December 15, 2006 - 10-Q: Quarterly report pursuant to Section 13 or 15(d)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2006

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 1-11316

OMEGA HEALTHCARE

INVESTORS, INC.

(Exact name of Registrant as specified in its charter)

Maryland		38-3041398
(State of Incorporation)		(I.R.S. Employer Identification No.)

9690 Deereco Road, Suite 100, Timonium, MD 21093
(Address of principal executive offices)

(410) 427-1700
(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 the filing requirements for the past 90 days.

Yes x

No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of accelerated filer and larger accelerated filer in Rule 12b-2 of the Exchange Act. (Check one:)

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o

No x

Indicate the number of shares outstanding of each of the issuers classes of common stock as November 30, 2006.

Common Stock, $.10 par value		59,703,258
(Class)		(Number of shares)

OMEGA HEALTHCARE INVESTORS, INC.
FORM 10-Q
September 30, 2006

TABLE OF CONTENTS

		Page No.
PART I	Financial Information

Item 1.	Financial Statements:
	Consolidated Balance Sheets
	September 30, 2006 (unaudited) and December 31, 2005 (audited & restated)	2

	Consolidated Statements of Operations (unaudited)
	Three and nine months ended September 30, 2006 and 2005 (restated)	3

	Consolidated Statements of Cash Flows (unaudited)
	Nine months ended September 30, 2006 and 2005 (restated)	4

	Notes to Consolidated Financial Statements
	September 30, 2006 (unaudited)	5

Item 2.	Managements Discussion and Analysis of Financial Condition
	and Results of Operations	26

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	52

Item 4.	Controls and Procedures	53

PART II	Other Information

Item 1.	Legal Proceedings	54

Item 1A.	Risk Factors	54

Item 5.	Other Information	54

Item 6.	Exhibits	55

PART I FINANCIAL INFORMATION

Item 1 Financial Statements

OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

	September 30,			December 31,
	2006			2005
	(Unaudited)			(Restated)
ASSETS
Real estate properties
Land and buildings at cost	$	1,240,398		$	996,127
Less accumulated depreciation	(180,270		)	(157,255		)
Real estate properties net	1,060,128			838,872
Mortgage notes receivable net	32,185			104,522
	1,092,313			943,394
Other investments net	37,327			28,918
	1,129,640			972,312
Assets held for sale net	737			1,243
Total investments	1,130,377			973,555

Cash and cash equivalents				3,948
Accounts receivable net	39,488			15,018
Other assets	13,189			37,769
Total assets	$	1,183,054		$	1,030,290

LIABILITIES AND STOCKHOLDERS EQUITY
Revolving line of credit	$	157,500		$	58,000
Unsecured borrowings net	484,735			505,429
Other long term borrowings	41,410			2,800
Accrued expenses and other liabilities	27,813			19,563
Income tax liabilities	5,038			3,299
Operating liabilities for owned properties	98			256
Total liabilities	716,594			589,347

Stockholders equity:
Preferred stock	118,488			118,488
Common stock and additional paid-in-capital	695,948			663,607
Cumulative net earnings	279,357			237,069
Cumulative dividends paid	(585,397		)	(536,041		)
Cumulative dividends redemption	(43,067		)	(43,067		)
Unamortized restricted stock awards				(1,167		)
Accumulated other comprehensive income	1,131			2,054
Total stockholders equity	466,460			440,943
Total liabilities and stockholders equity	$	1,183,054		$	1,030,290

Note  The balance sheet at December 31, 2005 has been restated and derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See notes to consolidated financial statements.

OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
(in thousands, except per share amounts)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005 (Restated)			2006			2005 (Restated)
Revenues
Rental income	$	33,153		$	24,858		$	93,056		$	70,329
Mortgage interest income	1,054			1,221			3,392			4,417
Other investment income net	994			867			2,878			2,364
Miscellaneous	42			141			483			4,453
Total operating revenues	35,243			27,087			99,809			81,563

Expenses
Depreciation and amortization	8,360			6,182			23,414			17,872
General and administrative	5,669			2,235			10,331			6,470
Provision for impairment on real estate properties				3,072						3,072
Provision for uncollectible mortgages, notes and accounts receivable	179						179			83
Leasehold expiration expense										750
Total operating expenses	14,208			11,489			33,924			28,247

Income before other income and expense	21,035			15,598			65,885			53,316
Other income (expense):
Interest and other investment income	189			25			371			90
Interest	(11,190		)	(7,709		)	(30,246		)	(21,431		)
Interest amortization of deferred financing costs	(439		)	(539		)	(1,513		)	(1,570		)
Interest refinancing costs							(3,485		)
Provision for impairment on equity securities										(3,360		)
Gain on sale of equity securities	2,709						2,709
Change in fair value of derivatives	1,764			(16		)	9,672			(427		)
Total other expense	(6,967		)	(8,239		)	(22,492		)	(26,698		)

Income before gain on assets sold	14,068			7,359			43,393			26,618
Gain on assets sold net	1,188						1,188
Income from continuing operations before income taxes	15,256			7,359			44,581			26,618
Provision for income taxes	(600		)	(588		)	(1,739		)	(1,776		)
Income from continuing operations	14,656			6,771			42,842			24,842
(Loss) from discontinued operations	(33		)	(1,087		)	(554		)	(7,061		)
Net income	14,623			5,684			42,288			17,781
Preferred stock dividends	(2,480		)	(2,481		)	(7,442		)	(8,904		)
Preferred stock conversion and redemption charges										(2,013		)
Net income available to common	$	12,143		$	3,203		$	34,846		$	6,864

Income per common share:
Basic:
Income from continuing operations	$	0.21		$	0.08		$	0.61		$	0.27
Net income	$	0.21		$	0.06		$	0.60		$	0.13
Diluted:
Income from continuing operations	$	0.20		$	0.08		$	0.61		$	0.27
Net income	$	0.20		$	0.06		$	0.60		$	0.13

Dividends declared and paid per common share	$	0.24		$	0.22		$	0.71		$	0.63

Weighted-average shares outstanding, basic	59,021			51,187			58,203			51,050
Weighted-average shares outstanding, diluted	59,446			51,479			58,407			51,386

Components of other comprehensive income:
Net income	$	14,623		$	5,684		$	42,288		$	17,781
Unrealized gain on common stock investment				730			1,580			730
Reclassification adjustment for gain on common stock investment	(1,740		)				(1,740		)
Unrealized loss on preferred stock investment	(172		)	(332		)	(763		)	(959		)
Total comprehensive income	$	12,711		$	6,082		$	41,365		$	17,552

See notes to consolidated financial statements.

OMEGA HEALTHCARE INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited (in thousands)

	Nine Months Ended September 30,
	2006			2005 (Restated)
Operating activities
Net income	$	42,288		$	17,781
Adjustment to reconcile net income to cash provided by operating activities:
Depreciation and amortization (including amounts in discontinued operations)	23,432			19,068
Provision for impairment on real estate properties (including amounts in discontinued operations)	121			9,154
Provision for uncollectible mortgages, notes and accounts receivable	179			83
Provision for impairment on equity securities				3,360
Refinancing costs	3,485
Amortization of deferred financing costs	1,513			1,570
(Gains) losses on assets sold and equity securities net	(3,516		)	3,492
Restricted stock amortization expense	4,224			856
Change in fair value of derivatives	(9,672		)	428
Income from accretion of marketable securities to redemption value	(1,155		)	(1,225		)
Other	(35		)	(1,532		)
Net change in accounts receivable	(24,650		)	(1,276		)
Net change in other assets	1,941			2,087
Net change in tax liabilities	1,739			1,776
Net change in operating assets and liabilities	8,121			(363		)
Net cash provided by operating activities	48,015			55,259

Cash flows from investing activities
Acquisition of real estate	(178,906		)	(120,696		)
Proceeds from sale of stock	7,573
Proceeds from sale of real estate investments	1,527			25,937
Capital improvements and funding of other investments	(5,416		)	(2,749		)
Proceeds from other investments	27,092			1,759
Investments in other investments	(29,238		)	(6,167		)
Collection of mortgage principal net	10,588			60,869
Net cash used in investing activities	(166,780		)	(41,047		)

Cash flows from financing activities
Proceeds from credit facility borrowings	234,200			180,200
Payments on credit facility borrowings	(134,700		)	(114,500		)
Receipts from other long-term borrowings	39,000
Payments of other long-term borrowings	(390		)	(370		)
Prepayment of re-financing penalty	(755		)
Receipts from dividend reinvestment plan	29,161			2,415
Receipts/(payments) from exercised options net	225			(984		)
Dividends paid	(49,356		)	(41,914		)
Redemption of preferred stock				(50,013		)
Payment on common stock offering	(178		)	(28		)
Deferred financing costs paid	(2,390		)	(333		)
Net cash provided by (used in) financing activities	114,817			(25,527		)

(Decrease) increase in cash and cash equivalents	(3,948		)	(11,315		)
Cash and cash equivalents at beginning of period	3,948			12,083
Cash and cash equivalents at end of period	$			$	768
Interest paid during the period	$	21,442		$	18,949

See notes to consolidated financial statements.

