8-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_______________________

FORM 8-K

CURRENT REPORT

PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

Date of Report (Date of earliest event reported): July 14, 2009

REHABCARE GROUP, INC.

(Exact name of registrant as specified in its charter)

Delaware	0-19294	51-0265872
(State or other jurisdiction	(Commission File Number)	(I.R.S. Employer
of incorporation)		Identification No.)

7733 Forsyth Boulevard
Suite 2300
St. Louis, Missouri	63105
(Address of principal executive offices)	(Zip Code)

(800) 677-1238

(Company’s telephone number, including area code)

Not applicable

(Former name or former address if changed since last report)

	Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions.
o	Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
o	Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
o	Pre-commencement communications pursuant to Rule 14d-2(b) under the  Exchange Act (17 CFR 240.14d-2(b))
o	Pre-commencement communications pursuant to Rule 13e-4(c) under the  Exchange Act (17 CFR 240.13e-4(c))

Item 2.02		Results of Operations and Financial Condition
		In the first quarter of 2009, the Company made certain changes to the structure of its internal organization.  These changes primarily consisted of making the Company’s skilled nursing rehabilitation services division responsible for oversight of the Company’s businesses that provide resident-centered management consulting services and staffing services for therapists and nurses.  Accordingly, the Company has revised the segment information included in the notes to the Company’s consolidated financial statements for the years ended December 31, 2008, 2007 and 2006 to reflect these changes. In August 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“Statement 160”), which requires noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity.  The Company adopted Statement 160 effective January 1, 2009.  The Company’s adoption of the new standard resulted in changes to the presentation of noncontrolling interests within the Company’s consolidated financial statements for the years ended December 31, 2008, 2007 and 2006. The disclosure in this Item 2.02, as well as Exhibits 99.1 and 99.2 included herewith, which revise Items 7 and 8, respectively, of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2008, are to be considered "filed" with the Securities and Exchange Commission for all purposes under the Securities Exchange Act of 1934, as amended.
Item 9.01		Financial Statements and Exhibits
(d)		Exhibits
		The following exhibits are filed pursuant to Item 2.02:
	23.1	Consent of KPMG LLP.
	99.1	Item 7 of the Company’s 2008 Annual Report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
	99.2	Item 8 of the Company’s 2008 Annual Report on Form 10-K, “Financial Statements and Supplementary Data”

SIGNATURES

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

Dated: July 14, 2009

REHABCARE GROUP, INC.

By: /s/	Jay W. Shreiner
	Jay W. Shreiner
	Executive Vice President and
	Chief Financial Officer

EXHIBIT INDEX

Exhibit No.		Description
23.1	Consent of KPMG LLP
99.1	Item 7 of the Company’s 2008 Annual Report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
99.2	Item 8 of the Company’s 2008 Annual Report on Form 10-K, “Financial Statements and Supplementary Data”

EX-23.1

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors

RehabCare Group, Inc:

We consent to the incorporation by reference in registration statements Nos. 33-67944, 33-82106, 33-82048, 333-11311, 333-120005, and 333-138628 on Form S-8 of RehabCare Group, Inc. (the Company) of our report dated March 10, 2009 except for Note 19 and Note 23, as to which the date is July 14, 2009, with respect to the consolidated balance sheets of the Company as of December 31, 2008 and 2007, and the related consolidated statements of earnings, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2008, which report appears in the Current Report on Form 8-K of the Company dated July 14, 2009.

Our report dated March 10, 2009 except for Note 19 and Note 23, as to which the date is July 14, 2009, on the consolidated financial statements contains an explanatory paragraph that refers to the adoption of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, effective January 1, 2007.

/s/ KPMG LLP

St. Louis, Missouri

July 14, 2009

EX-99.1

Exhibit 99.1

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

In the first quarter of 2009, we made certain changes to the structure of our internal organization.  These changes primarily consisted of making our skilled nursing rehabilitation services division responsible for oversight of our businesses that provide resident-centered management consulting services and staffing services for therapists and nurses.  Following these structural changes, we now operate in the following three business segments, which are managed separately based on fundamental differences in operations: program management services, hospitals and healthcare management consulting.  Program management services include hospital rehabilitation services (including inpatient acute and subacute rehabilitation and outpatient therapy programs) and skilled nursing rehabilitation services (including contract therapy in skilled nursing facilities, resident-centered management consulting services and staffing services for therapists and nurses).  Our hospitals segment owns and operates six inpatient rehabilitation hospitals and five long-term acute care hospitals (LTACHs).  The healthcare management consulting segment consists of our Phase 2 Consulting business.

Explanatory Note

The financial information contained in Item 7 has been derived from our revised consolidated financial statements and reflects (i) the restatement of our segment information to reflect the operational oversight changes as noted above and (ii) the retrospective application of Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements.”  These reclassifications are discussed further in Notes 19 and 23 to the revised consolidated financial statements contained in Item 8.

- 1 - -

	Year Ended December 31,
		2008			2007			2006
	(in thousands)
Revenues:
Program management:
Skilled nursing rehabilitation services	$	457,229		$	432,910		$	348,139
Hospital rehabilitation services		165,658			164,102			179,798
Program management total		622,887			597,012			527,937
Hospitals		112,525			96,001			73,870
Healthcare management consulting		9,563			12,480			10,323
Less intercompany revenues (1)		(1,878	)		(944	)		(568	)
Total	$	743,097		$	704,549		$	611,562
Operating Earnings (Loss):
Program management:
Skilled nursing rehabilitation services	$	25,544		$	7,249		$	(1,206	)
Hospital rehabilitation services		21,997			22,893			23,661
Program management total		47,541			30,142			22,455
Hospitals (2)		(13,903	)		(1,972	)		1,889
Healthcare management consulting		(957	)		465			39
Unallocated asset impairment charge (3)		—			—			(2,351	)
Unallocated corporate expenses (4)		—			—			(22	)
Restructuring		—			—			191
Total	$	32,681		$	28,635		$	22,201

(1) Intercompany revenues represent sales of services, at market rates, between our operating divisions.

(2) The 2007 operating earnings of hospitals include a $4.9 million impairment loss on a separately identifiable intangible asset.  See Note 7 to the consolidated financial statements for additional information.

(3) Represents an impairment charge associated with the abandonment of internally developed software that was never placed in service.   See Note 5 to the consolidated financial statements for additional information.

(4) Represents certain expenses associated with our StarMed staffing business, which was sold on February 2, 2004.

Effective August 30, 2008, the Company completed the sale of equipment, goodwill, other intangible assets and certain related assets associated with its 38-bed inpatient rehabilitation hospital located in Midland, Texas (the “Midland hospital”) to HealthSouth Corporation for $7.2 million less direct selling costs.  This transaction was the result of a strategic review of the Midland-Odessa market.  The Midland hospital has been classified as a discontinued operation pursuant to the requirements of FASB Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  Prior year comparative amounts throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations have been adjusted to reflect the treatment of the Midland hospital as a discontinued operation.

Sources of Revenue

In our program management segment, we derive the majority of our revenues from fees paid directly by healthcare providers rather than through payment or reimbursement by government or other third-party payers.  A portion of our revenues in this segment are derived from our direct bill contract therapy rehab agencies.  Our inpatient and outpatient therapy programs are typically provided through agreements with hospital clients with three to five-year terms.  Our contract therapy services are typically provided under one to two year agreements primarily with skilled nursing facilities.  In our hospitals segment, we derive substantially all of our revenues from fees for patient care services, which are usually paid for or reimbursed by Medicare, Medicaid or third party managed care programs.

- 2 - -

Results of Operations

The following table sets forth the percentage that selected items in the consolidated statements of earnings bear to operating revenues for the years ended December 31, 2008, 2007 and 2006:

	Year Ended December 31,
	2008			2007		2006
Operating revenues		100.0	%	100.0	%	100.0	%
Cost and expenses:
Operating		81.3		80.9		80.7
Selling, general and administrative		12.4		12.0		13.0
Impairment of assets		—		0.7		0.4
Depreciation and amortization		1.9		2.3		2.3
Operating earnings		4.4		4.1		3.6
Interest income		—		0.1		0.1
Interest expense		(0.5	)	(1.2	)	(0.9	)
Equity in net income (loss) of affiliates		0.1		—		(0.5	)
Earnings from continuing operations before income taxes		4.0		3.0		2.3
Income taxes		1.7		1.1		1.0
Earnings from continuing operations, net of tax		2.3		1.9		1.3
Loss from discontinued operations, net of tax		(0.1	)	(0.2	)	(0.1	)
Net earnings		2.2		1.7		1.2
Net loss attributable to noncontrolling interests		0.3		0.1		—
Net earnings attributable to RehabCare		2.5	%	1.8	%	1.2	%

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Twelve Months Ended December 31, 2008 Compared to Twelve Months Ended December 31, 2007

Revenues
	2008			2007			% Change
		(dollars in thousands)
Skilled nursing rehabilitation services	$	457,229		$	432,910		5.6	%
Hospital rehabilitation services		165,658			164,102		0.9
Hospitals		112,525			96,001		17.2
Healthcare management consulting		9,563			12,480		(23.4	)
Less intercompany revenues		(1,878	)		(944	)	98.9
Consolidated revenues	$	743,097		$	704,549		5.5	%

Consolidated operating revenues increased from 2007 to 2008 primarily due to the growth in our skilled nursing rehabilitation services and hospital businesses, partially offset by a decrease in revenues in our healthcare management consulting business.

Skilled Nursing Rehabilitation Services (SRS).  SRS operating revenues increased $24.3 million from 2007 to 2008.  Same store contract therapy revenues increased by $39.7 million or 12.4% reflecting a 10.3% increase in same store minutes of service.  The same store revenue growth more than offset the impact of a 5.3% decline in the average number of contract therapy locations operated during 2008.   Higher average daily census and improved productivity contributed to the growth in same store revenues and same store minutes of service.

Hospital Rehabilitation Services (HRS).  HRS operating revenues increased 0.9% in 2008 as inpatient revenue increased 1.4% and outpatient revenue declined 0.4%.  The increase in inpatient revenue reflects a 5.3% increase in average revenue per program, partially offset by a 3.7% decline in the average number of units operated.  Same store acute rehabilitation discharges increased 1.9% in 2008 as the division’s units were able to increase patient volumes in 2008 following the January 1, 2008 effective date of the freeze in the 60% Rule’s compliance threshold.  The decline in outpatient revenue reflects a 4.2% decline in the average number of units operated, partially offset by a 3.9% increase in average revenue per program.  Outpatient same store revenues grew 4.9% in 2008.

