RESULTS OF OPERATIONS

Our reportable segments consist of our senior living community business and our rehabilitation hospital business. In the senior living community segment, we operate independent living, congregate care communities, assisted living communities and skilled nursing facilities, or SNFs. Our rehabilitation hospital segment provides inpatient rehabilitation services at two hospital locations and three satellite locations and outpatient rehabilitation services at 14 outpatient clinics. We do not consider our institutional pharmacy operations to be a material, separately reportable segment of our business but we report our institutional pharmacy revenues and expense as separate items within our corporate and other activities. All of our operations and assets are located in the United States, except for our two captive insurance companies that participate in our workers' compensation and liability insurance programs and which are located in Bermuda and the Cayman Islands.

We use segment operating profit as an important measure to evaluate our performance and for internal business decision making purposes. Segment operating profit excludes interest and other income, interest and other expense and certain corporate expenses.

Key Statistical Data (for the three months ended March 31, 2009 and 2008):

The following tables present a summary of our operations for the three months ended March 31, 2009 and 2008:

Senior living communities:

                                               Three months ended March 31,
(dollars in thousands, except
average daily rate)                    2009          2008        $ Change      % Change
Senior living revenue               $  252,206    $  216,927    $    35,279        16.3 %
Senior living wages and benefits      (128,085 )    (109,094 )      (18,991 )      17.4 %
Other senior living operating
expenses                               (61,828 )     (53,421 )       (8,407 )      15.7 %
Rent expense                           (41,214 )     (32,794 )       (8,420 )      25.7 %
Depreciation and amortization
expense                                 (3,157 )      (2,440 )         (717 )      29.4 %
Interest and other expense                (202 )        (306 )          104       (34.0 )%
Interest and other income                  272           951           (679 )     (71.4 )%
Senior living income from
continuing operations               $   17,992    $   19,823    $    (1,831 )      (9.2 )%

No. of communities (end of
period)                                    210           183             27        14.8 %
No. of living units (end of
period)                                 22,260        19,666          2,594        13.2 %
Occupancy %                               86.5 %        89.6 %          n/a        (3.1 )%
Average daily rate                  $   146.69    $   142.30    $      4.39         3.1 %
Percent of senior living revenue
from Medicare                             14.9 %        16.1 %          n/a        (1.2 )%
Percent of senior living revenue
from Medicaid                             16.0 %        17.8 %          n/a        (1.8 )%
Percent of senior living revenue
from private and other sources            69.1 %        66.1 %          n/a         3.0 %

Comparable communities (senior living communities that we have operated continuously since January 1, 2008):

                                                Three months ended March 31,
(dollars in thousands, except
average daily rates)                     2009         2008       $ Change     % Change
Senior living revenue                 $  217,542   $  214,752   $     2,790        1.3 %
Senior living community expenses      $ (165,219 ) $ (161,007 ) $    (4,212 )      2.6 %
No. of communities (end of period)           168          168             -          -
No. of living units (end of period)       18,652       18,652             -          -
Occupancy %                                 87.5 %       89.7 %         n/a       (2.2 )%
Average daily rate                    $   149.46   $   142.43   $      7.03        4.9 %
Percent of senior living revenue
from Medicare                               16.8 %       16.1 %         n/a        0.7 %
Percent of senior living revenue
from Medicaid                               18.0 %       17.9 %         n/a        0.1 %
Percent of senior living revenue
from private and other sources              65.2 %       66.0 %         n/a       (0.8 )%

Rehabilitation hospitals:

                                              Three months ended March 31,
(dollars in thousands)               2009          2008         $ Change     % Change
Rehabilitation hospital
revenues                          $    24,694   $    24,744   $        (50 )      (0.2 )%
Rehabilitation hospital
expenses                              (22,899 )     (22,592 )         (307 )       1.4 %
Rent expense                           (2,786 )      (2,650 )         (136 )       5.1 %
Depreciation and amortization
expense                                   (37 )        (308 )          271       (88.0 )%
Rehabilitation hospital loss
from continuing operations        $    (1,028 ) $      (806 ) $       (222 )     (27.5 )%

Corporate and Other:(1)