OMEGA HEALTHCARE INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
September 30, 2006

NOTE 1 BASIS OF PRESENTATION

Business Overview

We have one reportable segment consisting of investments in real estate. Our business is to provide financing and capital to the long-term healthcare industry with a particular focus on skilled nursing facilities located in the United States. Our core portfolio consists of long-term lease and mortgage agreements. All of our leases are triple-net leases, which require the tenants to pay all property-related expenses. Our mortgage revenue derives from fixed-rate mortgage loans, which are secured by first mortgage liens on the underlying real estate and personal property of the mortgagor. Substantially all depreciation expenses reflected in the consolidated statements of operations relate to the ownership of our investment in real estate.

Restated Financial Data

We have restated certain historical results in the accompanying consolidated financial statements to correct errors in previously reported amounts related to income tax matters and certain debt and equity investments in Advocat Inc. (Advocat), as well as to record certain straight-line rental income. See Note 2 Restatement of Previously Issued Financial Statements.

Basis of Presentation

The accompanying unaudited consolidated financial statements for Omega Healthcare Investors, Inc. (Omega or the Company) have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain reclassifications have been made to the 2005 financial statements for consistency with the presentation adopted for 2006. Such reclassifications have no effect on previously reported earnings or equity.

Operating results for the three- and nine-month periods ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the financial statements and footnotes included in our annual report on Form 10-K/A for the year ended December 31, 2005.

Our consolidated financial statements include the accounts of Omega, all direct and indirect wholly owned subsidiaries and one variable interest entity (VIE) for which we are the primary beneficiary. All inter-company accounts and transactions have been eliminated in consolidation of the financial statements.

FAS 123R Adoption

In December 2004, the Financial Accounting Standards Board (FASB) issued FAS No. 123 (revised 2004), Share-Based Payment (FAS No. 123R), which is a revision of FAS No. 123, Accounting for Stock-Based Compensation. FAS No. 123R supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and amends FAS No. 95, Statement of Cash Flows. We adopted FAS No. 123R on January 1, 2006.

FIN 46R

Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities, (FIN 46R), addresses the consolidation by business enterprises of VIEs. As a result of the adoption of FIN 46R, we consolidate all VIEs for which we are the primary beneficiary. Generally, a VIE is an entity with one or more of the following characteristics: (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support; (b) as a group the holders of the equity investment at risk lack (i) the ability to make decisions about an entitys activities through voting or similar rights, (ii) the obligation to absorb the expected losses of the entity, or (iii) the right to receive the expected residual returns of the entity; or (c) the equity investors have voting rights that are not proportional to their economic interests, and substantially all of the entitys activities either involve, or are conducted on behalf of, an investor that has disproportionately few voting rights. FIN 46R requires a VIE to be consolidated in the financial statements of the entity that is determined to be the primary beneficiary of the VIE. The primary beneficiary generally is the entity that will receive a majority of the VIEs expected losses, receive a majority of the VIEs expected residual returns, or both.

In accordance with FIN 46R, we determined that we were the primary beneficiary of one VIE. This VIE is derived from a financing relationship entered into between Omega and one company that is engaged in the ownership and rental of six skilled nursing facilities (SNFs) and one assisted living facility (ALF). The consolidation of the VIE as of September 30, 2006 resulted in an increase in our consolidated total assets (primarily real estate) and liabilities (primarily indebtedness) of approximately $37.8 million. The creditors of the VIE do not have recourse to our assets.

FIN 48 Evaluation

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 is an interpretation of FASB Statement No. 109, Accounting for Income Taxes, and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective as of the beginning of our 2007 fiscal year. We are currently evaluating the impact, if any, that FIN 48 will have on our financial statements.

NOTE 2 RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

Summary of Restatement Items

Our Board of Directors, including our Audit Committee, concluded on October 24, 2006, to restate our audited financial results as of December 31, 2005 and 2004 and for the three years ended December 31, 2005, 2004 and 2003 and for other periods affected, including our unaudited financial statements for each quarterly period in 2004, 2005 and 2006 as necessary. As a result, we have previously filed with the Securities and Exchange Commission (SEC) amendments to our Annual Report on Form 10-K for the period ending December 31, 2005 and our Quarterly Reports on Form 10-Q for the three-month periods ended March 31, 2006 and June 30, 2006, respectively, reflecting the restated matters (the Restatement). The Restatement reflects the following adjustments that affect the three- and nine-months ended September 30, 2005.

1. We recorded asset values for securities received from Advocat (and the increases therein) since the completion of the restructuring of Advocat obligations pursuant to leases and mortgages for the facilities then operated by Advocat in 2000. These adjustments increased net income by $0.4 million and $0.8 million for the three and nine months ended September 30, 2005, respectively. These adjustments increased total assets by $5.4 million as of December 31, 2005. Changes in the fair value of the securities not currently recognized in net income were reflected in other comprehensive income.

2. As a result of our holdings of Advocat securities, we recorded reserves related to a potential tax liability arising from our ownership of such securities. This tax liability along with related interest expense had not been previously accrued for and this adjustment decreased net income by $0.6 million and $1.8 million for the three and nine months ended September 30, 2005, respectively. The amount accrued represents the estimated liability, which remains subject to final resolution and therefore is subject to change.

3. Subsequent to October 25, 2006, we made a correction to our accounting for certain leases because these leases contain provisions (such as increases in rent based on the lesser of a fixed amount or two times the Consumer Price Index (CPI)) that require us to record rental income on a straight-line basis subject to an appropriate evaluation of collectibility. We had not previously recorded rental income on these leases on a straight-line basis. As a result of this adjustment, our net income increased by $0.8 million and $2.1 million for the three and nine months ended September 30, 2005, respectively. In addition, net accounts receivable and retained earnings increased by $9.1 million as of December 31, 2005, to reflect the effects of this adjustment from inception of the affected leases.

Additional information about the decision to restate these financial statements can be found in our Current Report on Form 8-K, filed with the SEC on October 25, 2006.

Events Causing the Restatement Advocat Restructuring

In November 2000, Advocat, an operator of various skilled nursing facilities owned by or mortgaged to us, was in default on its obligations to us. As a result, we entered into an agreement with Advocat with respect to the restructuring of Advocats obligations pursuant to leases and mortgages for the facilities then operated by Advocat (the Initial Advocat Restructuring). As part of the Initial Advocat Restructuring in 2000, Advocat issued to us (i) 393,658 shares of Advocats Series B non-voting, redeemable (on or after September 30, 2007), convertible preferred stock, which was convertible into up to 706,576 shares of Advocats common stock (representing 9.9% of the outstanding shares of Advocats common stock on a fully diluted, as-converted basis and accruing dividends at 7% per annum), and (ii) a secured convertible subordinated note in the amount of $1.7 million bearing interest at 7% per annum with a September 30, 2007 maturity.

Subsequent to the Initial Advocat Restructuring, Advocats operations and financial condition have improved and there has been a significant increase in the market value of Advocats common stock from approximately $0.31 per share at the time of the Initial Advocat Restructuring to the closing price on October 20, 2006 of $18.84. As a result of the significant increase in the value of the common stock underlying the Series B preferred stock of Advocat held by us, on October 20, 2006 we again restructured our relationship with Advocat (the Second Advocat Restructuring) by entering into a Restructuring Stock Issuance and Subscription Agreement with Advocat (the 2006 Advocat Agreement). Pursuant to the 2006 Advocat Agreement, we exchanged the Advocat Series B preferred stock and subordinated note issued in the Initial Advocat Restructuring for 5,000 shares of Advocats Series C non-convertible, redeemable (at our option after September 30, 2010) preferred stock with a face value of approximately $4.9 million and a dividend rate of 7% payable quarterly, and a secured non-convertible subordinated note in the amount of $2.5 million maturing September 30, 2007 and bearing interest at 7% per annum. As part of the Second Advocat Restructuring, we also amended our Consolidated Amended and Restated Master Lease by and between one of our subsidiaries, as lessor, and a subsidiary of Advocat, as lessee, to commence a new 12-year lease term through September 30, 2018 (with a renewal option for an additional 12 year term) and Advocat has agreed to increase the master lease annual rent by approximately $687,000 to approximately $14 million commencing on January 1, 2007.