Hospitals.  Hospitals segment revenues increased $16.5 million from 2007 to 2008.  The increase in revenues reflects the acquisition of The Specialty Hospital in Rome, Georgia effective June 1, 2008 and a full year of operations of our inpatient rehabilitation hospital in Austin, Texas, which received its Medicare provider number in November 2007.  The hospital segment also opened an LTACH in Kansas City, Missouri in April 2008 and a rehabilitation hospital in St. Louis, Missouri in November 2008.  Same store revenues increased by $1.5 million or 1.6% in 2008 as compared to 2007.  Our inpatient rehabilitation hospital in Amarillo, Texas, which was in its ramp-up phase in the first quarter of 2007, contributed $1.2 million to the same store revenue growth.  We define the ramp-up phase as the period during which a recently opened hospital builds its patient census following the receipt of its Medicare provider number.

Healthcare Management Consulting.  Healthcare management consulting segment revenues declined $2.9 million in 2008 compared to 2007.  Our Phase 2 Consulting business experienced more difficulty selling services to new clients in 2008 in part due to the slowdown in our nation’s economy.

- 4 - -

Cost and Expenses
				% of					% of
		2008	Revenue				2007	Revenue
	(dollars in thousands)
Consolidated costs and expenses:
Operating expenses	$	603,935		81.3	%	$	569,828		80.9	%
Division selling, general and administrative		46,538		6.3			45,520		6.5
Corporate selling, general and administrative		45,311		6.1			39,078		5.5
Impairment of assets		—		—			4,906		0.7
Depreciation and amortization		14,632		1.9			16,582		2.3
Total costs and expenses	$	710,416		95.6	%	$	675,914		95.9	%

Operating expenses increased slightly as a percentage of revenues as a decline in earnings realized by our hospital segment was mostly offset by improved operating performance from our skilled nursing rehabilitation services division.  Both variances are discussed further below.  The increase in corporate selling, general and administrative expenses reflects the costs of severance benefits incurred in 2008, an increase in share-based compensation and other management incentive costs and an investment in back office resources to support the current year and expected future growth of our hospital segment.  These cost increases were partially offset by the cost savings achieved from closing Symphony’s corporate office in Hunt Valley, Maryland at the end of June 2007.  The hospital segment incurred a $4.9 million impairment charge in 2007 as discussed in more detail below.  Depreciation and amortization expense decreased primarily due to lower amortization associated with capitalized software and intangible assets which became fully amortized in 2007 and 2008.

The Company’s provision for doubtful accounts is included in operating expenses.  On a consolidated basis, the provision for doubtful accounts increased by $1.0 million from 2007 to 2008.  The provisions recorded by our Phase 2 Consulting business and hospital rehabilitation services (HRS) business increased by $1.4 million and $0.9 million, respectively, in 2008.  For Phase 2, the increased provision is primarily related to the write-off of a receivable from a large client hospital.  This write-off followed a failed attempt to mediate a dispute with the hospital.  For HRS, the increased provision is primarily related to the Company’s trade and note receivables due from Signature Healthcare Foundation as a result of Signature’s deteriorating financial condition during 2008.  See Notes 21 and 22 to our accompanying consolidated financial statements for further information on the Signature matter.  We consider both of these bad debt items to be isolated to the specific circumstances of the respective clients and not as events indicative of a greater level of risk in the broader portfolio of accounts receivable of these businesses.  The increased provisions for Phase 2 and HRS were partially offset by a $1.7 million decrease for our skilled nursing rehabilitation services business.  This decrease reflects the results of a concerted focus on collection activities and our efforts over the past two years to improve the quality of the division’s portfolio of accounts receivable.

- 5 - -

				% of					% of
			Unit					Unit
		2008	Revenue				2007	Revenue
	(dollars in thousands)
Skilled Nursing Rehabilitation Services:
Operating expenses	$	373,939		81.8	%	$	363,909		84.1	%
Division selling, general and administrative		26,383		5.8			26,922		6.2
Corporate selling, general and administrative		24,528		5.3			26,053		6.0
Depreciation and amortization		6,835		1.5			8,777		2.0
Total costs and expenses	$	431,685		94.4	%	$	425,661		98.3	%
Hospital Rehabilitation Services:
Operating expenses	$	118,291		71.4	%	$	115,706		70.5	%
Division selling, general and administrative		13,441		8.1			13,552		8.2
Corporate selling, general and administrative		9,288		5.6			7,847		4.8
Depreciation and amortization		2,641		1.6			4,104		2.5
Total costs and expenses	$	143,661		86.7	%	$	141,209		86.0	%
Hospitals:
Operating expenses	$	105,649		93.9	%	$	81,618		85.0	%
Division selling, general and administrative		4,599		4.1			2,959		3.1
Corporate selling, general and administrative		11,086		9.9			4,833		5.1
Impairment of intangible assets		—		—			4,906		5.1
Depreciation and amortization		5,094		4.5			3,657		3.8
Total costs and expenses	$	126,428		112.4	%	$	97,973		102.1	%
Healthcare Management Consulting:
Operating expenses	$	7,934		83.0	%	$	9,539		76.4	%
Division selling, general and administrative		2,115		22.1			2,087		16.7
Corporate selling, general and administrative		409		4.3			345		2.8
Depreciation and amortization		62		0.6			44		0.4
Total costs and expenses	$	10,520		110.0	%	$	12,015		96.3	%

Skilled Nursing Rehabilitation Services (SRS).  Total SRS costs and expenses as a percentage of unit revenue decreased in 2008 primarily due to operational efficiencies and cost savings achieved from completing the integration of Symphony and closing Symphony’s corporate office in Hunt Valley, Maryland at the end of June 2007.  Direct operating expenses declined as a percentage of unit revenue reflecting the combined impact of continued efficiencies realized from the integration of the former RehabWorks’ units and improved therapist productivity throughout the division.  Contract therapy labor and benefit costs per minute of service declined by 0.5% in 2008 as therapist productivity improvements during 2008 more than offset the impact of wage rate increases.  Division and corporate selling, general and administrative expenses decreased as a percentage of unit revenue primarily due to synergies achieved from the integration of the Symphony business.  Depreciation and amortization expense decreased primarily because capitalized software assets associated with the Symphony acquisition became fully amortized in the fourth quarter of 2007.  SRS’s operating earnings were $25.5 million in 2008 compared to $7.2 million in 2007.

- 6 - -

Hospital Rehabilitation Services (HRS).  Total HRS costs and expenses as a percentage of unit revenue increased in 2008 primarily due to an increase in direct operating expenses.  Direct operating expenses increased as a percentage of unit revenue reflecting an increase in professional liability expense due to favorable reserve adjustments recognized in 2007 and the increase in the provision for doubtful accounts explained above.  Corporate selling, general and administrative expenses increased reflecting increases in legal expense, share-based compensation expense and other management incentive costs.  The increased legal expense in 2008 primarily related to the proposed settlement of a wage and hour lawsuit in California.  Depreciation and amortization expense decreased primarily due to lower depreciation and amortization associated with capitalized software and other fixed assets which became fully depreciated.  Total hospital rehabilitation services operating earnings were $22.0 million in 2008 compared to $22.9 million in 2007.

Hospitals.  Total hospital segment costs and expenses increased as a percentage of unit revenue in 2008 despite the recognition of a $4.9 million impairment loss in 2007.  This impairment loss reduced the carrying value of an intangible asset to its revised estimate of fair value based on the impact of a change in LTACH regulations issued by CMS on May 1, 2007.  Operating expenses increased as a percentage of unit revenue in 2008 primarily due to increased start-up and ramp-up losses and a decline in earnings from our mature hospitals, including our Clear Lake, Texas hospital which was significantly impacted by Hurricane Ike.  The division incurred start-up losses of $5.0 million in 2008 primarily related to the development of an LTACH in Kansas City.  Start-up losses were $1.6 million in 2007.  Selling, general and administrative expenses increased from the prior year period reflecting an investment in back office resources to support the growth in the business expected in 2009 and a $1.2 million charge to expense in 2008 of previously deferred direct acquisition costs related to our decision to discontinue efforts to acquire a controlling interest in an inpatient rehabilitation hospital in Rhode Island.  Depreciation and amortization expense increased in 2008 primarily due to depreciation and amortization associated with our newest facilities.  As a result of these factors, the hospitals segment incurred operating losses of $13.9 million in 2008 and $2.0 million in 2007.

Healthcare Management Consulting.  The healthcare management consulting segment generated an operating loss of $1.0 million in 2008 compared to operating earnings of $0.5 million in 2007.  The decrease in operating earnings reflects the decrease in revenues from our Phase 2 Consulting business and the increase in provision for doubtful accounts discussed earlier.

Non-operating Items

Interest income decreased from $0.8 million in 2007 to $0.1 million in 2008 primarily due to the recognition of $0.7 million of interest income in 2007 related to a federal income tax refund claim.

Interest expense decreased from $8.4 million in 2007 to $3.9 million in 2008 primarily due to both a reduction in interest rates and a reduction in average total debt outstanding.  The balance outstanding on our revolving credit facility was $57.0 million and $68.5 million at December 31, 2008 and 2007, respectively.  Interest expense also includes interest on subordinated promissory notes issued as partial consideration for various acquisitions completed over the last three years, commitment fees paid on the unused portion of our line of credit, and fees paid on outstanding letters of credit.

Earnings from continuing operations before income taxes increased to $29.4 million in 2008 from $21.4 million in 2007.  The provision for income taxes was $12.0 million in 2008 compared to $8.1 million in 2007, reflecting effective income tax rates of 40.7% and 37.8%, respectively.  The increase in the effective tax rate reflects the increase in net losses attributable to noncontrolling interests from which we do not derive a related tax benefit.

- 7 - -

The Company incurred losses from discontinued operations, net of tax, of $0.7 million and $1.0 million during the years ended December 31, 2008 and 2007, respectively.  The losses in 2008 relate to the operations of RehabCare Rehabilitation Hospital – Permian Basin, a 38-bed inpatient rehabilitation hospital located in Midland, Texas (the “Midland hospital”) partially offset by a net gain of $0.3 million recognized on the sale of that hospital effective August 30, 2008.  The losses in 2007 relate entirely to the operations of the Midland hospital.

Net losses attributable to noncontrolling interests in consolidated subsidiaries increased to $2.0 million in 2008 from $0.4 million in 2007.  This increase is primarily due to the recognition of the noncontrolling interests’ share of the losses incurred by our LTACH in Kansas City.

Net earnings attributable to RehabCare were $18.7 million in 2008 compared to $12.7 million in 2007.  Diluted earnings per share attributable to RehabCare were $1.05 in 2008 compared to $0.73 in 2007.