                                               Three months ended March 31,
(dollars in thousands)                  2009         2008       $ Change     % Change
Institutional pharmacy revenue       $   18,265   $   17,206   $     1,059        6.2 %
Institutional pharmacy expenses         (18,373 )    (16,203 )      (2,170 )     13.4 %
Depreciation and amortization
expense                                    (983 )       (887 )         (96 )     10.8 %
General and administrative(2)           (12,442 )    (11,133 )      (1,309 )     11.8 %
Unrealized gain on investments in
trading securities                        3,516       (3,270 )       6,786     (207.5 )%
Unrealized loss on UBS put right
related to auction rate
securities                               (3,527 )          -        (3,527 )        -
Impairment on investments in
available for sale securities            (2,947 )          -        (2,947 )        -
Gain on early extinguishment of
debt                                     25,125            -        25,125          -
Interest and other income                   859        1,543          (684 )    (44.3 )%
Interest and other expense                 (979 )     (1,288 )         309      (24.0 )%
Provision for income taxes                 (516 )       (566 )          50       (8.8 )%
Corporate and Other income (loss)
from continuing operations           $    7,998   $  (14,598 ) $    22,596      154.8 %

(2) General and administrative expenses are not attributable to a specific segment and include items such as corporate payroll and benefits and third party service expenses.

Consolidated:



                                            Three months ended March 31,
(dollars in thousands)             2009          2008         $ Change     % Change
Summary of revenue:
Senior living revenue           $   252,206   $   216,927   $     35,279        16.3 %
Rehabilitation hospital
revenue                              24,694        24,744            (50 )      (0.2 )%
Corporate and other                  18,265        17,206          1,059         6.2 %
Total revenue                   $   295,165   $   258,877   $     36,288        14.0 %

Summary of income from
continuing operations:
Senior living communities       $    17,992   $    19,823   $     (1,831 )      (9.2 )%
Rehabilitation hospitals             (1,028 )        (806 )         (222 )     (27.5 )%
Corporate and other                   7,998       (14,598 )       22,596       154.8 %
Income from continuing
operations                      $    24,962   $     4,419   $     20,543       464.9 %

Three Months Ended March 31, 2009, Compared to Three Months Ended March 31, 2008

Senior living communities:

The 16.3% increase in senior living revenue for the three months ended March 31, 2009 was due primarily to revenues from the 42 communities we began to operate after January 1, 2008 and increased per diem charges, partially offset by a decrease in occupancy. The 1.3% increase in senior living revenue at the communities that we have operated continuously since January 1, 2008 was due primarily to increased per diem charges, partially offset by a decrease in occupancy.

Our 17.4% increase in senior living wages and benefits costs for the three months ended March 31, 2009 was primarily due to wages and benefits from the 42 communities we began to operate after January 1, 2008 and wage increases. The 15.7% increase in other senior living operating expenses, which include utilities, housekeeping, dietary, maintenance, insurance and community level administrative costs, primarily resulted from the other operating expenses at the 42 communities we began to operate after January 1, 2008. The senior living community expenses for the senior living communities that we have operated continuously since January 1, 2008 have increased by 2.6%, due primarily to increases in wages and benefits. The 25.7% rent expense increase was due to the 33 communities that we began to lease after January 1, 2008 and our payment of additional rent for senior living community capital improvements purchased by Senior Housing since January 1, 2008.

The 29.4% increase in depreciation and amortization expense for the three months ended March 31, 2009 was primarily attributable to our acquisition of ten communities after January 1, 2008 and our purchase of furniture and fixtures for our owned communities.

Interest and other expense decreased by 34.0%, for the three months ended March 31, 2009, primarily due to our September 2008 prepayment of two HUD insured mortgages secured by one of our communities.

Interest and other income decreased by $679,000, or 71.4%, for the three months ended March 31, 2009, primarily as a result of the recognition in the first quarter of 2008 of an $840,000 gain related to the 2003 sale of a property that was previously deferred until the buyer paid our note receivable related to the sale.

Rehabilitation hospitals:

The 0.2% decrease in rehabilitation hospital revenues for the three months ended March 31, 2009 was primarily due to lower Medicare payment rates and a decrease in occupancy.

The 1.4% increase in rehabilitation hospital expenses for the three months ended March 31, 2009 was primarily due to increases in labor and benefit expenses.

The 5.1% increase in rent expense for the three months ended March 31, 2009 was due to our payment of additional rent for rehabilitation hospital capital improvements purchased by Senior Housing since January 1, 2008.