Management believes that certain of the terms of the Advocat Series B preferred stock previously held by us could be interpreted as affecting our compliance with federal income tax rules applicable to real estate investment trusts (REITs) regarding related party tenant income as described below.

In 2000 at the time of the Initial Advocat Restructuring, we determined that no value should be ascribed to the Advocat preferred stock and subordinated note and, as a result, no value was recorded on our financial statements at that time or in any subsequent period. Management now believes that the accounting treatment in previous periods was incorrect and, in addition to the related party tenant issues described below, the Restatement reflects the appropriate carrying value (in accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS No. 115)) of the Advocat preferred stock of $4.6 million and $4.3 million and an embedded derivative (in accordance with FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS No. 133)) of $9.0 million and $1.1 million on our restated balance sheets as of June 30, 2006 and December 31, 2005, respectively. In addition, in accordance with FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan (FAS No. 114), the Advocat subordinated note of $1.7 million was fully reserved at September 30, 2006 and December 31, 2005, respectively.

The market value for Advocats common stock has increased significantly since the completion of the Initial Advocat Restructuring. In connection with exploring the potential disposition of the Advocat Series B preferred stock as part of the Second Advocat Restructuring, we were advised by our tax counsel that due to the structure of the Initial Advocat Restructuring, Advocat may be deemed to be a related party tenant under applicable federal income tax rules and, in such event, rental income from Advocat would not be qualifying income under the gross income tests that are applicable to REITs.

In order to maintain qualification as a REIT, we annually must satisfy certain tests regarding the source of our gross income. The applicable federal income tax rules provide a savings clause for REITs that fail to satisfy the REIT gross income tests, if such failure is due to reasonable cause. A REIT that qualifies for the savings clause will retain its REIT status but will pay a tax under section 857(b)(5) and related interest.

We currently plan to submit to the IRS a request for a closing agreement to resolve the related party tenant issue. While we believe there are valid arguments that Advocat should not be deemed a related party tenant, the matter is not free from doubt, and we believe it is in our best interest to request a closing agreement in order to resolve the matter, minimize potential interest charges and obtain assurances regarding its continuing REIT status. By submitting a request for a closing agreement, we intend to establish that any failure to satisfy the gross income tests was due to reasonable cause. In the event that it is determined that the savings clause described above does not apply, we could be treated as having failed to qualify as a REIT for one or more taxable years. If we fail to qualify for taxation as a REIT for any taxable year, our income will be taxed at regular corporate rates, and we could be disqualified as a REIT for the following four taxable years.

As noted above, we have completed the Second Advocat Restructuring and have been advised by tax counsel that we will not receive any non-qualifying related party tenant income from Advocat in future fiscal years. Accordingly, we do not expect to incur tax expense associated with related party tenant income in future periods commencing January 1, 2007. We will continue to accrue an income tax liability related to this matter during 2006.

Recording of Rental Income

During the course of preparing the Restatement due to the issues related to Advocat described above, we determined that we should correct our accounting for certain leases because these leases contain provisions (such as increases in rent based on the lesser of a fixed amount or two times CPI) that require us to record rental income on a straight-line basis subject to an appropriate evaluation of collectibility. Historically, we have recorded rental income for leases with these provisions based on

contractual scheduled rent payments, rather than on a straight-line basis. In accordance with Statement of Financial Accounting Standard (SFAS) No. 13, Accounting for Leases and Financial Accounting Standards Board Technical Bulletin No. 88-1 Issues Related to Accounting for Leases, we have determined that the recording of rental revenue associated with these leases should be on a straight-line basis. As a result of this adjustment, our net income will increase by $1.1 million and $3.0 million for the three and nine months ended September 30, 2005, respectively. In addition, accounts receivable and retained earnings will increase by $9.1 million as of December 31, 2005, to reflect the effects of this adjustment from inception of the affected leases.

The following table sets forth the effects of the adjustments related to the Restatement on our consolidated balance sheet as of December 31, 2005:

CONSOLIDATED BALANCE SHEETS
(Audited)
(in thousands)

	As of December 31, 2005,
	As Reported			Adjustments		Restated
ASSETS
Real estate properties
Land and buildings at cost	$	996,127		$		$	996,127
Less accumulated depreciation	(157,255		)			(157,255		)
Real estate properties net	838,872					838,872
Mortgage notes receivable net	104,522					104,522
	943,394					943,394
Other investments net	23,490			5,428		28,918
	966,884			5,428		972,312
Assets held for sale net	1,243					1,243
Total investments	968,127			5,428		973,555

Cash and cash equivalents	3,948					3,948
Accounts receivable net	5,885			9,133		15,018
Other assets	37,769					37,769
Total assets	$	1,015,729		$	14,561	$	1,030,290

LIABILITIES AND STOCKHOLDERS EQUITY
Revolving line of credit	$	58,000		$		$	58,000
Unsecured borrowings net	505,429					505,429
Other long-term borrowings	2,800					2,800
Accrued expenses and other liabilities	19,563					19,563
Income tax liabilities				3,299		3,299
Operating liabilities for owned properties	256					256
Total liabilities	586,048			3,299		589,347

Stockholders equity:
Preferred stock	118,488					118,488
Common stock and additional paid-in-capital	663,607					663,607
Cumulative net earnings	227,701			9,368		237,069
Cumulative dividends paid	(536,041		)			(536,041		)
Cumulative dividends redemption	(43,067		)			(43,067		)
Unamortized restricted stock awards	(1,167		)			(1,167		)
Accumulated other comprehensive income	160			1,894		2,054
Total stockholders equity	429,681			11,262		440,943
Total liabilities and stockholders equity	$	1,015,729		$	14,561	$	1,030,290

The effects of the adjustments related to the Restatement for the three and nine months ended September 30, 2005 are summarized below:

	Three Months Ended September 30, 2005
	As Reported(1)			Adjustments			Restated
Revenues
Rental income	$	24,099		$	759		$	24,858
Mortgage interest income	1,221						1,221
Other investment income net	457			410			867
Miscellaneous	141						141
Total operating revenues	25,918			1,169			27,087

Expenses
Depreciation and amortization	6,182						6,182
General and administrative	2,235						2,235
Provision for impairment on real estate properties	3,072						3,072
Provision for uncollectible mortgages, notes and accounts receivable
Leasehold expiration expense
Total operating expenses	11,489						11,489

Income before other income and expense	14,429			1,169			15,598
Other income (expense):
Interest and other investment income	25						25
Interest	(7,709		)				(7,709		)
Interest amortization of deferred financing costs	(539		)				(539		)
Provision for impairment on equity securities
Change in fair value of derivatives				(16		)	(16		)
Total other expense	(8,223		)	(16		)	(8,239		)

Income from continuing operations before income taxes	6,206			1,153			7,359
Provision for income taxes				(588		)	(588		)
Income from continuing operations	6,206			565			6,771
Loss from discontinued operations	(1,087		)				(1,087		)
Net income	5,119			565			5,684
Preferred stock dividends	(2,481		)				(2,481		)
Preferred stock conversion and redemption charges
Net income available to common	$	2,638		$	565		$	3,203

Income per common share:
Basic:
Income from continuing operations	$	0.07		$	0.01		$	0.08
Net income	$	0.05		$	0.01		$	0.06
Diluted:
Income from continuing operations	$	0.07		$	0.01		$	0.08
Net income	$	0.05		$	0.01		$	0.06

Dividends declared and paid per common share	$	0.22		$			$	0.22

Weighted-average shares outstanding, basic	51,187						51,187
Weighted-average shares outstanding, diluted	51,479						51,479

Components of other comprehensive income:
Net income	$	5,119		$	565		$	5,684
Unrealized gain on common stock investment	730						730
Reclassification adjustment for gains on common stock investment
Unrealized (loss) on preferred stock investment				(332		)	(332		)
Total comprehensive income	$	5,849		$	233		$	6,082

(1) Includes current period reclassification for discontinued operations.