Twelve Months Ended December 31, 2007 Compared to Twelve Months Ended December 31, 2006

Revenues
	2007			2006			% Change
		(dollars in thousands)
Skilled nursing rehabilitation services	$	432,910		$	348,139		24.3	%
Hospital rehabilitation services		164,102			179,798		(8.7	)
Hospitals		96,001			73,870		30.0
Healthcare management consulting		12,480			10,323		20.9
Less intercompany revenues		(944	)		(568	)	66.2
Consolidated revenues	$	704,549		$	611,562		15.2	%

Consolidated operating revenues increased from 2006 to 2007 primarily due to the acquisition of Symphony on July 1, 2006 and the addition of two new hospitals during 2006 and one new rehabilitation hospital in 2007.  The various Symphony businesses and the three added hospitals generated incremental revenues of approximately $81.2 million and $14.6 million, respectively, in 2007.

Skilled Nursing Rehabilitation Services (SRS).  SRS operating revenues increased $84.8 million from $348.1 million in 2006 to $432.9 million in 2007.  This revenue growth reflects the acquisition of three Symphony businesses (RehabWorks, a provider of contract therapy services; Polaris, a provider of resident-centered management consulting services; and VTA, a provider of staffing services for therapists and nurses) in 2006.  The three new businesses contributed incremental revenues of $81.2 million in 2007.  Legacy contract therapy revenues increased by $3.6 million primarily due to a 7.1% increase in contract therapy same store revenues and a 1.4% increase in average contract therapy revenue per minute of service, which more than offset a 5.9% reduction in the average number of legacy contract therapy locations operated during 2007.  The year-over-year same store contract therapy revenue growth of 7.1% was an improvement over the 1.0% same store growth rate achieved in 2006.  Contract therapy same store revenue growth in 2006 was negatively affected by the Part B therapy caps that went into place on January 1, 2006 and had a significant impact on Part B revenues in the first half of 2006.

- 8 - -

Hospital Rehabilitation Services (HRS).  HRS operating revenues declined 8.7% in 2007 as inpatient revenue declined 7.4% and outpatient revenue declined 12.3%.  The decline in inpatient revenue reflects a 7.3% decline in the average number of units operated in 2007.  Same store acute rehabilitation revenues and discharges were down 1.7% and 1.4%, respectively, compared to 2006.  The 75% Rule continued to impact our unit level census and the number of discharges in 2007 as patients with diagnoses outside of the 13 qualifying diagnoses were treated at other patient care settings.  The decline in outpatient revenue reflects a 15.5% decline in the average number of units operated, partially offset by a 2.7% increase in outpatient same store revenues.

Hospitals.  Hospitals segment revenues were $96.0 million in 2007 compared to $73.9 million in 2006.  The increase in revenues in 2007 reflects the mid-2006 acquisition of Louisiana Specialty Hospital, the October 2006 opening of a rehabilitation hospital in Amarillo, Texas and the August 2007 opening of a majority owned rehabilitation hospital in Austin, Texas.  The increase in revenues also reflects year-over-year same store revenue growth of $3.8 million or 6.3%.  Approximately $1.4 million of this revenue growth is attributable to favorable adjustments to net liabilities for prior year Medicare and Medicaid cost reports assumed in the acquisition of the four MeadowBrook hospitals.

Healthcare Management Consulting.  Healthcare management consulting segment revenues were $12.5 million in 2007 compared to $10.3 million in 2006.  This revenue increase resulted from increased demand for services from our Phase 2 Consulting business as well as the successful marketing of several large consulting engagements.

Cost and Expenses
				% of						% of
		2007	Revenue				2006		Revenue
	(dollars in thousands)
Consolidated costs and expenses:
Operating expenses	$	569,828		80.9	%	$	493,440			80.7	%
Division selling, general and administrative		45,520		6.5			42,413			6.9
Corporate selling, general and administrative		39,078		5.5			37,034			6.1
Impairment of assets		4,906		0.7			2,351			0.4
Restructuring		—		—			(191	)		—
Depreciation and amortization		16,582		2.3			14,314			2.3
Total costs and expenses	$	675,914		95.9	%	$	589,361			96.4	%

Operating expenses increased as a percentage of revenues in 2007 due to the overall shift in revenue mix toward our skilled nursing rehabilitation services and hospital businesses, which tend to have lower operating margins than our hospital rehabilitation services business.  The increase in operating expenses as a percentage of revenues was partially mitigated by a $2.5 million decrease in professional liability expense and a $1.6 million decrease in workers compensation expense in 2007.  These decreases, which primarily affect our operating divisions that provide patient care, reflect a favorable change in the Company’s actuarial estimates of ultimate expected losses on both claims incurred and reported and claims incurred but not reported.  The decrease in selling, general and administrative expenses as a percentage of revenues reflects greater leveraging of these expenses with the July 1, 2006 acquisition of Symphony and cost savings achieved from closing Symphony’s corporate office in Hunt Valley, Maryland at the end of June 2007.  The hospitals segment incurred a $4.9 million impairment charge in 2007 as discussed in more detail below.  Depreciation and amortization increased primarily as a result of the acquisition of Symphony.

- 9 - -

The Company’s provision for doubtful accounts is included in operating expenses.  On a consolidated basis, the provision for doubtful accounts increased by $3.2 million from $5.9 million in 2006 to $9.1 million in 2007.  This increase is primarily attributable to incremental bad debt expense for the Symphony businesses.  Of the $3.2 million year-over-year increase, $2.0 million is attributable to incremental provisions for doubtful accounts for the RehabWorks contract therapy business which was acquired in the Symphony transaction on July 1, 2006.  During 2007, the provision for doubtful accounts attributable to the RehabWorks business was a greater percentage of revenue than the historical levels for our legacy contract therapy business.  We concluded that an incremental provision for doubtful accounts for RehabWorks receivables was warranted in 2007 primarily based on our assessment of the collection risk of several larger clients where we terminated services and our assessment of the overall risk in the portfolio of RehabWorks receivables.

				% of					% of
			Unit					Unit
		2007	Revenue				2006	Revenue
	(dollars in thousands)
Skilled Nursing Rehabilitation Services:
Operating expenses	$	363,909		84.1	%	$	295,796		85.0	%
Division selling, general and administrative		26,922		6.2			23,301		6.7
Corporate selling, general and administrative		26,053		6.0			23,360		6.7
Depreciation and amortization		8,777		2.0			6,888		1.9
Total costs and expenses	$	425,661		98.3	%	$	349,345		100.3	%
Hospital Rehabilitation Services:
Operating expenses	$	115,706		70.5	%	$	126,604		70.4	%
Division selling, general and administrative		13,552		8.2			15,125		8.4
Corporate selling, general and administrative		7,847		4.8			9,668		5.4
Depreciation and amortization		4,104		2.5			4,740		2.6
Total costs and expenses	$	141,209		86.0	%	$	156,137		86.8	%
Hospitals:
Operating expenses	$	81,618		85.0	%	$	63,701		86.2	%
Division selling, general and administrative		2,959		3.1			1,983		2.7
Corporate selling, general and administrative		4,833		5.1			3,676		5.0
Impairment of intangible assets		4,906		5.1			—		—
Depreciation and amortization		3,657		3.8			2,621		3.5
Total costs and expenses	$	97,973		102.1	%	$	71,981		97.4	%
Healthcare Management Consulting:
Operating expenses	$	9,539		76.4	%	$	7,885		76.4	%
Division selling, general and administrative		2,087		16.7			2,004		19.4
Corporate selling, general and administrative		345		2.8			330		3.2
Depreciation and amortization		44		0.4			65		0.6
Total costs and expenses	$	12,015		96.3	%	$	10,284		99.6	%

Skilled Nursing Rehabilitation Services (SRS).  Total SRS costs and expenses increased in 2007 primarily due to the increase in direct operating expenses associated with the acquisition of Symphony’s RehabWorks and other businesses.  SRS’s direct operating expenses as a percentage of unit revenue decreased from 85.0% in 2006 to 84.1% in 2007 mainly as a result of productivity improvements achieved in both the legacy contract therapy and the RehabWorks businesses.  Driving the large productivity improvements in the RehabWorks business was the completion of the conversion of all RehabWorks sites to the same systems and processes that are in place in the legacy contract therapy business.  The division’s productivity improvements helped offset the effect of an increase in the division’s provision for doubtful accounts, as previously discussed, and an increase in employee incentive costs, which was largely due to the conversion of all RehabWorks’ employees to RehabCare’s incentive plan on January 1, 2007.  Division and corporate selling, general and administrative expenses decreased as a percentage of unit revenue reflecting the cost benefit of the synergies achieved in the integration of the Symphony business as well as cost savings achieved from closing Symphony’s corporate office in Hunt Valley at the end of June 2007.  Depreciation and amortization expense increased primarily as a result of the amortization of intangible assets resulting from the July 1, 2006 acquisition of Symphony.  SRS’s operating earnings were $7.2 million in 2007 compared to a loss of $1.2 million in 2006.

- 10 - -

Hospital Rehabilitation Services (HRS).  Total hospital rehabilitation services costs and expenses declined from 2006 to 2007 primarily due to declines in both direct operating expenses and selling, general and administrative expenses.  Direct operating expenses declined as average units in operation fell 9.2%.  The division’s direct operating expenses as a percentage of unit revenue increased slightly from 70.4% in 2006 to 70.5% in 2007 as an increase in bad debt expense and a decline in therapist productivity, particularly in our outpatient business, was largely offset by a decrease in professional liability and workers compensation expense.  Fiscal year 2006 bad debt expense in this division was lower than historical levels primary due to several recoveries of accounts previously turned over to attorneys for collection.  Selling, general and administrative expenses decreased from 2006 to 2007 reflecting efforts to control costs and a greater leveraging of these expenses across the company with the acquisition of Symphony.  Total hospital rehabilitation services operating earnings were $22.9 million in 2007 compared to $23.7 million in 2006.

Hospitals.  Total hospital costs and expenses increased as a percentage of unit revenue in 2007 primarily due to the recognition of an impairment loss on an intangible asset.  The segment recognized an impairment loss of $4.9 million in the second quarter of 2007 to reduce the carrying value of an intangible asset to its revised estimate of fair value based on the impact of a change in LTACH regulations issued by CMS on May 1, 2007.  Note 7 to the consolidated financial statements contains additional background information regarding the impairment loss.  The division incurred start-up losses of approximately $1.6 million and $2.0 million during the years ended December 31, 2007 and 2006, respectively.  The start-up losses in 2007 relate primarily to our majority-owned Austin, Texas joint venture.  Division selling, general and administrative expenses as a percentage of unit revenue increased from the prior year reflecting efforts to grow this segment, the reallocation of certain resources from our other divisions and an investment in back office resources to support the growth in the division expected in 2008.  Depreciation and amortization expense increased primarily as a result of the amortization of intangible assets resulting from the 2006 acquisition of Louisiana Specialty Hospital and the depreciation of leasehold improvements in our rehabilitation hospitals in Amarillo, Texas and Austin, Texas.  As a result of these factors, the hospitals segment generated an operating loss of $2.0 million in 2007 compared to operating earnings of $1.9 million in 2006.

