of our variable-rate cash flow exposure to fixed-rate cash flows at an interest rate of 6.4% until December 31, 2009. We continue to assess our exposure to interest rate risk on an ongoing basis.

The table below presents the principal amounts, weighted-average interest rates and fair values by year of expected maturity to evaluate our expected cash flows and sensitivity to interest rate changes (dollars in thousands):


	Twelve Months Ending June 30,
	2010			2011			2012			2013			2014			Thereafter			Total		Fair Value
Fixed-rate debt ⁽¹⁾	$	839		$	137		$	146		$	155		$	130,165		$	876		$	132,318	$	135,567
Average interest rate		4.8	%		6.0	%		6.0	%		6.0	%		11.0	%		6.0	%

Variable-rate debt	$	2,600		$	2,600		$	339,400		$	—		$	—		$	—		$	344,600	$	319,640
Average interest rate⁽²⁾		3.2	%		4.7	%		5.7	%		—			—			—


(1)		Excludes unamortized original issue discount of $0.5 million on our 11.0% senior subordinated notes.

(2)		Based on implied forward three-month LIBOR rates in the yield curve as of June 30, 2009.

For the six months ended June 30, 2009, the loss recognized from converting from floating rate (three-month LIBOR) to fixed rate from a portion of the interest payments under our long-term debt obligations was approximately $1.5 million. At June 30, 2009, an unrealized loss of $1.1 million (net of income tax) is included in accumulated other comprehensive loss. Below is a table listing the interest expense exposure detail and the fair value of the interest rate swap agreement as of June 30, 2009 (dollars in thousands):

Notional

Trade

Effective

Six Months Ended

Fair Value

Loan

Amount

Date

Maturity

June 30, 2009

(Pre-tax)

First Lien

100,000

10/24/07

10/31/07

12/31/09

715

(1,839

)

The fair value of interest rate swap agreements designated as hedging instruments against the variability of cash flows associated with floating-rate, long-term debt obligations are reported in accumulated other comprehensive income. These amounts subsequently are reclassified into interest expense as a yield adjustment in the same period in which the related interest on the floating-rate debt obligation affects earnings. We evaluate the effectiveness of the cash flow hedge, in accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities, on a quarterly basis. Should the hedge become ineffective, the change in fair value would be recognized in our consolidated statements of operations. Should the counterparty’s credit rating deteriorate to the point at which it would be likely for the counterparty to default, the hedge would be ineffective.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

As required by Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report.

Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding our required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply its judgment in evaluating and implementing possible controls and procedures.

We conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based upon their evaluation and subject to the foregoing, the Chief Executive Officer and Chief Financial Officer have concluded that, as of end of the period covered by this report, the disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required.

Changes in Internal Control Over Financial Reporting

As disclosed in our Form 10-Q/A for the quarter ended March 31, 2009, management identified a material weakness in internal control over financial reporting for the quarter ended March 31, 2009.

In May 2009, a former employee left the employment of the Company after a disciplinary meeting on unrelated matters. During a review of the former employee’s work, we discovered that there had been understatements of the LTC segment accounts receivable allowance for doubtful accounts for the quarterly periods ended March 31, 2006 through March 31, 2009. The former employee performed functions that should have been assigned to other employees, and thereafter reviewed by him and other senior personnel. The former employee improperly manipulated consolidated LTC accounts receivable aging reports used in the allowance for doubtful accounts calculation by transferring balances from delinquent aging categories to more current categories. For the quarters ended March 31, 2006 to June 30, 2007, this was accomplished through worksheets that the former employee prepared by modifying system generated data. For the quarters ended September 30, 2007 to March 31, 2009, the former employee altered the accounts receivable aging by posting transactions to fictitious patient accounts in a test facility which had been a part of the production environment. Our policy is to apply a higher reserve percentage to the more delinquent accounts. Thus, the Company understated the LTC segment accounts receivable allowance for doubtful accounts because we relied on the aging reports produced by the former employee, which made the accounts receivable appear more current.

To remediate the material weakness described above and enhance our internal control over financial reporting, management has implemented the changes listed below.

•

In May 2009, concurrent with the departure of the former employee, we transferred our then Senior Vice President of Reimbursement and Financial Analysis (the “successor SVP”) to fill the vacancy caused by the departure of the former employee. The successor SVP is a qualified Certified Public Accountant with many years of operational finance responsibility with other LTC providers and has been an employee of the Company since July 2007. We have also changed the chain of reporting for the role of the successor SVP. Instead of reporting directly to the President of the Company, the position of the successor SVP now reports directly to the Chief Financial Officer.