	Nine Months Ended September 30, 2005
	As Reported (1)			Adjustments			Restated
Revenues
Rental income	$	68,251		$	2,078		$	70,329
Mortgage interest income	4,417						4,417
Other investment income net	1,139			1,225			2,364
Miscellaneous	4,453						4,453
Total operating revenues	78,260			3,303			81,563

Expenses
Depreciation and amortization	17,872						17,872
General and administrative	6,470						6,470
Provision for impairment on real estate properties	3,072						3,072
Provision for uncollectible mortgages, notes and accounts receivable	83						83
Leasehold expiration expense	750						750
Total operating expenses	28,247						28,247

Income before other income and expense	50,013			3,303			53,316
Other income (expense):
Interest and other investment income	90						90
Interest	(21,431		)				(21,431		)
Interest amortization of deferred financing costs	(1,570		)				(1,570		)
Provision for impairment on equity securities	(3,360		)				(3,360		)
Change in fair value of derivatives				(427		)	(427		)
Total other expense	(26,271		)	(427		)	(26,698		)

Income from continuing operations before income taxes	23,742			2,876			26,618
Provision for income taxes				(1,776		)	(1,776		)
Income from continuing operations	23,742			1,100			24,842
Loss from discontinued operations	(7,061		)				(7,061		)
Net income	16,681			1,100			17,781
Preferred stock dividends	(8,904		)				(8,904		)
Preferred stock conversion and redemption charges	(2,013		)				(2,013		)
Net income available to common	$	5,764		$	1,100		$	6,864

Income per common share:
Basic:
Income from continuing operations	$	0.25		$	0.02		$	0.27
Net income	$	0.11		$	0.02		$	0.13
Diluted:
Income from continuing operations	$	0.25		$	0.02		$	0.27
Net income	$	0.11		$	0.02		$	0.13

Dividends declared and paid per common share	$	0.63		$			$	0.63

Weighted-average shares outstanding, basic	51,050						51,050
Weighted-average shares outstanding, diluted	51,386						51,386

Components of other comprehensive income:
Net income	$	16,681		$	1,100		$	17,781
Unrealized gain (loss) on common stock investment	730						730
Reclassification adjustment for gains on common stock investment
Unrealized (loss) gain on preferred stock investment				(959		)	(959		)
Total comprehensive income	$	17,411		$	141		$	17,552

(1) Includes current period reclassification for discontinued operations.

NOTE 3 PROPERTIES

In the ordinary course of our business activities, we periodically evaluate investment opportunities and extend credit to customers. We also regularly engage in lease and loan extensions and modifications. Additionally, we actively monitor and manage our investment portfolio with the objectives of improving credit quality and increasing returns. In connection with portfolio management, we may engage in various collection and foreclosure activities.

If we acquire real estate pursuant to a foreclosure, lease termination or bankruptcy proceeding and do not immediately re-lease or sell the properties to new operators, the assets will be included on the balance sheet as foreclosed real estate properties, and the value of such assets is reported at the lower of cost or estimated fair value.

The table below summarizes our number of properties and investment by category for the nine months ended September 30, 2006:

				Mortgage						Total
	Leased			Notes			Facilities			Healthcare
Facility Count	Property			Receivable			Held for Sale			Facilities
Balance at December 31, 2005	192			32			3			227
Properties sold/mortgages paid				(15		)	(3		)	(18		)
Properties acquired	32									32
Properties transferred to assets held for sale	(2		)				2
Properties transferred to purchase/leaseback	7			(7		)
Balance at September 30, 2006	229			10			2			241

Investment ($000s)
Balance at December 31, 2005	$	996,127		$	104,522		$	1,243		$	1,101,892
Properties transferred to assets held for sale	(1,354		)				1,354
Properties sold/mortgages paid				(48,990		)	(1,860		)	(50,850		)
Properties acquired	178,906									178,906
Properties transferred to purchase/leaseback	61,750			(22,750		)				39,000
Impairment on properties	(121		)							(121		)
Capital expenditures and other	5,090			(597		)				4,493
Balance at September 30, 2006	$	1,240,398		$	32,185		$	737		$	1,273,320

Leased Property

Our leased real estate properties, represented by 227 long-term care facilities and two rehabilitation hospitals at September 30, 2006, are leased under provisions of single leases and master leases with initial terms typically ranging from 5 to 15 years, plus renewal options. Substantially all of our leases contain provisions for specified annual increases over the rents of the prior year and are generally computed in one of three methods depending on specific provisions of each lease as follows: (i) a specific annual increase over the prior years rent, generally 2.5%; (ii) an increase based on the change in pre-determined formulas from year to year (i.e., such as increases in the CPI); or (iii) specific dollar increases over prior years. Under the terms of the leases, the lessee is responsible for all maintenance, repairs, taxes and insurance on the leased properties.

Set forth below is a summary of the transactions that occurred in the nine months ended September 30, 2006.

Litchfield Transaction

On August 1, 2006, we completed a transaction with Litchfield Investment Company, LLC and its affiliates (Litchfield) to purchase 30 skilled nursing facilities and one independent living center for a total investment of approximately $171 million. The facilities total 3,847 beds and are located in the states of Colorado (5), Florida (7), Idaho (1), Louisiana (13), and Texas (5). The facilities were subject to master leases with three national healthcare providers, which are existing tenants of the Company. The

tenants are Home Quality Management, Inc. (HQM), Nexion Health, Inc. (Nexion), and Peak Medical Corporation, which was acquired by Sun Healthcare Group, Inc. (Sun) in December of 2005. We used a combination of cash on hand and $150 million of credit facility borrowings to finance the Litchfield transaction.

Simultaneously with the close of the purchase transaction, the seven HQM facilities were combined into an Amended and Restated Master Lease containing 13 facilities between us and HQM. In addition, the 18 Nexion facilities were combined into an Amended and Restated Master Lease containing 22 facilities between us and Nexion.

We entered into a Master Lease, Assignment and Assumption Agreement with Litchfield on the six Sun facilities. These six facilities are currently under a master lease that expires on September 30, 2007.

Guardian LTC Management, Inc.

On September 1, 2006, we completed a $25.0 million investment with subsidiaries of Guardian LTC Management, Inc. (Guardian), an existing operator of ours. The transaction involved the purchase and leaseback of a skilled nursing facility (SNF) in Pennsylvania and a termination of a purchase option on a combination SNF and rehabilitation hospital in West Virginia owned by us. The facilities were included in an existing master lease with Guardian with an increase in contractual annual rent of approximately $2.6 million in the first year and the master lease now includes 17 facilities. In addition, the master lease term was extended from October 2014 through August 2016.

In accordance with FASB Statement No. 13, Accounting Leases (FAS No. 13) and FASB Technical Bulletin No. 88-1, Issues Relating to Accounting for Leases (FASB TB No. 88-1), $19.2 million of the $25.0 million transaction amount will be accounted for as a lease inducement and is classified within accounts receivable net on our consolidated balance sheet. The lease inducement will be amortized as a reduction to rental income on a straight-line basis over the term of the new master lease. The remaining payment to Guardian of $5.8 million will be allocated to the purchase of the Pennsylvania SNF.

Advocat, Inc.

On October 20, 2006, as part of the Second Advocat Restructuring, we amended our master lease with Advocat to commence a new 12-year lease term through September 30, 2018 (with a renewal option for an additional 12 year term) and Advocat agreed to increase the master lease annual rent by approximately $687,000 to approximately $14 million commencing on January 1, 2007. See Note 2 Restatement of Previously Issued Financial Statements.

The Second Advocat Restructuring will be accounted for as a new lease in accordance with FAS No. 13 and FASB TB No. 88-1. The fair value of the assets exchanged in the restructuring (i.e., the Series B non-voting redeemable convertible preferred stock and the secured convertible subordinated note, with a fair value of $14.9 million and $2.5 million, respectively, at October 20, 2006) in excess of the fair value of the assets received (the Series C non-voting redeemable non-convertible preferred stock and the secured non-convertible subordinated note, with a fair value of $4.1 million and $2.5 million, respectively, at October 20, 2006) will be recorded as a lease inducement of approximately $10.8 million in the fourth quarter of 2006. The $10.8 million lease inducement asset will be amortized as a reduction to rental income on a straight-line basis over the term of the new master lease. The exchange of securities will also result in a gain in the fourth quarter of 2006 of approximately $3.0 million representing: (i) the fair value of the secured convertible subordinated note of $2.5 million, previously reserved; (ii) the realization of the gain on investments previously classified in other comprehensive income of approximately $1.1 million relating to the Series B non-voting redeemable convertible preferred stock; and (iii) a loss of approximately

$0.6 million resulting from the change in the fair value of the embedded derivative from September 30, 2006 to October 20, 2006. See also Note 8 Investments in Debt and Equity Securities.