The 88.0% decrease in depreciation and amortization expense for the three months ended March 31, 2009 was primarily attributable to our write off of long lived assets in the fourth quarter of 2008, partially offset by our purchase of computers and related information technology equipment.

Corporate and other:

The 6.2% increase in institutional pharmacy revenues for the three months ended March 31, 2009 was primarily the result of adding new customers from our senior living and third party senior living communities.

The 13.4% increase in institutional pharmacy expenses for the three months ended March 31, 2009 was primarily the result of adding new customers from our senior living and third party senior living communities and additional expenses related to the opening of a new business office and one satellite pharmacy located in Nebraska.

The 11.8% increase in general and administrative expenses for the three months ended March 31, 2009 was primarily the result of the costs associated with the 47 communities we began to operate in 2008.

The 10.8% increase in depreciation and amortization expense for the three months ended March 31, 2009 was primarily attributable to our purchase of furniture and fixtures and computers and related information technology equipment for our pharmacies and corporate and regional offices.

Our interest and other income decreased by $684,000, or 44.3%, for the three months ended March 31, 2009 primarily as a result of lower cash available for investment and lower interest rates earned on our cash investments.

Our interest and other expense decreased by $309,000, or 24.0%, primarily as a result of our retirement of $46.5 million of our outstanding Notes.

During the three months ended March 31, 2009, we recognized:

† an unrealized gain of $3.5 million on investments in trading securities, principally related to our holdings of auction rate securities, or ARS;

† an unrealized loss of $3.5 million on the value of our UBS put right;

† an "other than temporary" loss of $2.9 million on investments in available for sale securities.

In January 2009, we purchased and retired $46.5 million par value of our outstanding Notes for $20.0 million, plus accrued interest. As a result of this transaction we recorded a gain on extinguishment of debt of $25.1 million during the first quarter of 2009.

For the three months ended March 31, 2009, we recognized tax expenses of $516,000, which includes tax expense of $186,000 for state taxes payable on operating income and state tax expense of $330,000 attributable to the gain on extinguishment of debt, each payable without regard to our tax loss carry forwards.

LIQUIDITY AND CAPITAL RESOURCES

For the three months ended March 31, 2009, we had $23.1 million of cash flows from continuing operations. As of March 31, 2009, we had unrestricted cash and cash equivalents of $28.4 million. We had no amounts outstanding on our $40.0 million revolving line of credit and $37.1 million outstanding and $2.7 million available under our line with UBS. We believe that our operations will continue to provide us with adequate cash flow to run our businesses and invest in and maintain our properties. If, however, our occupancy continues to decline and we are unable to generate positive cash flow for some period of time, we intend to further reduce costs or to borrow additional funds from our outstanding lines of credit.

Auction Rate Securities

At March 31, 2009, we had $66.4 million invested in student loan ARS with a par value of $74.8 million which we classified as long term investments in trading securities. The funds which we invested in ARS were held to invest in potential acquisitions. Accordingly, these funds are not needed to fund our current operations. Based upon our expected operating cash flows and other sources of cash, we do not expect the failure of auctions affecting our ARS holdings to have a material adverse impact upon our day to day operations or our ability to meet our liquidity needs.

In November 2008, we entered into a settlement with UBS regarding our ARS. The settlement offer was made in connection with UBS's settlement with the Securities and Exchange Commission, the New York Attorney General and other state agencies related to UBS's sale and marketing of ARS. Under the terms of the settlement, we obtained a put right pursuant to which UBS will repurchase our ARS at 100% of par value (including accrued and unpaid interest, if any) at our option during the period beginning June 2010 and ending July 2012. In certain circumstances, UBS has the right to purchase these securities earlier at par. As part of the settlement terms, we released UBS from all claims arising from its marketing of the ARS to us. In connection with the settlement, UBS provided us with a non-recourse credit facility secured by our investments in these ARS. The principal amount available to us under the credit facility is up to 60% of the market value of the ARS from time to time. As of March

31, 2009, the estimated fair value of our investment in ARS was $66.4 million, we had borrowings of $37.1 million outstanding under the credit facility and $2.7 million available for future borrowings. Our interest rate under the credit facility varies depending on the interest payable to us on the ARS, but will not exceed LIBOR plus 50 basis points.