•

Access rights to the patient accounts receivable system have been curtailed so that the successor SVP cannot directly post transactions.

•

We have strengthened the design of access and user rights to all of our reporting systems and have implemented routine reviews of such access and user rights. We expect to complete the initial reviews of all of our reporting systems prior to the filing of our Form 10-Q for the quarter ended September 30, 2009.

•

We segregated testing and training environments from the production environment in all key applications.

•

We implemented regularly scheduled segregation of duties reviews for conflicts identified by management, to be performed on each of the applications which have a direct impact on financial reporting. We expect to complete the segregation of duties reviews on each of the applications mentioned above prior to the filing of our Form 10-Q for the quarter ended September 30, 2009.

•

The accounts receivable allowance for doubtful accounts calculation is prepared by the Accounting Department. The allowance for doubtful accounts calculation is then reviewed by the successor SVP as well as by the Chief Accounting Officer for quality control and oversight purposes.

•

We have provided additional training on fraud risk and awareness to management and other key personnel.

•

In April 2009, we hired a Vice President of Internal Audit from a leading registered public accounting firm with an extensive background in Sarbanes-Oxley compliance, internal audit and the LTC industry. She is a Certified Public Accountant.

•

In May 2009, we hired an Assistant Controller from a leading registered public accounting firm with an extensive background in audit, public reporting and the healthcare industry. He is a Certified Public Accountant.

Other than as described above, during the three months ended June 30, 2009, there was no change in our internal control over financial reporting (as defined in Rules 12a-15(f) and 15d-15(f) of the Exchange Act) that has materially affected, or is reasonably likely to affect, our internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

The information required by this Item is incorporated herein by reference to Note 9, “Commitments and Contingencies—Litigation,” to the unaudited condensed consolidated financial statements under Part I, Item 1 of this report.

Item 1A. Risk Factors

For a detailed discussion of the risk factors that should be understood by any investor contemplating investment in our stock, please refer to Part II, Item 1A, Risk Factors, in our Form 10-K/A for the year ended December 31, 2008 filed with the Securities and Exchange Commission. Other than the changes noted below, there has been no material change in our risk factors from those set therein.

A significant portion of our business is concentrated in a few markets, and an economic downturn or changes in the laws affecting our business in those markets could have a material adverse effect on our operating results.

In the six months ended June 30, 2009, we received approximately 44.7% and 25.0% of our revenue from operations in California and Texas, respectively, and in the six months ended June 30, 2008, we received approximately 44.9% and 25.9% of our revenue from operations in California and Texas, respectively. Accordingly, isolated economic conditions and changes in state healthcare spending prevailing in either of these markets could affect the ability of our patients and third-party payors to reimburse us for our services, either through a reduction of the tax base used to generate state funding of Medicaid programs, an increase in the number of indigent patients eligible for Medicaid benefits, changes in state funding levels or healthcare programs or other factors. An economic downturn or changes in the laws affecting our business in these markets could have a material adverse effect on our financial position, results of operations and cash flows.

We expect the federal and state governments to continue their efforts to contain growth in Medicaid expenditures, which could adversely affect our revenue and profitability.

We receive a significant portion of our revenue from Medicaid, which accounted for 31.0% and 30.7% of our total revenue for the six months ended June 30, 2009 and 2008, respectively. In addition, many private payors for our third-party rehabilitation therapy services are reimbursed under the Medicaid program for services that we provided to patients. Accordingly, if Medicaid reimbursement rates are reduced or fail to increase as quickly as our costs, or if there are changes in the rules governing the Medicaid program that are disadvantageous to our business or industry, our business and results of operations could be adversely affected.

Medicaid is a state-administered program financed by both state funds and matching federal funds. Medicaid spending has increased rapidly in recent years, becoming a significant component of state budgets. This, combined with slower state revenue growth, has led both the federal government and many states to institute measures aimed at controlling the growth of Medicaid spending. For example, the DRA included several measures that are expected to reduce Medicare and Medicaid payments to skilled nursing facilities by $100.0 million over five years (2006-2010). These included limiting the circumstances under which an individual may become financially eligible for nursing home services under Medicaid, which could result in fewer patients being able to afford our services. In addition, the presidential budget submitted for federal fiscal year 2009 included proposed reforms of the Medicaid program to cut a total of $18.0 billion in Medicaid expenditures over the next five years. The American Recovery and Reinvestment Act, passed in February 2009, contained several temporary measures expected to increase Medicaid expenditures. In order to qualify for increases in Medicaid matching funds from the federal government, states cannot implement eligibility standards, methodologies or procedures that are more restrictive than those in effect as of July 1, 2008 and, in addition, must comply with prompt pay requirements when making Medicaid payments. We can provide no assurances regarding the temporary measures’ actual effect on Medicaid claims payment in any particular state, whether these temporary measures will eventually be made permanent, or what effect, if any, they will have on our business. Despite these temporary measures, we expect continued efforts to contain Medicaid expenditures generally.