Healthcare Management Consulting.  Operating earnings for the healthcare management consulting segment increased from approximately break-even profitability in 2006 to $0.5 million in 2007.  This increase is due to the improved operating performance of our Phase 2 Consulting business.

Non-operating Items

Interest income increased from $0.5 million in 2006 to $0.8 million in 2007 primarily due to the recognition of $0.7 million of interest income in 2007 related to a federal income tax refund claim, which was partially offset by a decline in interest income earned on average cash and investment balances.

- 11 - -

Interest expense increased from $5.5 million in 2006 to $8.4 million in 2007 primarily due to the increase in borrowings against our revolving credit facility which occurred in connection with funding of the mid-2006 acquisitions of Symphony and Memorial Rehabilitation Hospital (Midland).  As of December 31, 2007, the balance outstanding on the revolving credit facility was $68.5 million.  Interest expense also includes interest on subordinated promissory notes issued as partial consideration for various acquisitions completed over the last three years, commitment fees paid on the unused portion of our line of credit, and fees paid on outstanding letters of credit.

Equity in net income (loss) of affiliates was $0.3 million in 2007 and $(3.0) million in 2006.   During the first quarter of 2006, we elected to abandon our equity interest in InteliStaf Holdings and therefore wrote off the remaining $2.8 million carrying value of our investment in that entity.  The remainder of the year over year variance is the result of improved operating performance by our 40% owned rehabilitation hospital in Kokomo, Indiana.

Earnings from continuing operations before income taxes increased to $21.4 million in 2007 from $14.1 million in 2006.  The provision for income taxes was $8.1 million in 2007 compared to $6.1 million in 2006, reflecting effective income tax rates of 37.8% and 43.5%, respectively.  The higher effective tax rate in 2006 is principally the result of not recognizing a full tax benefit for the equity losses from non-consolidated affiliates.

The Company incurred losses from discontinued operations, net of tax, of $1.0 million and $0.7 million during the years ended December 31, 2007 and 2006, respectively.  Such losses relate entirely to the operations of the Midland hospital.

Net earnings attributable to RehabCare were $12.7 million in 2007 compared to $7.3 million in 2006.  Diluted earnings per share attributable to RehabCare were $0.73 in 2007 compared to $0.42 in 2006.

Liquidity and Capital Resources

As of December 31, 2008, we had $27.4 million in cash and cash equivalents, and a current ratio, the amount of current assets divided by current liabilities, of 2.1 to 1.  Net working capital increased by $17.0 million to $97.3 million at December 31, 2008 as compared to $80.3 million at December 31, 2007 principally due to a $17.1 million year over year increase in cash and cash equivalents.  Net accounts receivable were $139.2 million at December 31, 2008, compared to $135.2 million at December 31, 2007.  The number of days sales outstanding (“DSO”) in net receivables was 66.0, 71.8 and 77.9 at December 31, 2008, 2007 and 2006, respectively.  The increase in accounts receivable is primarily due to the increase in revenues in 2008.  The improvement in DSO occurred primarily in our skilled nursing rehabilitation services division and reflects the results of a concerted focus on collection activities and our efforts over the past two years to improve the quality of the division’s portfolio of accounts receivable.

We generated cash from operations of $48.7 million, $52.0 million and $19.5 million in the years ended December 31, 2008, 2007 and 2006, respectively.   Cash from operations of $19.5 million for the year ended December 31, 2006 were negatively impacted by a $19.1 million increase in accounts receivable.  Delays in receiving Medicare and Medicaid reimbursements and a temporary shift in focus from collection activities to Symphony integration activities contributed to the 2006 increase in accounts receivable.

- 12 - -

Capital expenditures were $18.5 million, $10.0 million and $14.9 million in the years ended December 31, 2008, 2007 and 2006, respectively.  Our capital expenditures primarily relate to the construction of new hospitals, investments in information technology systems, equipment additions and replacements and various other capital improvements.  Over the next few years, we plan to continue to invest in information technology systems and the development and renovation of hospitals.

The Company has historically financed its operations with funds generated from operating activities and borrowings under credit facilities and long-term debt instruments.  We believe our cash on hand, cash generated from operations and availability under our credit facility will be sufficient to meet our future working capital, capital expenditures, internal and external business expansion, and debt service requirements.  We have a $175 million, five-year revolving credit facility, dated June 16, 2006, with $57.0 million outstanding as of December 31, 2008 at a weighted-average interest rate of approximately 3.2%.  The revolving credit facility is expandable to $225 million, subject to the approval of the lending group and subject to our continued compliance with the terms of the credit agreement.  As of December 31, 2008, we had $7.2 million in letters of credit issued to insurance carriers as collateral for reimbursement of claims.  The letters of credit reduce the amount we may borrow under the revolving credit facility.  As of December 31, 2008, after consideration of the effects of restrictive covenants, the available borrowing capacity under the line of credit was approximately $90.7 million.

Inflation

Although inflation has abated during the last several years, the rate of inflation in healthcare related services continued to exceed the rate experienced by the economy as a whole.  Our management contracts often provide for an annual increase in the fees paid to us by our clients based on increases in various inflation indices.

Effect of Recent Accounting Pronouncements

See Note 1 to the consolidated financial statements in Item 8 for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein by reference.

Commitments and Contractual Obligations

The following table summarizes our scheduled contractual commitments as of December 31, 2008 (in thousands):

			Less than		2-3		4-5		More than
	Total		1 year		years		years		5 years		Other
Operating leases (1)	$	178,644	$	13,344	$	27,390	$	26,288	$	111,622	$	—
Purchase obligations (2)		5,124		1,803		3,321		—		—		—
Long-term debt		57,000		—		57,000		—		—		—
Interest on long-term debt (3)		3,583		1,830		1,753		—		—		—
FIN 48 liability (4)		448		—		—		—		—		448
Other long-term liabilities (5)		2,833		—		—		—		—		2,833
Total	$	247,632	$	16,977	$	89,464	$	26,288	$	111,622	$	3,281

(1) We lease many of our facilities under non-cancelable operating leases in the normal course of business.  Some lease agreements provide us with the option to renew the lease. Our future operating lease obligations would change if we exercised these renewal options and if we entered into additional operating lease agreements. For more information, see Note 13 to our accompanying consolidated financial statements.

- 13 - -

(2) Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding on us and that specify all significant terms. Purchase obligations exclude agreements that are cancelable without penalty.

(3) For the purpose of computing the interest payments shown here, we have assumed a constant balance outstanding under our revolving credit facility of $57.0 million through June 16, 2011, which is the date on which our credit facility expires.  This also assumes our contracts under the revolving credit facility are renewed at the currently existing rates of interest.

(4) Represents our total liability for unrecognized tax benefits based on the guidance in FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).  There is a high degree of uncertainty regarding the timing of future cash outflows associated with our FIN 48 liabilities, which involve various taxing authorities.  As a result, we are unable to predict the timing of payments against this obligation.

(5) We maintain a nonqualified deferred compensation plan for certain employees. Under the plan, participants may defer up to 70% of their salary and cash incentive compensation. The amounts are held in trust in investments designated by participants but remain our property until distribution. Because most distributions of funds are tied to the termination of employment or retirement of participants, we are not able to predict the timing of payments against this obligation.  At December 31, 2008, we owned trust assets with a value approximately equal to the total amount of this obligation.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. Management has discussed and will continue to discuss its critical accounting policies with the audit committee of our board of directors.

Certain of our accounting policies require higher degrees of judgment than others in their application. These include estimating the allowance for doubtful accounts, estimating contractual allowances, impairment of goodwill and other intangible assets, impairment of long-lived assets and establishing accruals for known and incurred but not reported health, workers compensation and professional liability claims.  In addition, Note 1 to the consolidated financial statements includes further discussion of our significant accounting policies.

Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Allowance for Doubtful Accounts.  We make estimates of the collectability of our accounts receivable balances.  We determine an allowance for doubtful accounts based upon an analysis of the collectability of specific accounts, historical experience and the aging of the accounts receivable.  We specifically analyze customers with historical poor payment history and customer creditworthiness when evaluating the adequacy of the allowance for doubtful accounts. Our accounts receivable balance as of December 31, 2008 was $139.2 million, net of allowance for doubtful accounts of $19.5 million.  Our estimates of collectability require significant judgment.  If our customers’ ability to make payments to us were to deteriorate beyond the levels estimated, additional allowances may be required.   We continually evaluate the adequacy of our allowance for doubtful accounts and make adjustments in the periods any excess or shortfall is identified.

- 14 - -

Contractual Allowances.   Our hospitals recognize net patient revenue in the reporting period in which the services are performed based on our current billing rates, less actual adjustments and estimated discounts for contractual allowances.  An individual patient’s bill is subject to adjustment on a patient-by-patient basis in the ordinary course of business by the payers following their review of each particular bill.  We estimate the discounts for contractual allowances using the balance sheet approach on an individual hospital basis. Patient accounts receivable detail is analyzed to determine expected reimbursement for each patient.  Expected reimbursement is summarized by payer classification and reconciled to the balance sheet.  A secondary review is completed at the consolidated hospitals level to validate calculations.  Estimates are regularly reviewed for accuracy by taking into consideration Medicare reimbursement rules and known changes to contract terms, laws and regulations and payment history.  If such information indicates that our allowances are overstated or understated, we reduce or provide for additional allowances as appropriate in the period in which we make such a determination.

Laws and regulations governing Medicare and Medicaid programs are complex and subject to interpretation.  As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount.  The estimated reimbursement amounts are adjusted in subsequent periods as cost reports are prepared and filed and as final settlements are determined.  In 2007, our hospitals recorded favorable net settlements of prior year Medicare and Medicaid cost reports aggregating $1.4 million.  We did not record any significant adjustments for prior year cost reports in 2006 or 2008.  We are not aware of any material claims, disputes, or unsettled matters with third-party payers.

Goodwill and Other Intangible Assets.The cost of acquired companies is allocated first to their identifiable assets, both tangible and intangible, based on estimated fair values.  Costs allocated to identifiable intangible assets are generally amortized on a straight-line basis over the remaining estimated useful lives of the assets.  The excess of the purchase price over the fair value of identifiable assets acquired, net of liabilities assumed, is recorded as goodwill.