We expect to sell our ARS by exercising our put right with UBS. However, if we do not exercise our put right before July 2, 2012, it will expire and UBS will have no further right or obligation to buy our ARS. The value of the put right is the difference between our estimated value of UBS' repurchase obligation and our estimate of the fair value of the ARS. Accordingly, the value of the put right may increase or decrease as our estimate of the value of UBS' repurchase obligation and our estimate of the fair value of the ARS changes. We reassess the fair values in each reporting period based on several factors, including auction and investment redemption experience, changes in credit ratings of UBS and our ARS investments, market risk and other factors. During the quarter ended March 31, 2009 we had an unrealized gain of $3.5 million on our investments in ARS and we recognized a corresponding $3.5 million decrease in the fair value of the put right.

Assets and Liabilities

Our total current assets at March 31, 2009 were $116.3 million, compared to $114.3 million at December 31, 2008. At March 31, 2009, we had cash and cash equivalents of $28.4 million compared to $16.1 at December 31, 2008. Our current liabilities were $135.8 million at March 31, 2009, compared to $129.1 million at December 31, 2008.

We had cash flows from continuing operations of $23.1 million for the first three months of 2009 as compared with $21.7 million for the same period of 2008. Acquisitions of property plant and equipment, on a net basis after considering the proceeds from sales of fixed assets to Senior Housing, were $6.2 million and $2.1 million for the three month periods ended March 31, 2009 and 2008, respectively. During the first three months of 2009, we purchased and retired $46.5 million par value of our Notes for $20.0 million plus accrued interest.

Our Leases with Senior Housing

As of March 31, 2009, we leased 181 senior living communities and two rehabilitation hospitals from Senior Housing under seven leases (in four combinations). Our leases with Senior Housing require us to pay minimum rent of $173.9 million annually and percentage rent for most senior living communities but not for our rehabilitation hospitals. We paid approximately $639,000 and $1.0 million in percentage rent to Senior Housing for the three months ended March 31, 2009 and 2008, respectively.

Upon our request, Senior Housing may purchase capital improvements made at the properties we lease from Senior Housing and increase our rent pursuant to contractual formulas. During the three months ended March 31, 2009, Senior Housing reimbursed us $12.7 million for capital expenditures made at the properties leased from Senior Housing and these purchases resulted in our annual rent being increased by $1.0 million.

Our Revenues

Our revenues from services to residents at our senior living communities and patients of our rehabilitation hospitals and clinics are our primary source of cash to fund our operating expenses, including rent, principal and interest payments on our debt and our capital expenditures.

During the past year, our occupancy has been negatively affected by worsening economic conditions in many of the markets that we serve. These conditions appear to be impacting many companies both within and outside of our industry and there can be no certainty as to when current economic conditions may improve.

At some of our senior living communities and at our rehabilitation hospitals and clinics, operating revenues for skilled nursing and rehabilitation services are received from the Medicare and Medicaid programs. Medicare and Medicaid revenues were earned primarily at our SNFs and rehabilitation hospitals. We derived 33.8% and 37.2% of our revenues from these programs during the three months ended March 31, 2009 and 2008, respectively.

Our net Medicare revenues from services to senior living community residents totaled $37.2 million and $34.6 million for the three months ended March 31, 2009 and 2008, respectively. In October 2008 our senior living community