Haven Eldercare, LLC

· During the three months ended March 31, 2006, Haven Eldercare, LLC (Haven), an existing operator of ours, entered into a $39 million first mortgage loan with General Electric Capital Corporation (GE Loan). Haven used the $39 million of proceeds to partially repay on a $62 million mortgage it has with us. Simultaneously, we subordinated the payment of our remaining $23 million of the mortgage note, due in October 2012, to that of the GE Loan. As a result of this transaction, the interest rate on our remaining mortgage note to Haven rose from 10% to approximately 15%, with annual escalators.

· In conjunction with the above transactions and the application of FIN 46R, we consolidated the financial statements and related real estate of this Haven entity into our financial statements. The consolidation resulted in the following changes to our consolidated balance sheet as of September 30, 2006: (1) an increase in total gross investments of $39.0 million; (2) an increase in accumulated depreciation of $1.2 million; (3) an increase in other long-term borrowings of $39.0 million; and (4) a reduction of $1.2 million in cumulative net earnings for the nine months ended September 30, 2006 due to the increased depreciation expense. General Electric Capital Corporation and Havens other creditors do not have recourse to our assets. We have an option to purchase the mortgaged facilities for a fixed price in 2012. Our results of operations reflect the effects of the consolidation of this entity, which is being accounted for similarly to our other purchase-leaseback transactions.

Acquisitions

The table below summarizes the acquisitions completed during the nine months ended September 30, 2006. The purchase price includes estimated transaction costs.

100% Interest Acquired	Acquisition Date	Purchase Price ($000s)
One facility in PA	September 1, 2006	$	5,800
Thirty-one facilities in 5 states	August 1, 2006	173,100

The acquired properties are included in our results of operations from the respective date of acquisition. The following unaudited pro forma results of operations reflect these transactions as if each had occurred on January 1 of the year presented. According to management, all significant adjustments necessary to reflect the effects of the acquisitions have been made.

	Pro Forma
	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005 (Restated)		2006		2005 (Restated)
	(in thousands, except per share amounts)
Revenues	$	36,854	$	31,776	$	110,797	$	95,629
Net income	$	14,784	$	6,184	$	43,450	$	19,282

Earnings (loss) per share Basic	$	0.21	$	0.07	$	0.62	$	0.16
Earnings (loss) per share Diluted	$	0.21	$	0.07	$	0.62	$	0.16

Assets Sold or Held for Sale

Assets Sold

· On June 30, 2006, we sold two SNFs in California resulting in an accounting loss of approximately $0.1 million.

· On March 31, 2006, we sold a SNF in Illinois resulting in an accounting loss of approximately $0.2 million.

Held for Sale

· At September 30, 2006, we had two assets held for sale with a net book value of approximately $0.7 million.

· During the three months ended March 31, 2006, a $0.1 million provision for impairment charge was recorded to reduce the carrying value to its sales price of one facility that was under contract to be sold that was subsequently sold during the second quarter of 2006.

Mortgage Notes Receivable

Mortgage notes receivable relate to ten long-term care facilities. The mortgage notes are secured by first mortgage liens on the borrowers underlying real estate and personal property. The mortgage notes receivable relate to facilities located in five states, operated by seven independent healthcare operating companies. We monitor compliance with mortgages and when necessary have initiated collection, foreclosure and other proceedings with respect to certain outstanding loans. As of September 30, 2006, we had no foreclosed property, and none of our mortgages were in foreclosure proceedings.

Mortgage interest income is recognized as earned over the terms of the related mortgage notes. Reserves are taken against earned revenues from mortgage interest when collection of amounts due becomes questionable or when negotiations for restructurings of troubled operators lead to lower expectations

regarding ultimate collection. When collection is uncertain, mortgage interest income on impaired mortgage loans is recognized as received after taking into account application of security deposits.

Hickory Creek Healthcare Foundation, Inc.

On June 16, 2006, we received approximately $10 million in proceeds on a mortgage loan payoff. We held mortgages on 15 facilities located in Indiana, representing 619 beds.

Haven Eldercare, LLC.

During the three months ended March 31, 2006, Haven used the $39 million of proceeds from the GE Loan to partially repay on a $62 million mortgage it has with us. Simultaneously, we subordinated the payment of its remaining $23 million on the mortgage note to that of the GE Loan (see Note 3 Properties; Leased Property, above).

NOTE 4 CONCENTRATION OF RISK

As of September 30, 2006, our portfolio of domestic investments consisted of 241 healthcare facilities, located in 27 states and operated by 33 third-party operators. Our gross investment in these facilities, net of impairments and before reserve for uncollectible loans, totaled approximately $1.3 billion at September 30, 2006, with approximately 98% of our real estate investments related to long-term care facilities. This portfolio is made up of 227 long-term healthcare facilities, two rehabilitation hospitals owned and leased to third parties, fixed rate mortgages on 10 long-term healthcare facilities and two facilities held for sale. At September 30, 2006, we also held miscellaneous investments of approximately $37 million, consisting primarily of secured loans to third-party operators of our facilities.

At September 30, 2006, approximately 25% of our real estate investments were operated by two public companies: Sun (17%) and Advocat (8%). Our largest private company operators (by investment) were CommuniCare Health Services, Inc. (CommuniCare) (15%), Haven (9%), HQM (8%), Guardian (7%), Nexion (6%) and Essex Healthcare Corporation (6%). No other operator represents more than 4% of our investments. The three states in which we had our highest concentration of investments were Ohio (22%), Florida (14%) and Pennsylvania (9%) at September 30, 2006.

For the three-month period ended September 30, 2006, our revenues from operations totaled $35.2 million, of which approximately $6.6 million were from Sun (19%), $5.1 million from CommuniCare (14%) and $3.7 million from Advocat (10%). For the nine-month period ended September 30, 2006, our revenues from operations totaled $99.8 million, of which approximately $18.2 million were from Sun (18%), $15.2 million from CommuniCare (15%) and $10.8 million from Advocat (11%). No other operator generated more than 10% of our revenues from operations for the three- and nine-month periods ended September 30, 2006.

Sun and Advocat are subject to the reporting requirements of the SEC and are required to file with the SEC annual reports containing audited financial information and quarterly reports containing unaudited interim financial information. Suns and Advocats filings with the SEC can be found at the SECs website at www.sec.gov. We are providing this data for information purposes only, and you are encouraged to obtain Suns and Advocats publicly available filings from the SEC.

NOTE 5 DIVIDENDS

In order to qualify as a REIT, we are required to distribute dividends (other than capital gain dividends) to our stockholders in an amount at least equal to (A) the sum of (i) 90% of our REIT taxable income (computed without regard to the dividends paid deduction and our net capital gain), and (ii) 90% of the net income (after tax), if any, from foreclosure property, minus (B) the sum of certain items of non-cash

income. In addition, if we dispose of any built-in gain asset during a recognition period, we will be required to distribute at least 90% of the built-in gain (after tax), if any, recognized on the disposition of such asset. Such distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for such year and paid on or before the first regular dividend payment after such declaration. In addition, such distributions are required to be made pro rata, with no preference to any share of stock as compared with other shares of the same class, and with no preference to one class of stock as compared with another class except to the extent that such class is entitled to such a preference. To the extent that we do not distribute all of our net capital gain or do distribute at least 90%, but less than 100% of our REIT taxable income, as adjusted, we will be subject to tax thereon at regular ordinary and capital gain corporate tax rates. In addition, our $200 million revolving senior secured credit facility (Credit Facility) has certain financial covenants that limit the distribution of dividends paid during a fiscal quarter to no more than 95% of our aggregate cumulative funds from operations (FFO) as defined in the loan agreement governing the Credit Facility (the Loan Agreement), unless a greater distribution is required to maintain REIT status. The Loan Agreement defines FFO as net income (or loss) plus depreciation and amortization and shall be adjusted for charges related to: (i) restructuring our debt; (ii) redemption of preferred stock; (iii) litigation charges up to $5.0 million; (iv) non-cash charges for accounts and notes receivable up to $5.0 million; (v) non-cash compensation related expenses; (vi) non-cash impairment charges; and (vii) tax liabilities in an amount not to exceed $8.0 million.