Under Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“Statement 142”), goodwill and intangible assets with indefinite lives are not amortized but must be reviewed at least annually for impairment.  If the impairment test indicates that the carrying value of an intangible asset exceeds its fair value, then an impairment loss should be recognized in the consolidated statement of earnings in an amount equal to the excess carrying value.  In 2007, we recognized an impairment loss of $4.9 million to reduce the carrying value of an intangible asset to its revised estimate of fair value based on the impact of a change in LTACH regulations issued by CMS on May 1, 2007.  See Note 7 to our accompanying consolidated financial statements for additional information regarding this impairment loss.

As required by Statement No. 142, we evaluate goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable.  Goodwill impairment is determined using a two-step process.  The first step is to identify if a potential impairment exists by comparing the fair value of each reporting unit to its carrying amount.  If the fair value of a reporting unit exceeds its carrying amount, goodwill of that reporting unit is not considered to have a potential impairment and the second step of the impairment test is not necessary.  However, if the carrying amount of a reporting unit exceeds its fair value, the second step is performed to determine the implied fair value of a reporting unit’s goodwill, by comparing the reporting unit’s fair value to the allocated fair values of all assets and liabilities, including any unrecognized intangible assets, as if the reporting unit had been acquired in a business combination.  If the carrying amount of goodwill exceeds its implied fair value, an impairment is recognized in an amount equal to that excess.

- 15 - -

Reporting units are defined as an operating segment or one level below an operating segment.  Our primary reporting units are our skilled nursing rehabilitation services, hospital rehabilitation services and hospital businesses.  We calculated the fair value of each reporting unit based on a discounted cash flow analysis which requires us to make assumptions and estimates about future cash flows and discount rates.  These assumptions are often subjective and can be affected by a variety of factors, including external factors such as economic trends and government regulations, and internal factors such as changes in our forecasts or in our business strategies.  We believe the assumptions used in our impairment analysis are reasonable and appropriate; however, different assumptions and estimates could affect the results of our impairment analysis and in turn result in an impairment charge.  We could be required to evaluate the recoverability of goodwill prior to the annual assessment if we experience disruptions to the business, unexpected significant declines in operating results, a divestiture of a significant component of our business, significant declines in market capitalization or other triggering events.  In addition, as our business or the way we manage our business changes, our reporting units may also change.  These types of events and the resulting analyses could result in goodwill impairment charges in the future which could materially impact our reported earnings in the periods such charges occur.

At December 31, 2008, unamortized goodwill related to our skilled nursing rehabilitation services, hospital rehabilitation services, hospitals and healthcare management consulting businesses was $79.4 million, $39.7 million, $48.1 million and $4.1 million, respectively.  We have not recorded any goodwill impairments during the three years ended December 31, 2008.  Our most recent impairment test was as of December 31, 2008.  For our hospitals reporting unit, a 5% decrease in the fair value of the reporting unit would not have resulted in a goodwill impairment; however, a 10% decrease in the fair value of the reporting unit would have resulted in a potential goodwill impairment.  The amount of the impairment loss, if any, would be determined during the second step of the impairment test.

Impairment of Long-Lived Assets.   Under Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” a long-lived asset is tested for impairment whenever events or changes in circumstances indicate that the asset might be impaired.  In 2006, we decided to abandon an internal software development project we began in 2004.  We had intended for this software application to be the building block of an integrated platform to support our strategy of clinically integrated post acute continuums of care.  Because of cost overruns, this project was put on hold in 2005 with the intention of restarting the project at a later date.  Following the hiring of a new chief information officer in the fourth quarter of 2006, we completed a review of our information technology applications and concluded that this project would not meet the needs of the business and any additional costs necessary to make the application functional would be in excess of the anticipated benefit to be derived.  As a result of the decision to abandon this project, we recognized an impairment loss of $2.4 million in 2006 to write off the entire carrying value of the previously capitalized software development costs.

- 16 - -

Health, Workers Compensation, and Professional Liability Insurance Accruals.   We maintain an accrual for our health, workers compensation and professional liability claim costs that are partially self-insured and are classified in accrued salaries and wages (health insurance) and accrued expenses (workers compensation and professional liability) in our consolidated balance sheets.  At December 31, 2008, the combined amount of these accruals was approximately $16.2 million. We determine the adequacy of these accruals by periodically evaluating our historical experience and trends related to health, workers compensation, and professional liability claims and payments, based on actuarial computations and industry experience and trends.  In analyzing the accruals, we also consider the nature and severity of the claims, analyses provided by third party claims administrators, as well as current legal, economic and regulatory factors.  If such information indicates that our accruals are overstated or understated, we reduce or provide for additional accruals as appropriate in the period in which we make such a determination.  The ultimate cost of these claims may be greater than or less than the established accruals.  While we believe that the recorded amounts are appropriate, there can be no assurances that changes to management’s estimates will not occur due to limitations inherent in the estimation process.

We are subject to various claims and legal actions in the ordinary course of our business.  Some of these matters include professional liability and employee-related matters.  Our hospital and healthcare facility clients may also become subject to claims, governmental inquiries and investigations and legal actions to which we may become a party relating to services provided by our professionals.  From time to time, and depending upon the particular facts and circumstances, we may be subject to indemnification obligations under our contracts with our hospital and healthcare facility clients relating to these matters.  Although we are currently not aware of any such pending or threatened litigation that we believe is reasonably likely to have a material adverse effect on us, if we become aware of such claims against us, we will evaluate the probability of an adverse outcome and provide accruals for such contingencies as necessary.

Investments in Unconsolidated Affiliates.  We account for our former minority equity investment in InteliStaf Holdings, Inc. (“InteliStaf”) and our current minority equity investment in Howard Regional Specialty Care, LLC (“HRSC”) using the provisions of APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.”  The Company sold its StarMed staffing business to InteliStaf on February 2, 2004 in exchange for a minority equity interest in InteliStaf.  The Company recorded its initial investment in InteliStaf at its fair value of $40 million, as determined with the assistance of a third party valuation firm.  During 2005, InteliStaf incurred significant operating losses even though the healthcare staffing industry as a whole showed signs of recovery.  The Company reviewed its investment in InteliStaf for impairment in accordance with requirements of APB Opinion No. 18.  Based on this review, the Company concluded that an other than temporary decline in the value of the Company’s investment had occurred in 2005.  This impairment combined with the Company’s share of InteliStaf’s operating losses reduced the carrying value of the Company’s investment in InteliStaf to $2.8 million at December 31, 2005.

On March 3, 2006, we elected to abandon our interest in InteliStaf.  This decision was made for a variety of business reasons including InteliStaf’s continuing poor operating performance, InteliStaf’s liquidity problems, the disproportionate share of RehabCare management time and effort that has been devoted to this non-core business and an expected income tax benefit to be derived from the abandonment.  Our investment in InteliStaf had a carrying value of approximately $2.8 million as of December 31, 2005.  This remaining carrying value was written off during the first quarter of 2006.

- 17 - -

The carrying value of our investment in HRSC was $4.8 million at December 31, 2008.  According to APB Opinion No. 18, a series of operating losses of an investee or other factors may indicate that a decrease in value of the investment has occurred which is other than temporary and which should be recognized even though the decrease in value is in excess of what would otherwise be recognized by application of the equity method.  We currently believe no significant factors exist that would indicate an other than temporary decline in the value of our investment in HRSC has occurred.

Forward-Looking Statements

This annual report contains historical information, as well as forward-looking statements that involve known and unknown risks and relate to future events, our future financial performance or our projected business results.  In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “targets,” “potential,” or “continue” or the negative of these terms or other comparable terminology.  These statements are made on the basis of our views and assumptions as of the time the statements are made and we undertake no obligation to update these statements.  We caution investors that any such forward-looking statements we make are not guarantees of future performance and that actual results may differ materially from anticipated results or expectations expressed in our forward-looking statements as a result of a variety of factors.  While it is impossible to identify all such factors, some of the factors that could impact our business and cause actual results to differ materially from forward-looking statements are discussed in Item 1A, “Risk Factors.”

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EX-99.2

Exhibit 99.2

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm	2
Consolidated Balance Sheets as of December 31, 2008 and 2007	3
Consolidated Statements of Earnings for the years
ended December 31, 2008, 2007 and 2006	4
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2008, 2007 and 2006	5
Consolidated Statements of Changes in Equity for the years
ended December 31, 2008, 2007 and 2006	6
Consolidated Statements of Cash Flows for the years
ended December 31, 2008, 2007 and 2006	7
Notes to the Consolidated Financial Statements	8

- 1 - -

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

RehabCare Group, Inc.

We have audited the accompanying consolidated balance sheets of RehabCare Group, Inc. (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of earnings, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RehabCare Group, Inc as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 14 to the consolidated financial statements, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, effective January 1, 2007.

St. Louis, Missouri

March 10, 2009

Except for Note 19 and Note 23,

as to which the date is July 14, 2009

- 2 - -

REHABCARE GROUP, INC.

Consolidated Balance Sheets

(dollars in thousands, except per share data)

	December 31,
Assets	2008			2007
Current assets:
Cash and cash equivalents	$	27,373		$	10,265
Accounts receivable, net of allowance for doubtful accounts of $19,480 and $16,266, respectively		139,197			135,194
Deferred tax assets		14,876			15,863
Other current assets		7,165			7,892
Total current assets		188,611			169,214
Marketable securities, trading		2,810			3,547
Property and equipment, net		37,851			29,705
Goodwill		171,365			168,517
Intangible assets, net		28,944			28,027
Investment in unconsolidated affiliate		4,772			4,701
Other		4,053			4,849
Total assets	$	438,406		$	408,560
Liabilities and Equity
Current liabilities:
Current portion of long-term debt	$	—		$	9,500
Accounts payable		8,330			5,825
Accrued salaries and wages		55,188			49,886
Income taxes payable		776			192
Accrued expenses		27,033			23,526
Total current liabilities		91,327			88,929
Long-term debt, less current portion		57,000			65,000
Deferred compensation		2,833			3,552
Deferred tax liabilities		8,306			5,375
Other		1,140			415
Total liabilities		160,606			163,271
Stockholders’ equity:
Preferred stock, $.10 par value; authorized 10,000,000 shares, none issued and outstanding		—			—
Common stock, $.01 par value; authorized 60,000,000 shares, issued 21,657,544 shares and 21,466,994 shares as of December 31, 2008 and 2007, respectively		217			215
Additional paid-in capital		145,647			140,246
Retained earnings		177,036			158,331
Accumulated other comprehensive loss		(424	)		(66	)
Less common stock held in treasury at cost; 4,002,898 shares as of December 31, 2008 and 2007		(54,704	)		(54,704	)
Total stockholders’ equity		267,772			244,022
Noncontrolling interests		10,028			1,267
Total equity		277,800			245,289
Total liabilities and equity	$	438,406		$	408,560

See accompanying notes to consolidated financial statements.