Medicare rates increased by approximately 3.5% over the prior period. Our net Medicaid revenues from services to senior living community residents totaled $39.9 million and $38.2 million for the three months ended March 31, 2009 and 2008, respectively. Federal agencies and some members of Congress have proposed Medicare and Medicaid policy changes and freezes on rate increases or rate reductions to be phased in during the next several years. The Federal Centers for Medicare and Medicaid Services, or CMS, has recently proposed rules that it estimates would decrease aggregate Medicare payments to SNFs by approximately 1.2% in federal fiscal year 2010. In addition, some of the states in which we operate either have not raised Medicaid rates by amounts sufficient to offset increasing costs or are expected to freeze or reduce Medicaid rates. The current recession and worsening economic conditions are causing budget shortfalls in many states, increasing the likelihood of Medicaid rate reductions, freezes on rate increases, or increases that are insufficient to offset increasing operating costs. The magnitude of the potential Medicare and Medicaid rate reductions and the impact on us of the failure of these programs to increase rates to match increasing expenses, as well as the impact on us of the potential Medicare and Medicaid policy changes, cannot currently be estimated, but they may be material to our operations and may affect our future results of operations. Effective as of October 1, 2008 CMS increased Medicare rates for SNFs by approximately 3.5% for the federal fiscal year ending September 30, 2009, under a rule adding an annual update to account for inflation in the cost of goods and services included in a SNF stay. CMS had proposed a recalibration of the payment categories for SNFs, which would have resulted in a net reduction of rates by approximately 0.3% in federal fiscal year 2009, but delayed the recalibration in order to continue to evaluate the data. CMS has recently issued proposed rules recalibrating the Medicare prospective payment categories for SNFs for federal fiscal year 2010. If CMS adopts the proposed rules, the recalibration will result in a decrease of approximately 3.3% in projected SNF payments, offset by a proposed increase of approximately 2.1% to account for inflation. As a result, CMS anticipates that aggregate Medicare payments for SNFs would be reduced by approximately 1.2% in fiscal year 2010, for discharges on or after October 1, 2009. On July 15, 2008, as part of the Medicare Improvements for Patients and Providers Act of 2008, Congress enacted an 18-month extension of the Medicare outpatient therapy exception process through the end of 2009, under which Medicare may approve payments for medically necessary outpatient therapies which exceed the Medicare payment caps. This July 15, 2008 law forestalls a reduction in certain therapy revenues that we have historically realized.

Approximately 63.4% and 66.3% of our revenues from our two rehabilitation hospitals came from the Medicare and Medicaid programs for the three months ended March 31, 2009 and 2008, respectively. In October 2007, the Medicare rates at our inpatient rehabilitation facilities, or IRFs, increased by approximately 3.2% over the prior period. However, this increase was later rescinded and, for payments on and after April 1, 2008, the Medicare rate increase was reset to zero per cent for federal fiscal years 2008 and 2009. Also, on July 1, 2008, CMS issued a rule updating the Medicare IRF prospective rate formulas for the federal fiscal year 2009. The rule revises the weights assigned to patient case-mix groups that are used to calculate rates under the IRF prospective payment system, and re-sets the outlier threshold to maintain estimated outlier payments at 3% of total estimated IRF payments for the year. CMS estimated that the rule would result in a decrease of 0.7% to total Medicare payments to IRFs for the year. CMS has recently proposed an increase of approximately 2.4% to Medicare prospective payment rates at IRFs for fiscal year 2010, to account for inflation and update the outlier payment limits. If adopted, this increase would take effect as of October 1, 2009. In May 2004, CMS issued the "75% Rule" establishing revised Medicare criteria that rehabilitation hospitals are required to meet in order to participate as IRFs in the Medicare program. As recently amended, the rule requires that for cost reporting periods starting on and after July 1, 2006, 60% of a facility's inpatient population must require intensive rehabilitation services for one of the CMS's designated medical conditions. An IRF that fails to meet the requirements of this rule is subject to reclassification as a different type of healthcare provider; and the effect of such reclassification would be to lower Medicare payment rates. As of March 31, 2009 and May 6, 2009, we believe we are in compliance with the CMS requirements to remain an IRF. However, the actual percentage of patients at these hospitals who meet these Medicare requirements may not be or remain as high as we believe or anticipate or may decline. Our failure to remain in compliance, or a CMS finding of noncompliance, if it occurs, will result in our receiving lower Medicare rates than we currently receive at our rehabilitation hospitals.

Debt Financings and Covenants

In October 2006, we issued $126.5 million principal amount of Notes. These Notes are convertible into our common shares at any time. The initial conversion rate, which is subject to adjustment, is 76.9231 common shares per $1,000 principal amount of Notes, which represents an initial conversion price of $13.00 per share. The Notes are guaranteed by certain of our wholly owned subsidiaries. These Notes mature on October 15, 2026. We may

prepay the Notes at any time after October 20, 2011 and the Note holders may require that we purchase all or a portion of these Notes on each of October 15 of 2013, 2016 and 2021. We issued these Notes pursuant to an indenture which contains various customary covenants. As of March 31, 2009 and May 6, 2009, we believe we are in compliance with all applicable covenants of this indenture.

In January 2009, we purchased and retired $46.5 million par value, or 36.8%, of our outstanding Notes for $20.0 million plus accrued interest. We financed this purchase, principally by borrowings under our UBS credit facility. As a result of this transaction, we recorded a gain of $25.1 million net of related . . .