On February 19, 2009, the California legislature approved a new budget to help relieve a $42 billion budget deficit. Signed the following day, the budget package came after months of negotiation, during which time California’s governor, Arnold Schwarzenegger, declared a fiscal state of emergency in California. The new budget implements spending cuts in several areas, including spending on Medi-Cal, California’s Medicaid program. Some of the spending cuts are triggered only if an inadequate amount of federal funding is received from the American Recovery and Reinvestment Act of 2009 described above. Further, California initially had extended its cost-based Medi-Cal long-term care reimbursement system enacted through Assembly Bill 1629 (A.B. 1629) through the 2009-2010 and 2010-2011 rate years with a growth rate of up to five percent for both years. However, due to California’s severe budget crisis, on July 24, 2009, the California Legislature passed a budget-balancing proposal that eliminated this five percent growth cap by amending current statute to provide that, for the 2009-2010 and 2010-2011 rate years, the weighted average Medi-Cal reimbursement rate paid to long-term care facilities shall not exceed the weighted average Medi-Cal reimbursement rate for the 2008-2009 rate year. In addition, the budget proposal increased the amounts that California nursing facilities will pay to Medi-Cal in quality assurance fees for the 2009-2010 and 2010-2011 rate years by including Medicare revenue in the calculation of the quality assurance fee that nursing facilities pay under A.B. 1629. California’s Governor signed the budget into law on July 28, 2009.

Any decrease in California’s Medi-Cal spending for skilled nursing facilities could adversely affect our financial condition and results of operation. We expect continuing cost containment pressures on Medicaid outlays for skilled nursing facilities both in the states in which we operate and by the federal government. These may take the form of both direct decreases in reimbursement rates or in rule changes that limit the beneficiaries, services or providers eligible to receive Medicaid benefits. For a description of other currently proposed reductions in Medicaid expenditures and a description of the implementation of the Medicaid program in the states in which we operate, see Part I, Item 2 of this report, “Revenue— Regulatory and Other Governmental Actions Affecting Revenue.”

Healthcare reform legislation could adversely affect our revenue and financial condition.

In recent years, there have been numerous initiatives on the federal and state levels for comprehensive reforms affecting the payment for, the availability of, and reimbursement for, healthcare services in the United States. These initiatives have ranged from proposals to fundamentally change federal and state healthcare reimbursement programs, including to provide comprehensive healthcare coverage to the public under governmental funded programs, to minor modifications to existing programs. The ultimate content or timing of any future healthcare reform legislation, and its impact on us, is impossible to predict. If significant reforms are made to the U.S. healthcare system, those reforms may have an adverse effect on our financial condition and results of operations.

In addition, we incur considerable administrative costs in monitoring the changes made within the various reimbursement programs, determining the appropriate actions to be taken in response to those changes and implementing the required actions to meet the new requirements and minimize the repercussions of the changes to our organization, reimbursement rates and costs.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

We held our 2009 annual meeting of stockholders on May 7, 2009.

The stockholders voted to elect Jose C. Lynch and Michael D. Stephens to serve as Class II directors until our 2012 annual meeting of stockholders and until their respective successors are duly elected and qualified. The results of the vote (cast in person or by proxy) are as follows:


	Mr. Lynch		Mr. Stephens
For		169,453,704		182,280,066
Withheld From		15,251,637		2,425,275

Total Votes		184,705,341		184,705,341

The stockholders also voted to ratify the selection of Ernst & Young LLP as our independent registered public accounting firm. The results of the vote (cast in person or by proxy) are as follows:


	Number of
	Votes
For		184,649,003
Against		50,963
Abstain		5,375

Total Votes		184,705,341
Broker Non-Votes		0

Item 5. Other Information

None.

Item 6. Exhibits

(a) Exhibits.


Number		Description

	31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	32	Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

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


	SKILLED HEALTHCARE GROUP, INC.
Date: August 4, 2009	/s/ Devasis Ghose
	Devasis Ghose
	Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer and Authorized Signatory)

	/s/ Christopher N. Felfe
	Christopher N. Felfe
	Senior Vice President, Finance and Chief Accounting Officer (Principal Accounting Officer and Authorized Signatory)

EXHIBIT INDEX


Number		Description

	31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	32	Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.