Common Dividends

On October 24, 2006, the Board of Directors announced a common stock dividend of $0.25 per share, an increase of $0.01 per common share compared to the prior quarter, which was paid November 15, 2006 to common stockholders of record on November 3, 2006.

On July 17, 2006, the Board of Directors declared a common stock dividend of $0.24 per share. The common dividend was paid August 15, 2006 to common stockholders of record on July 31, 2006.

On April 18, 2006, the Board of Directors declared a common stock dividend of $0.24 per share, an increase of $0.01 per common share compared to the prior quarter. The common dividend was paid May 15, 2006 to common stockholders of record on April 28, 2006.

On January 17, 2006, the Board of Directors declared a common stock dividend of $0.23 per share, an increase of $0.01 per common share compared to the prior quarter. The common stock dividend was paid February 15, 2006 to common stockholders of record on January 31, 2006.

Series D Preferred Dividends

On October 24, 2006, the Board of Directors declared the regular quarterly dividends for the 8.375% Series D Preferred Stock to stockholders of record on November 3, 2006. The stockholders of record of the Series D Preferred Stock on November 3, 2006 were paid dividends in the amount of $0.52344 per preferred share on November 15, 2006. The liquidation preference for our Series D Preferred Stock is $25.00 per share. Regular quarterly preferred dividends for the Series D Preferred Stock represent dividends for the period August 1, 2006 through October 31, 2006.

On July 17, 2006, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on the Series D Preferred Stock that were paid August 15, 2006 to preferred stockholders of record on April 28, 2006.

On April 18, 2006, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on the Series D Preferred Stock that were paid May 15, 2006 to preferred stockholders of record on April 28, 2006.

On January 17, 2006, the Board of Directors declared regular quarterly dividends of approximately $0.52344 per preferred share on the Series D Preferred Stock that were paid February 15, 2006 to preferred stockholders of record on January 31, 2006.

NOTE 6 TAXES

So long as we qualify as a REIT and, among other things, we distribute 90% of our taxable income, we will not be subject to Federal income taxes on our income, except as described below. We are permitted to own up to 100% of a taxable REIT subsidiary (TRS). Currently, we have two TRSs that are taxable as corporations and that pay federal, state and local income tax on their net income at the applicable corporate rates. These TRSs had net operating loss carry-forwards as of September 30, 2006 of $11.6 million. These loss carry-forwards were fully reserved with a valuation allowance due to uncertainties regarding realization.

During the fourth quarter of 2006, we determined that certain terms of the Advocat Series B non-voting, redeemable convertible preferred stock could be interpreted as affecting our compliance with federal income tax rules applicable to REITs regarding related party tenant income. As such, Advocat, one of our lessees, may be deemed to be a related party tenant under applicable federal income tax rules. In such event, our rental income from Advocat would not be qualifying income under the gross income tests that are applicable to REITs. In order to maintain qualification as a REIT, we annually must satisfy certain tests regarding the source of our gross income. The applicable federal income tax rules provide a savings clause for REITs that fail to satisfy the REIT gross income tests if such failure is due to reasonable cause. A REIT that qualifies for the savings clause will retain its REIT status but will pay a tax under section 857(b)(5) and related interest. We currently plan to submit to the IRS a request for a closing agreement to resolve the related party tenant issue. While we believe there are valid arguments that Advocat should not be deemed a related party tenant, the matter is not free from doubt, and we believe it is in our best interest to request a closing agreement in order to resolve the matter, minimize potential interest charges and obtain assurances regarding our continuing REIT status. By submitting a request for a closing agreement, we intend to establish that any failure to satisfy the gross income tests was due to reasonable cause (see Note 2 Restatement of Previously Issued Financial Statements). In the event that it is determined that the savings clause described above does not apply, we could be treated as having failed to qualify as a REIT for one or more taxable years. If we fail to qualify for taxation as a REIT for any taxable year, our income will be taxed at regular corporate rates, and we could be disqualified as a REIT for the following four taxable years.

As a result of the potential related party tenant issue described above and further discussed in Note 2 Restatement of Previously Issued Financial Statements, we have recorded a $0.6 million and $1.7 million provision for income taxes, including related interest expense, for the three and nine months ended September 30, 2006, respectively, and $0.6 million and $1.8 million for the three and nine months ended September 30, 2005, respectively. The amount accrued represents the estimated liability and interest, which remains subject to final resolution and therefore is subject to change. In addition, in October 2006, we restructured our Advocat relationship and have been advised by tax counsel that we will not receive any non-qualifying related party tenant income from Advocat in future fiscal years. Accordingly, we do not expect to incur tax expense associated with related party tenant income in future periods commencing January 1, 2007. We will continue to accrue an income tax liability related to this matter during 2006.

NOTE 7 STOCK-BASED COMPENSATION

Stock Options

Prior to January 1, 2006, we accounted for stock based compensation using the intrinsic value method as defined by APB Opinion No. 25, Accounting for Stock Issued to Employees. Effective January 1, 2006, we adopted FAS No. 123R using the modified prospective method. Accordingly, we have not restated prior period amounts. The additional expense to be recorded in 2006 as a result of this adoption is approximately $3 thousand. Under the provisions of FAS No. 123R, the Unamortized restricted stock awards line on our consolidated balance sheet, a contra-equity line representing the amount of unrecognized share-based compensation costs, is no longer presented. Accordingly, for the nine-month period ended September 30, 2006, the amount that had been on the Unamortized restricted stock awards

line was reversed through the Common stock and additional paid-in-capital line on our consolidated balance sheet.

Under the terms of our 2000 Stock Incentive Plan (the 2000 Plan), we reserved 3,500,000 shares of common stock. The exercise price per share of an option under the 2000 Plan cannot be reduced after the date of grant, nor can an option be cancelled in exchange for an option with a lower exercise price per share. The 2000 Plan provides for non-employee directors to receive options that vest over three years while other grants vest over the period required in the agreement applicable to the individual recipient. Directors, officers, employees and consultants are eligible to participate in the 2000 Plan. At September 30, 2006, there were outstanding options for 52,581 shares of common stock granted to eight eligible participants under the 2000 Plan. Additionally, 355,655 shares of restricted stock have been granted under the provisions of the 2000 Plan, and as of September 30, 2006, there were no shares of unvested restricted stock outstanding under the 2000 Plan.

At September 30, 2006, under the 2000 Plan, there were outstanding options for 50,912 shares of common stock granted to eight participants currently exercisable with a weighted-average exercise price of $13.58, with exercise prices ranging from $2.96 to $37.20. There were 559,960 shares available for future grants as of September 30, 2006. A breakdown of the options outstanding under the 2000 Plan as of September 30, 2006, by price range, is presented below:

Option Price Range	Number	Weighted Average Exercise Price		Weighted Average Remaining Life (Years)	Number Exercisable	Weighted Average Price on Options Exercisable
$2.96 - $3.81	11,918	$	3.41	5.26	11,918	$	3.41
$6.02 - $9.33	22,330	$	6.67	5.81	20,661	$	6.46
$20.25 -$37.20	18,333	$	28.23	1.79	18,333	$	28.23

On April 20, 2004, our Board of Directors approved the 2004 Stock Incentive Plan (the 2004 Plan), which was subsequently approved by our stockholders at our annual meeting held on June 3, 2004. Under the terms of the 2004 Plan, we reserved 3,000,000 shares of common stock. The exercise price per share of an option under the 2004 Plan cannot be less than fair market value (as defined in the 2004 Plan) on the date of grant. The exercise price per share of an option under the 2004 Plan cannot be reduced after the date of grant, nor can an option be cancelled in exchange for an option with a lower exercise price per share. Directors, officers, employees and consultants are eligible to participate in the 2004 Plan. As of September 30, 2006, a total of 350,480 shares of restricted stock and 317,500 restricted stock units have been granted under the 2004 Plan, and as of September 30, 2006, there were no outstanding options to purchase shares of common stock under the 2004 Plan.