- 3 - -

REHABCARE GROUP, INC.

Consolidated Statements of Earnings

(in thousands, except per share data)

		Year Ended December 31,
		2008			2007			2006
Operating revenues	$	743,097		$	704,549		$	611,562
Costs and expenses:
Operating		603,935			569,828			493,440
Selling, general and administrative		91,849			84,598			79,447
Impairment of assets		—			4,906			2,351
Restructuring		—			—			(191	)
Depreciation and amortization		14,632			16,582			14,314
Total costs and expenses		710,416			675,914			589,361
Operating earnings		32,681			28,635			22,201
Interest income		143			830			468
Interest expense		(3,897	)		(8,362	)		(5,499	)
Other income (expense), net		21			37			(50	)
Equity in net income (loss) of affiliates		471			287			(3,029	)
Earnings from continuing operations before income taxes		29,419			21,427			14,091
Income taxes		11,975			8,098			6,130
Earnings from continuing operations, net of tax		17,444			13,329			7,961
Loss from discontinued operations, net of tax		(725	)		(1,047	)		(705	)
Net earnings		16,719			12,282			7,256
Net loss attributable to noncontrolling interests		1,986			377			24
Net earnings attributable to RehabCare	$	18,705		$	12,659		$	7,280
Amounts attributable to RehabCare stockholders:
Earnings from continuing operations, net of tax	$	19,430		$	13,706		$	7,985
Loss from discontinued operations, net of tax		(725	)		(1,047	)		(705	)
Net earnings	$	18,705		$	12,659		$	7,280
Basic earnings per share attributable to RehabCare:
Earnings from continuing operations, net of tax	$	1.11		$	0.80		$	0.47
Loss from discontinued operations, net of tax		(0.05	)		(0.07	)		(0.04	)
Net earnings	$	1.06		$	0.73		$	0.43
Diluted earnings per share attributable to RehabCare:
Earnings from continuing operations, net of tax	$	1.09		$	0.79		$	0.46
Loss from discontinued operations, net of tax		(0.04	)		(0.06	)		(0.04	)
Net earnings	$	1.05		$	0.73		$	0.42

See accompanying notes to consolidated financial statements.

- 4 - -

REHABCARE GROUP, INC.

Consolidated Statements of Comprehensive Income

(in thousands)

		Year Ended December 31,
		2008			2007			2006
Net earnings	$	16,719		$	12,282		$	7,256
Other comprehensive income (loss), net of tax:
Changes in the fair value of derivative designated as a cash flow hedge, net of tax of $226, $41 and $0, respectively		(358	)		(66	)		—
Total other comprehensive loss, net of tax		(358	)		(66	)		—
Comprehensive income		16,361			12,216			7,256
Comprehensive loss attributable to noncontrolling interests		1,986			377			24
Comprehensive income attributable to RehabCare	$	18,347		$	12,593		$	7,280

See accompanying notes to consolidated financial statements.

- 5 - -

REHABCARE GROUP, INC.

Consolidated Statements of Changes in Equity

(in thousands)

	Amounts Attributable to RehabCare Stockholders
										Accumulated
			Additional							other			Non-
	Common		paid-in		Retained		Treasury			comprehensive			controlling			Total
	stock		capital		earnings		stock			earnings (loss)			interests			equity
Balance, December 31, 2005	$	208	$	128,792	$	123,952	$	(54,704	)	$	—		$	—		$	198,248
Net earnings (loss)		—		—		7,280		—			—			(24	)		7,256
Stock-based compensation		—		1,697		—		—			—			—			1,697
Activity under stock plans		3		3,551		—		—			—			—			3,554
Contributions made by noncontrolling interests		—		—		—		—			—			110			110
Balance, December 31, 2006		211		134,040		131,232		(54,704	)		—			86			210,865
Net earnings (loss)		—		—		12,659		—			—			(377	)		12,282
Changes in the fair value of derivative, net of tax		—		—		—		—			(66	)		—			(66	)
Adjustment to initially apply FIN 48		—		—		14,440		—			—			—			14,440
Stock-based compensation		—		1,726		—		—			—			—			1,726
Activity under stock plans		4		4,480		—		—			—			—			4,484
Contributions made by noncontrolling interests		—		—		—		—			—			1,558			1,558
Balance, December 31, 2007		215		140,246		158,331		(54,704	)		(66	)		1,267			245,289
Net earnings (loss)		—		—		18,705		—			—			(1,986	)		16,719
Changes in the fair value of derivative, net of tax		—		—		—		—			(358	)		—			(358	)
Stock-based compensation		—		3,195		—		—			—			—			3,195
Activity under stock plans		2		2,206		—		—			—			—			2,208
Contributions made by noncontrolling interests		—		—		—		—			—			10,747			10,747
Balance, December 31, 2008	$	217	$	145,647	$	177,036	$	(54,704	)	$	(424	)	$	10,028		$	277,800

See accompanying notes to consolidated financial statements.

- 6 - -

REHABCARE GROUP, INC.

Consolidated Statements of Cash Flows

(in thousands)

		Year Ended December 31,
		2008			2007			2006
Cash flows from operating activities:
Net earnings	$	16,719		$	12,282		$	7,256
Reconciliation to net cash provided by operating activities:
Depreciation and amortization		14,886			17,021			14,537
Provision for doubtful accounts		10,178			9,194			5,937
Equity in net (income) loss of affiliates		(471	)		(287	)		3,029
Impairment of assets		—			4,906			2,351
Stock-based compensation		3,195			1,726			1,697
Income tax benefit related to stock options exercised		812			1,122			896
Excess tax benefit related to stock options exercised		(564	)		(973	)		(895	)
Restructuring		—			—			(191	)
Gain on disposal of discontinued operation		(321	)		—			—
(Gain) loss on disposal of property and equipment		(21	)		(37	)		50
Changes in assets and liabilities:
Accounts receivable, net		(11,318	)		7,883			(19,059	)
Other current assets		846			925			(274	)
Other assets		371			333			332
Accounts payable		2,328			(3,895	)		1,472
Accrued salaries and wages		4,952			(523	)		103
Income taxes payable and deferred taxes		4,456			5,871			2,330
Accrued expenses		2,629			(2,486	)		247
Deferred compensation		(19	)		(1,053	)		(326	)
Net cash provided by operating activities		48,658			52,009			19,492
Cash flows from investing activities:
Additions to property and equipment		(18,502	)		(9,989	)		(14,854	)
Purchase of marketable securities		(509	)		(354	)		(372	)
Proceeds from sale/maturities of marketable securities		546			1,390			710
Investment in unconsolidated affiliate		—			(1,119	)		—
Disposition of business		7,193			—			—
Purchase of businesses, net of cash acquired		(8,408	)		(1	)		(136,026	)
Other, net		(406	)		(871	)		(486	)
Net cash used in investing activities		(20,086	)		(10,944	)		(151,028	)
Cash flows from financing activities:
Net change in revolving credit facility		(11,500	)		(45,000	)		113,500
Principal payments on long-term debt		(6,000	)		(1,059	)		(3,408	)
Debt issuance costs		—			—			(892	)
Cash contributed by minority interests		3,663			1,373			110
Exercise of employee stock options		1,809			3,483			2,658
Excess tax benefit related to stock options exercised		564			973			895
Net cash provided by (used in) financing activities		(11,464	)		(40,230	)		112,863
Net increase (decrease) in cash and cash equivalents		17,108			835			(18,673	)
Cash and cash equivalents at beginning of year		10,265			9,430			28,103
Cash and cash equivalents at end of year	$	27,373		$	10,265		$	9,430

See accompanying notes to consolidated financial statements.

- 7 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements

December 31, 2008, 2007 and 2006

(1) Stock-Based Compensation

Adjustments to Consolidated Financial Statements

Effective January 1, 2009, the Company adopted Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“Statement 160”).  The Company’s consolidated financial statements and relevant financial information in the footnotes herein have been updated to reflect the changes required by Statement 160.  Refer to Note 23 for further discussion.

Overview of Company

RehabCare Group, Inc. (“the Company”) is a leading provider of program management services for inpatient rehabilitation and skilled nursing units, outpatient therapy programs and contract therapy services in conjunction with more than 1,200 hospitals, skilled nursing facilities, outpatient facilities and other long-term care facilities throughout the United States.  RehabCare also operates six rehabilitation hospitals and five long term acute care hospitals, which provide specialized acute care for medically complex patients.  The Company also provides other healthcare services including management consulting services to hospitals, physician groups and skilled nursing facilities and staffing services for therapists and nurses.

Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements of the Company and its subsidiaries were prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and include the accounts of the Company and all of its wholly owned subsidiaries, majority-owned subsidiaries over which the Company exercises control and, when applicable, entities for which the Company has a controlling financial interest.  All significant intercompany balances and transactions have been eliminated in consolidation.

Certain prior year amounts have been reclassified to conform to current year presentation.  Such reclassifications primarily relate to the sale of RehabCare Rehabilitation Hospital – Permian Basin, a 38-bed inpatient rehabilitation hospital located in Midland, Texas (the “Midland hospital”).  The Company reclassified its condensed consolidated statements of earnings for the years ended December 31, 2007 and 2006 to show the results of operations for the Midland hospital as discontinued operations.

The Company uses the equity method to account for its investments in entities that the Company does not control but has the ability to exercise significant influence over the entity’s operating and financial policies.

Cash Equivalents and Marketable Securities

Cash in excess of daily requirements is invested in short-term investments with original maturities of three months or less.  Such investments are deemed to be cash equivalents for purposes of the consolidated statements of cash flows.

The Company classifies its debt and equity securities into one of three categories:  held-to-maturity, trading, or available-for-sale. Management determines the appropriate classification of its investments at the time of purchase and reevaluates such determination at each balance sheet date.  Investments at December 31, 2008 and 2007 consist of noncurrent marketable equity and debt securities.  All noncurrent marketable securities are classified as trading, with all investment income, including unrealized gains or losses recognized in the consolidated statements of earnings.  Noncurrent marketable securities include assets held in trust for the Company’s deferred compensation plan that are not available for operating purposes.

- 8 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

Credit Risk

The Company provides services to a geographically diverse clientele of healthcare providers throughout the United States.  In addition, in its hospitals business, the Company is reimbursed for its services primarily by Medicare and other third party payers.  The Company performs ongoing credit evaluations of its clientele and does not require collateral.  An allowance for doubtful accounts is maintained at a level which management believes is sufficient to cover anticipated credit losses.  The Company determines its allowance for doubtful accounts based upon an analysis of the collectability of specific accounts, historical experience and the aging of the accounts receivable.  The Company specifically analyzes customers with historical poor payment history and customer creditworthiness when evaluating the adequacy of the allowance for doubtful accounts. The Company continually evaluates the adequacy of its allowance for doubtful accounts and makes adjustments in the periods any excess or shortfall is identified.