At September 30, 2006, the only options outstanding to purchase shares of our common stock were options issued under our 2000 Plan for 52,581 shares of common stock. For the quarter ended September 30, 2006, no options were granted under any of our stock incentive plans. The following is a summary of option activity under the 2000 Plan:

Stock Options	Number of Shares		Exercise Price		Weighted- Average Price		Weighted-Average Remaining Contractual Term
Outstanding at December 31, 2005	227,440		$	2.760 - $37.205	$	5.457	4.6
Granted during 1st quarter 2006
Exercised	(174,191	)	2.760 - 9.330		2.979
Cancelled	(668	)	22.452 - 22.452		22.452
Outstanding at March 31, 2006	52,581		$	2.960 - $37.205	$	13.448	4.4
Granted during 2nd quarter 2006
Exercised			-
Cancelled			-
Outstanding at June 30, 2006	52,581		$	2.960 - $37.205	$	13.448	4.2
Granted during 3rd quarter 2006
Exercised			-
Cancelled			-
Outstanding at September 30, 2006	52,581		$	2.960 - $37.205	$	13.448	4.0

Vested at September 30, 2006	50,912		$	2.960 - $37.205	$	13.583	3.8

Non-Vested Options	Number of Shares		Exercise Price		Weighted- Average Price		Weighted-Average Remaining Contractual Term
Non-vested at December 31, 2005	74,985		$	2.760 - $9.330	$	3.200	7.0
Vested during 1st quarter 2006	(73,316	)	2.760 - 9.330		3.059
Non-vested at March 31, 2006	1,669		$	9.330 - $9.330	$	9.330	7.8
Vested during 2nd quarter 2006			-
Non-vested at June 30, 2006	1,669		$	9.330 - $9.330	$	9.330	7.5
Vested during 3rd quarter 2006			-
Non-vested at September 30, 2006	1,669		$	9.330 - $9.330	$	9.330	7.3

Cash received from exercise under all stock-based payment arrangements for the nine months ended September 30, 2006 and 2005 was $0.9 million and $0.2 million, respectively. Cash used to settle equity instruments granted under stock-based payment arrangements for the nine months ended September 30, 2006 and 2005 was $0.7 million and $1.2 million, respectively.

In 2005, we accounted for our stock-based compensation arrangements in accordance with the intrinsic value method as defined by Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees. The following table presents the effect on net income and earnings per share if we had applied the fair value recognition provisions of FAS No. 123R to our stock-based compensation.

The reported and pro forma net income and earnings per share figures for 2006 in the table are the same because share-based compensation expense is calculated under the provisions of FAS No. 123R.

The 2006 amounts are included in the table below to provide detail for comparative purposes to the 2005 amounts.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005 (Restated)		2006		2005 (Restated)
	(in thousands, except per share amounts)
Net income to common stockholders	$	12,143	$	3,203	$	34,846	$	6,864
Add: Stock-based compensation expense included in net income to common stockholders	3,639		285		4,224		856
	15,782		3,488		39,070		7,720
Less: Stock-based compensation expense determined under the fair value based method for all awards	3,639		323		4,224		1,013
Pro forma net income to common stockholders	$	12,143	$	3,165	$	34,846	$	6,707

Earnings per share:
Basic, as reported	$	0.21	$	0.06	$	0.60	$	0.13
Basic, pro forma	$	0.21	$	0.06	$	0.60	$	0.13
Diluted, as reported	$	0.20	$	0.06	$	0.60	$	0.13
Diluted, pro forma	$	0.20	$	0.06	$	0.60	$	0.13

Restricted Stock

On September 10, 2004, we entered into restricted stock agreements with four executive officers under the 2004 Plan. A total of 317,500 shares of restricted stock were granted, which equated to approximately $3.3 million of deferred compensation. The shares vest thirty-three and one-third percent (33 1/3%) on each of January 1, 2005, January 1, 2006 and January 1, 2007 so long as the executive officer remains employed on the vesting date, with vesting accelerating upon a qualifying termination of employment or upon the occurrence of a change of control (as defined in the applicable restricted stock agreements). As a result of the grant, we recorded $0.3 million and $0.8 million of non-cash compensation expense for the three and nine-month periods ended September 30, 2006 and 2005, respectively.

For the nine-month period ended September 30, 2006, we issued 2,179 shares of restricted common stock to each non-employee director and an additional 2,000 shares of restricted common stock to the Chairman of the Board under the 2004 Plan for a total of 12,895 shares. These shares represent a payment of the portion of the directors annual retainer that is payable in shares of our common stock.

As of September 30, 2006, there was $377 thousand of total unrecognized compensation cost related to these restricted stock awards.

Performance Restricted Stock Units

On September 10, 2004, we entered into performance restricted stock unit agreements with our four executive officers under the 2004 Plan. A total of 317,500 restricted stock units were issued under the 2004 Plan and will fully vest into shares of common stock when our company attains $0.30 per share of adjusted funds from operations (as defined in the applicable restricted stock unit agreements), (AFFO) for two (2) consecutive quarters, with vesting accelerating upon a qualifying termination of employment or upon the occurrence of a change of control (as defined in the applicable restricted stock unit agreements). The performance restricted stock units expire on December 31, 2007 if the performance criteria has not been met. Under our current method of accounting for stock-based

compensation, the expense related to the restricted stock units will be recognized when it becomes probable that the vesting requirements will be met.

As of September 30, 2006, we have achieved the vesting target as defined in the 2004 Plan, and therefore, in accordance with FAS No. 123R (i.e., compensation expense for a performance-based stock award shall be recognized when the satisfaction of the performance conditions that cause the award to vest are probable to occur), we have recorded approximately $3.3 million for the three and nine months ending September 30, 2006 as compensation expense associated with the performance restricted stock units.

In accordance with FASB Statement No. 128, Earnings per Share, (FAS No. 128), the restricted stock unit shares are included in the computation of basic EPS on a weighted-average basis. In addition, in accordance with FAS No. 128, all of the 317,500 restricted stock units are included in diluted EPS as of September 30, 2006, as we have achieved all necessary conditions for the vesting of the restricted units for the quarter ended September 30, 2006. See Note 12 Earnings per Share.

NOTE 8 INVESTMENTS IN DEBT AND EQUITY SECURITIES

Marketable securities classified as available-for-sale are stated at fair value with unrealized gains and losses recorded in accumulated other comprehensive income. Realized gains and losses and declines in value judged to be other-than-temporary on securities held as available-for-sale are included in investment income. The cost of securities sold is based on the specific identification method. If events or circumstances indicate that the fair value of an investment has declined below its carrying value and we consider the decline to be other than temporary, the investment is written down to fair value and an impairment loss is recognized.

At September 30, 2006, we had the following marketable security:

Advocat Subordinated Debt and Convertible Preferred Stock Investments

· Under our 2000 restructuring agreement with Advocat, we received the following: (i) 393,658 shares of Advocats Series B non-voting, redeemable (on or after September 30, 2007), convertible preferred stock, which was convertible into up to 706,576 shares of Advocats common stock (representing 9.9% of the outstanding shares of Advocats common stock on a fully diluted, as-converted basis and accruing dividends at 7% per annum); and (ii) a secured convertible subordinated note in the amount of $1.7 million bearing interest at 7% per annum with a September 30, 2007 maturity (see Note 2 Restatement of Previously Issued Financial Statements).

· In accordance with FAS No. 115, the Advocat Series B security is a compound financial instrument. The embedded derivative value of the conversion feature is recorded separately at fair market value in accordance with FAS No. 133. The non-derivative portion of the security is classified as an available-for-sale investment and is stated at its fair value with unrealized gains or losses recorded in accumulated other comprehensive income. For the three- and nine-month periods ended September 30, 2006, we recorded an adjustment of $0.2 million and $0.8 million to other comprehensive income, respectively, and for the three- and nine-month periods ended September 30, 2005, we recorded an adjustment of $0.3 million and $1.0 million to other comprehensive income, respectively, to adjust the non-derivative portion of the Advocat security to its then current fair market value.

· In accordance with FASB No. 114 and FASB Statement No. 118, Accounting by Creditors for Impairment of a Loan Income Recognition and Disclosures, the Advocat secured convertible subordinated note is fully reserved and accounted for using the cost-recovery

method applying cash received against the outstanding principal balance prior to recording interest income.

Sun Healthcare Common Stock Investment

· Under our 2004 restructuring agreement with Sun, we received the right to convert deferred base rent owed to us, totaling approximately $7.8 million, into 800,000 shares of Suns common stock, subject to certain non-dilution provisions and the right of Sun to pay cash in an amount equal to the value of that stock in lieu of issuing stock to us.

· On March 30, 2004, we notified Sun of our intention to exercise our right to convert the deferred base rent into fully paid and non-assessable shares of Suns common stock. On April 16, 2004, we received a stock certificate for 760,000 restricted shares of Suns common stock and cash in the amount of approximately $0.5 million in exchange for the remaining 40,000 shares of Suns common stock. On July 23, 2004, Sun registered these shares with the SEC. We are accounting for the 760,000 shares received as available for sale marketable securities with changes in market value recorded in other comprehensive income.

· During the three months ended September 30, 2006, we sold our remaining 760,000 share of Suns common stock for approximately $7.6 million, realizing a gain on the sale of these securities of approximately $2.7 million.

NOTE 9 FINANCING ACTIVITIES AND BORROWING ARRANGEMENTS

Bank Credit Agreements

At September 30, 2006, we had $157.5 million outstanding under our $200 million revolving senior secured credit facility (the New Credit Facility) and $2.5 million was utilized for the issuance of letters of credit, leaving availability of $40.0 million. The $157.5 million of outstanding borrowings had a blended interest rate of 6.57% at September 30, 2006. The New Credit Facility, entered into on March 31, 2006, is being provided by Bank of America, N.A., as Administrative Agent, Deutsche Bank Trust Company Americas, UBS Securities LLC, General Electric Capital Corporation, LaSalle Bank N.A., and Citicorp North America, Inc. and will be used for acquisitions and general corporate purposes.

The New Credit Facility replaced our previous $200 million senior secured credit facility (the Prior Credit Facility), that was terminated on March 31, 2006. We will realize a 125 basis point savings on LIBOR-based loans under the New Credit Facility, as compared to LIBOR-based loans under our Prior Credit Facility. The New Credit Facility matures on March 31, 2010, and includes an accordion feature that permits us to expand our borrowing capacity to $300 million during our first two years.

For the three-month period ending March 31, 2006, we recorded a one-time, non-cash charge of approximately $2.7 million relating to the write-off of deferred financing costs associated with the termination of our Prior Credit Facility.

Our long-term borrowings require us to meet certain property level financial covenants and corporate financial covenants, including prescribed leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness and limitations on dividend payouts. As of September 30, 2006, we were in compliance with all property level and corporate financial covenants.

On October 23, 2006, we entered into a Second Amendment, Waiver and Consent to Credit Agreement (the Second Amendment) pursuant to which the lenders under the New Credit Facility waived any potential misrepresentations and events of default that could have been caused by the

Restatement.

$100 Million Aggregate Principal Amount of 6.95% Unsecured Notes Tender and Redemption

On December 16, 2005, we initiated a tender offer and consent solicitation for all of our outstanding $100 million aggregate principal amount 6.95% notes due 2007 (the 2007 Notes). On December 30, 2005, we accepted for purchase 79.3% of the aggregate principal amount of the 2007 Notes outstanding that were tendered. On December 30, 2005, our Board of Directors also authorized the redemption of all outstanding 2007 Notes that were not otherwise tendered. On December 30, 2005, upon our irrevocable funding of the full redemption price for the 2007 Notes and certain other acts required by the Indenture governing the 2007 Notes, the Trustee of the 2007 Notes certified in writing to us (the Certificate of Satisfaction and Discharge) that the Indenture was satisfied and discharged as of December 30, 2005, except for certain administrative provisions. In accordance with FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, (FAS No. 140) we removed 79.3% of the aggregate principal amount of the 2007 Notes, which were tendered in our tender offer and consent solicitation, and the corresponding portion of the funds held in trust by the Trustee to pay the tender price from our balance sheet and recognized $2.8 million of additional interest expense associated with the tender offer. On January 18, 2006, we completed the redemption of the remaining 2007 Notes not otherwise tendered. Accordingly, we reduced other assets, representing the funds deposited with the Trustee, and unsecured borrowings by $21 million. In connection with the redemption and in accordance with FAS No. 140, we recognized $0.8 million of additional interest expense in the first quarter of 2006. As of January 18, 2006, none of the 2007 Notes remained outstanding.

Other Long-Term Borrowings

During the three months ended March 31, 2006, Haven used the $39 million of proceeds from the GE Loan to partially repay a portion of a $62 million mortgage it has with us. Simultaneously, we subordinated the payment of its remaining $23 million on the mortgage note to that of the GE Loan. In conjunction with the above transactions and the application of FIN 46R, we consolidated the financial statements of this Haven entity into our financial statements, which contained the long-term borrowings with General Electric Capital Corporation of $39.0 million. The loan has an interest rate of approximately seven percent and is due in 2012. The lender of the $39.0 million does not have recourse to our assets (see Note 3 Properties; Leased Property).

NOTE 10 LITIGATION

We are subject to various legal proceedings, claims and other actions arising out of the normal course of business. While any legal proceeding or claim has an element of uncertainty, management believes that the outcome of each lawsuit, claim or legal proceeding that is pending or threatened, or all of them combined, will not have a material adverse effect on our consolidated financial position or results of operations.

We and several of our wholly-owned subsidiaries have been named as defendants in professional liability claims related to our former owned and operated facilities. Other third-party managers responsible for the day-to-day operations of these facilities have also been named as defendants in these claims. In these suits, patients of certain previously owned and operated facilities have alleged significant damages, including punitive damages against the defendants. The majority of these lawsuits representing the most significant amount of exposure were settled in 2004. There currently is one lawsuit pending that is in the discovery stage, and we are unable to predict the likely outcome of this lawsuit at this time.

NOTE 11 DISCONTINUED OPERATIONS

Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires the presentation of the net operating results of facilities sold during 2006 or currently classified as held-for-sale as income from discontinued operations for all periods presented. We incurred a net loss from discontinued operations of approximately $33 thousand and $0.6 million for the three- and nine-month periods ended September 30, 2006, respectively, in the accompanying consolidated statements of operations.

The following table summarizes the results of operations of facilities sold or held-for-sale during the three and nine months ended September 30, 2006 and 2005, respectively.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
	(in thousands)
Revenues
Rental income	$			$	678		$			$	3,685
Other income										24
Subtotal revenues				678						3,709
Expenses
Depreciation and amortization	2			93			18			1,196
General and administrative	31						34
Provision for impairment				2,382			121			6,082
Subtotal expenses	33			2,475			173			7,278

Income (loss) before loss on sale of assets	(33		)	(1,797		)	(173		)	(3,569		)
Gain (loss) on assets sold net				710			(381		)	(3,492		)
(Loss) from discontinued operations	$	(33	)	$	(1,087	)	$	(554	)	$	(7,061	)

NOTE 12 EARNINGS PER SHARE

We calculate basic and diluted earnings per common share (EPS) in accordance with FAS No. 128. The computation of basic EPS is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during the relevant period. Diluted EPS is computed using the treasury stock method, which is net income divided by the total weighted-average number of common outstanding shares plus the effect of dilutive common equivalent shares during the respective period. Dilutive common shares reflect the assumed issuance of additional common shares pursuant to certain of our share-based compensation plans, including stock options, restricted stock and restrictive stock units.

For the three- and nine-month periods ended September 30, 2006 and 2005, the dilutive effect from stock options was immaterial.

Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements, Reimbursement Issues and Other Factors Affecting Future Results

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this document. This document contains forward-looking statements within the meaning of the federal securities laws, including statements regarding potential financings and potential future changes in reimbursement. These statements relate to our expectations, beliefs, intentions, plans, objectives, goals, strategies, future events, performance and underlying assumptions and other statements other than statements of historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology including, but not limited to, terms such as may, will, anticipates, expects, believes, intends, should or comparable terms or the negative thereof. These statements are based on information available on the date of this filing and only speak as to the date hereof and no obligation to update such forward-looking statements should be assumed. Our actual results may differ materially from those reflected in the forward-looking statements contained herein as a result of a variety of factors, including, among other things:

(i) those items discussed under Risk Factors in Item 1A to our annual report on Form 10-K/A for the year ended December 31, 2005;

(ii) uncertainties relating to the business operations of the operators of our assets, including those relating to reimbursement by third-party payors, regulatory matters and occupancy levels;

(iii) the ability of any operators in bankruptcy to reject unexpired lease obligations, modify the terms of our mortgages and impede our ability to collect unpaid rent or interest during the process of a bankruptcy proceeding and retain security deposits for the debtors obligations;