Derivative Instruments and Hedging Activities

Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“Statement 133”),  requires that every derivative instrument be recorded in the balance sheet as either an asset or a liability measured at its fair value.  In December 2007, the Company entered into an interest rate swap agreement to reduce the Company’s exposure to changes in interest rates on certain borrowings that bear interest at floating rates.  The swap agreement expires in December 2009.  This swap agreement has been designated as a cash flow hedge.  Therefore, the unrealized gains and losses resulting from the change in fair value of the swap contract have been reflected in other comprehensive income.  Realized gains and losses have been reclassified to interest expense in the period in which the related interest payments being hedged were made.  The Company has formally documented its hedging relationships, including identification of the hedging instruments and hedged items, as well as the Company’s risk management objectives and strategies for undertaking each hedge transaction.

Property and Equipment

Property and equipment are initially recorded at cost.  Depreciation and amortization of property and equipment are computed using the straight-line method over the estimated useful lives of the related assets, principally: equipment – three to seven years; buildings – 39 years; and leasehold improvements – life of asset or life of lease, whichever is less. Upon retirement or disposition, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in the results of operations. Repairs and maintenance are expensed as incurred.

Goodwill and Other Intangible Assets

Under Statement of Financial Accounting Standards No. 141, “Business Combinations,” (“Statement 141”), the cost of acquired companies is allocated first to their identifiable assets, both tangible and intangible, based on estimated fair values.  The excess of the purchase price over the fair value of identifiable assets acquired, net of liabilities assumed, is recorded as goodwill.  Under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (“Statement 142”), goodwill and intangible assets with indefinite lives are not amortized to expense, but instead tested for impairment at least annually and any related losses recognized in earnings when identified.  See Note 7, “Goodwill and Other Intangible Assets,” for further discussion.  Other identifiable intangible assets with a finite life are amortized on a straight-line basis over their estimated lives.

- 9 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

Long-Lived Assets

Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“Statement 144”), addresses financial accounting and reporting for the impairment of long-lived assets to be disposed of.  The Company reviews identified intangible and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.  If such events or changes in circumstances are present, an impairment loss would be recognized if the sum of the expected future net cash flows was less than the carrying amount of the asset.  See Note 5, “Property and Equipment,” for additional information.

Disclosure About Fair Value of Financial Instruments

The Company’s financial instruments consist of cash equivalents, accounts receivable, marketable securities, accounts payable, an interest rate swap agreement and long-term debt.  The carrying values of cash equivalents, accounts receivable and accounts payable approximate fair value due to their relatively short-term nature.   The carrying value of long-term debt at December 31, 2008 and 2007 approximates fair value based on quoted market prices obtained from independent pricing sources for borrowings with comparable maturities.  The Company’s marketable securities and interest rate swap agreement are recorded at fair value.  See Note 18, “Fair Value Measurements,” for additional information.

Revenue Recognition

In the Company’s program management services segment, the Company derives a significant majority of its revenues from fees paid directly by healthcare providers (i.e., acute care hospitals and skilled nursing facilities) rather than through payment or reimbursement by government or other third-party payers.  Revenues are generally recognized as services are provided to patients based on the contractually agreed upon rate per unit of service, rate per patient discharge, a negotiated patient per diem rate, or a negotiated fee schedule based on the type of service rendered.  The Company’s inpatient business also accrues revenues at the end of each period for services provided to patients that have not been discharged by the period end based on the number of patient days completed as a percentage of the average length of stay for the facility under contract.

The Company’s hospitals segment derives substantially all of its revenues from fees for patient care services, which are usually reimbursed by Medicare, Medicaid or third party managed care programs.   The Company’s hospitals recognize net patient revenues in the reporting period in which the services are performed based on our current gross billing rates, less actual adjustments and estimated discounts for contractual allowances.  These allowances are principally required for patients covered by Medicare, Medicaid, managed care health plans and other third-party payers.  Laws governing the Medicare and Medicaid programs are complex and subject to interpretation.  All healthcare providers participating in the Medicare and Medicaid programs are required to meet certain financial reporting requirements. Federal regulations require submission of annual cost reports covering medical costs and expenses associated with the services provided by each facility to program beneficiaries.  Annual cost reports required under the Medicare and Medicaid programs are subject to routine audits, which may result in adjustments to the amounts ultimately determined to be due to the Company under these reimbursement programs.

- 10 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

In estimating the discounts for contractual allowances, the Company reduces its gross patient receivables to the estimated amount that will be recovered for the service rendered based upon previously agreed to rates with the payer.  These estimates are regularly reviewed for accuracy by taking into consideration Medicare reimbursement rules and known changes to payer contract terms, laws and regulations and payment history.  If such information indicates that the Company’s allowances are overstated or understated, the Company reduces or provides for additional allowances as appropriate in the period in which such a determination is made.

In 2007, the Company recorded favorable net settlements of prior year Medicare and Medicaid cost reports which resulted in an aggregate increase in revenues of $1.4 million.  The Company did not record any material revenue adjustments for prior year cost reports in 2008 or 2006.

Health, Workers Compensation and Professional Liability Insurance Accruals

The Company maintains an accrual for health, workers compensation and professional liability claim costs that are partially self-insured and are classified in accrued salaries and wages (health insurance) and accrued expenses (workers compensation and professional liability).  The Company determines the adequacy of these accruals by periodically evaluating historical experience and trends related to claims and payments based on actuarial computations and industry experiences and trends.  At December 31, 2008, the balances for accrued health, workers compensation and professional liability were $5.4 million, $4.6 million and $6.2 million, respectively.  At December 31, 2007, the balances for accrued health, workers compensation and professional liability were $5.4 million, $3.9 million and $6.1 million, respectively.

Income Taxes

Deferred tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.  Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those differences are expected to be recovered or settled.

Treasury Stock

The purchase of the Company’s common stock is recorded at cost.  Upon subsequent reissuance, the treasury stock account is reduced by the average cost basis of such stock.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements.  Estimates also affect the reported amounts of revenues and expenses during the period.  Actual results may differ from those estimates.

- 11 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

Recently Issued Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115” (“Statement 159”).  This statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value, with unrealized gains and losses related to these items reported in earnings at each subsequent reporting date.  The Company adopted this statement on January 1, 2008 and has elected not to apply the fair value option to any items not already carried at fair value in accordance with other accounting standards, so the adoption of Statement 159 did not impact the Company’s consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standard No. 141(R), “Business Combinations” (“Statement 141(R)”).  Statement 141(R) requires most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at “full fair value.”  The new standard is effective for fiscal years beginning after December 15, 2008.  Statement 141(R) will be applied to business combinations occurring after the effective date.

Statement 141(R) replaces Statement 141’s cost-allocation process.  Statement 141 required the acquirer to include acquisition-related costs (such as finder’s fees and legal fees) in the cost of the acquisition.  Statement 141(R) requires those costs to be expensed in the periods incurred.  The Company will be adopting Statement 141(R) effective January 1, 2009.  In the first quarter of 2009, the Company will expense approximately $0.1 million of acquisition-related costs that were deferred as of December 31, 2008 because the acquisitions were still in process.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“Statement 160”).  The new standard requires noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity and requires disclosure on the face on the consolidated income statement of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest.  The new standard also requires the amounts of consolidated comprehensive income attributable to the parent and to the noncontrolling interest to be presented separately on the face of the consolidated statement in which comprehensive income is presented.  The Company adopted Statement 160 on January 1, 2009.  The Company’s consolidated financial statements and relevant financial information in the footnotes herein have been updated to reflect the changes required by Statement 160.  Refer to Note 23 for further discussion.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, "Disclosures about Derivative Instruments and Hedging Activities" (“Statement 161”), which amends and expands the disclosure requirements of FAS 133 to require qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. Statement 161 will be effective for the Company beginning in 2009.  The adoption of this statement is expected to expand the Company’s disclosures about derivatives held by the Company.

In April 2008, the FASB issued FASB Staff Position FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset.  FSP FAS 142-3 also expands the disclosure requirements of Statement 142.  FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years.  The guidance for determining the useful life of a recognized intangible asset shall be applied prospectively to intangible assets acquired after the effective date.  The adoption of FSP FAS 142-3 in the first quarter of 2009 is not expected to have a material impact on the Company’s consolidated financial statements.

- 12 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

In June 2008, the FASB issued FASB Staff Position EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” (“FSP EITF 03-6-1”).  FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting, and therefore need to be included in the computation of earnings per share under the two-class method as described in Statement of Financial Accounting Standards No. 128, “Earnings per Share” (“Statement 128”).  FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years.  The adoption of FSP EITF 03-6-1 in the first quarter of 2009 is not expected to have an impact on the Company’s consolidated financial statements.

(2) Stock-Based Compensation

The Company adopted Statement of Financial Accounting Standards No.  123 – revised 2004, “Share-Based Payment” (“Statement 123R”), on January 1, 2006.  Statement 123R requires the recognition of compensation expense for all share-based compensation awarded to employees, net of estimated forfeitures, using a fair-value-based method.  Under Statement 123R, the grant-date fair value of each award is amortized to expense over the award’s vesting period.  Compensation expense associated with share-based awards is included in corporate selling, general and administrative expense in the accompanying consolidated statements of earnings.  Total pre-tax compensation expense and its related income tax benefit were as follows (in thousands of dollars):

		Year Ended December 31,
		2008		2007		2006
Share-based compensation expense	$	3,195	$	1,726	$	1,697
Income tax benefit		1,235		667		656

The Company has various incentive plans that provide long-term incentive and retention awards.  These awards include stock options and restricted stock awards.  At December 31, 2008, a total of 596,178 shares were available for future issuance under the plans.  The Company generally issues new shares of common stock to satisfy stock option exercises and restricted stock award vestings.

Stock Options

Stock options may be granted for a term not to exceed 10 years and must be granted within 5 years from the adoption of the current equity incentive plan.  All of the unvested stock options currently outstanding become fully exercisable after four years from date of grant.  The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option valuation model.  Estimates of fair value may not equal the value ultimately realized by those who receive equity awards.  The assumptions used to estimate fair value are noted in the following table.  No options were granted in 2008 or 2007.  The Company uses the historical volatility of the Company’s stock and other factors to estimate expected volatility.  The expected term of options is based on historical data and represents the period of time that options granted are expected to be outstanding; the range given below results from certain groups of participants exhibiting different behavior.  The risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.

- 13 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

	Year Ended December 31,
	2008	2007	2006
Expected volatility	N/A	N/A	33%
Expected dividends	N/A	N/A	0%
Expected term (in years)	N/A	N/A	6-8
Risk-free rate	N/A	N/A	4.3%-4.7%

The following table provides a summary of stock options outstanding as of December 31, 2008 and changes during the year then ended:

			Weighted-	Weighted-Average	Aggregate
			Average	Remaining	Intrinsic
			Exercise	Contractual	Value
Stock Options	Shares		Price	Life (yrs)	(millions)
Outstanding at January 1, 2008	1,483,610		$23.15
Granted	—		—
Exercised	(155,550	)	11.63
Forfeited or expired	(353,321	)	25.62
Outstanding at December 31, 2008	974,739		$24.10	4.2	$0.3
Exercisable at December 31, 2008	959,739		$24.18	4.2	$0.3

The weighted-average grant-date fair value of options granted during the year ended December 31, 2006 was $8.72.  The total intrinsic values of options exercised during the years ended December 31, 2008, 2007 and 2006 were approximately $1.4 million, $2.5 million and $2.3 million, respectively.

A summary of the status of the Company’s nonvested stock options as of December 31, 2008 and changes during the year ended December 31, 2008 is presented below:

			Weighted-
			Average
			Grant-Date
Nonvested Stock Options	Shares		Fair Value
Nonvested at January 1, 2008	176,537		$10.02
Granted	—		—
Vested	(84,743	)	9.77
Forfeited	(76,794	)	10.74
Nonvested at December 31, 2008	15,000		$ 7.78

- 14 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

As of December 31, 2008, there was approximately $0.1 million of unrecognized compensation cost related to nonvested options.  Such cost is expected to be recognized over a weighted-average period of 1.2 years.

Restricted Stock Awards

In 2006, the Company began issuing restricted stock awards to attract and retain key Company executives.  At the end of a three-year restriction period, the awards will vest and be transferred to the participant provided that the participant has been an employee of the Company continuously throughout the restriction period.  In the first quarter of 2007, the Company also began issuing restricted stock awards to its nonemployee directors.  One-fourth of such awards generally vest each quarter over the first four quarters following the date of grant.

The Company’s restricted stock awards have been classified as equity awards under Statement 123R.  The fair value of each award is the market price of the Company’s common stock on the date of grant and is amortized to expense ratably over the vesting period.  In general, the Company will receive a tax deduction for each restricted stock award on the vesting date equal to the fair market value of the restricted stock on the vesting date.

The following table provides a summary of the status of the Company’s nonvested restricted stock awards as of December 31, 2008 and the changes during the year ended December 31, 2008:

			Weighted-
			Average
			Grant-Date
Nonvested Restricted Stock Awards	Shares		Fair Value
Nonvested at January 1, 2008	254,760		$16.14
Granted	257,262		21.71
Vested	(35,000	)	22.01
Forfeited	(78,280	)	17.75
Nonvested at December 31, 2008	398,742		$18.90

The weighted-average grant-date fair value of restricted stock granted during the years ended December 31, 2008, 2007 and 2006 was $21.71, $15.20 and $18.35, respectively.   As of December 31, 2008, there was approximately $4.0 million of unrecognized compensation cost related to nonvested restricted stock awards.  Such cost is expected to be recognized over a weighted-average period of 1.5 years.

(3) Marketable Securities

Noncurrent marketable securities at December 31, 2008 and 2007 consist primarily of marketable equity securities ($1.2 million and $1.7 million at December 31, 2008 and 2007, respectively), corporate and government bonds ($1.0 million and $1.1 million at December 31, 2008 and 2007, respectively) and money market securities ($0.6 million and $0.7 million at December 31, 2008 and 2007, respectively) held in trust under the Company’s deferred compensation plan.

- 15 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

(4) Allowance for Doubtful Accounts

Accounts receivable is reported net of the allowance for doubtful accounts.  Activity in the allowance for doubtful accounts is as follows (in thousands):

		Year Ended December 31,
		2008			2007			2006
Balance at beginning of year	$	16,266		$	14,355		$	7,936
Provisions for doubtful accounts		9,643			9,194			5,937
Acquisitions		17			1,472			4,025
Accounts written off, net of recoveries		(6,446	)		(8,755	)		(3,543	)
Balance at end of year	$	19,480		$	16,266		$	14,355

In 2008, the Company also recorded a $535,000 provision for doubtful accounts related to its note receivable from Signature Healthcare Foundation.  See Note 21 for further information.

(5) Property and Equipment

Property and equipment, at cost, consist of the following (in thousands):

	December 31,
		2008		2007
Equipment	$	58,163	$	48,822
Land		1,010		1,046
Buildings and leasehold improvements		27,599		19,092
		86,772		68,960
Less accumulated depreciation		48,921		39,255
	$	37,851	$	29,705

Under Statement 144, a long-lived asset should be tested for recoverability and possible impairment whenever events or changes in circumstances indicate that the asset might be impaired.  In 2006, the Company decided to abandon an internal software development project it began in 2004.  Because of cost overruns, this project was put on hold in 2005 with the intention of restarting the project at a later date.  Following the hiring of a new chief information officer in the fourth quarter of 2006 and a complete review of the Company’s software applications and platforms, the Company decided that this project would not meet the needs of the business and any additional costs necessary to make the application functional would be in excess of the anticipated benefit to be derived.  As a result, the Company recognized an impairment loss of $2,351,000 in the fourth quarter of 2006 to write off the entire carrying value of the previously capitalized software development costs.

(6) Business Combinations

Effective June 1, 2008, the Company acquired an 80% equity interest in The Specialty Hospital, LLC for approximately $8.8 million, which includes the costs of executing the acquisition.  The Company accounted for this acquisition under the purchase method of accounting in accordance with Statement 141.  The Specialty Hospital is a 24-bed long-term acute care hospital located on the grounds of Floyd Medical Center in Rome, Georgia.  Floyd Healthcare Resources, Inc. has retained a 20% interest in the hospital.  In connection with this transaction, the Company recorded $6.8 million in intangible assets, consisting primarily of goodwill.   No adjustments to the purchase price allocation are anticipated in future periods.

- 16 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

Effective July 1, 2006, the Company acquired all of the outstanding limited liability company membership interests of Symphony Health Services, LLC (“Symphony”) at a cost of approximately $109.9 million, which includes costs of executing the transaction and an adjustment based on acquired working capital levels.  Symphony is a leading provider of skilled nursing rehabilitation services.  In connection with this transaction, the Company recorded $80.1 million in intangible assets, consisting primarily of goodwill and customer contracts and relationships.

The Company recognized employee termination costs and lease exit costs associated with exiting certain Symphony pre-acquisition activities as liabilities assumed in the acquisition and included in the allocation of the purchase price for Symphony.  The following table provides a roll-forward of the liability for accrued exit costs from the acquisition date through December 31, 2008 (amounts in millions):

	Employee				Lease			Total
	Termination				Exit			Exit
	Costs				Costs			Costs
Balance, July 1, 2006		$	4.2		$	1.6		$	5.8
Payments			(1.8	)		(0.4	)		(2.2	)
Balance, December 31, 2006			2.4			1.2			3.6
Change in purchase price allocation			(0.2	)		0.1			(0.1	)
Payments			(2.2	)		(0.8	)		(3.0	)
Balance, December 31, 2007			—			0.5			0.5
Payments			—			(0.3	)		(0.3	)
Balance, December 31, 2008		$	—		$	0.2		$	0.2

Effective July 1, 2006, the Company acquired the assets of Memorial Rehabilitation Hospital in Midland, Texas for approximately $8.6 million, which includes costs of executing the acquisition. Memorial Rehabilitation Hospital is a 38-bed freestanding inpatient rehabilitation hospital.  RehabCare had provided program management services to the hospital since the facility first opened in 1988.  In connection with this transaction, the Company recorded $8.5 million in intangible assets, consisting primarily of goodwill and noncompete agreements.  As further discussed in Note 8, effective August 30, 2008, the Company sold certain assets of this hospital and discontinued its operations.

Effective June 1, 2006, the Company purchased substantially all of the assets of Solara Hospital of New Orleans (now known as “Louisiana Specialty Hospital”) for approximately $19.5 million, which includes costs of executing the acquisition.  Louisiana Specialty Hospital is a 44-bed long-term acute care hospital with approximately 120 employees, located on the seventh floor of West Jefferson Medical Center in Marrero, LA.  In connection with this transaction, the Company recorded $17.6 million in intangible assets, consisting primarily of goodwill and a Medicare exemption.

The results of operations of The Specialty Hospital, Symphony, Memorial Rehabilitation Hospital and Louisiana Specialty Hospital have been included in the Company’s financial statements prospectively beginning on the dates of acquisition.

- 17 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

(7) Goodwill and Other Intangible Assets

In accordance with the provisions of Statement 142, the Company performs an annual test of impairment for goodwill and other indefinite lived intangible assets.  The impairment analysis is performed more frequently if events or changes in circumstances indicate that the carrying amount of such assets may exceed fair value.

Under Statement 142, intangible assets with indefinite lives are not amortized but must be reviewed for impairment annually and whenever events or changes in circumstances indicate that the asset might be impaired.  If the impairment test indicates that the carrying value of an intangible asset exceeds its fair value, then an impairment loss should be recognized in the consolidated statement of earnings in an amount equal to the excess carrying value.  The Company performed a test for impairment for goodwill and other indefinite lived intangible assets as of December 31, 2008, 2007 and 2006.  Based upon the results of the tests performed, no impairment of goodwill or other intangible assets with indefinite useful lives was identified in 2008 or 2006; however, in 2007, the Company recognized an impairment loss of $4.9 million to reduce the carrying value of the Medicare exemption it acquired in the June 1, 2006 acquisition of the assets of Louisiana Specialty Hospital, the Company’s LTACH in New Orleans, Louisiana.  This hospital had been grandfathered and statutorily exempt from the so-called 25% Rule.  The 25% Rule limits LTACH prospective payment system (“PPS”) paid admissions from a single referral source to 25%.  Admissions beyond the 25% threshold would be paid using lower inpatient PPS rates.  On May 1, 2007, the Centers for Medicare and Medicaid Services (“CMS”) released a rule extending the 25% Rule to all LTACHs, including those LTACHs that had previously operated under a statutory exemption.

As part of the purchase price allocation for Louisiana Specialty Hospital, the Company initially recorded the value of the statutory exemption as an indefinite-lived intangible asset at its estimated acquisition date fair value of $5.4 million.  The Company determined that the issuance of the May 1, 2007 rule by CMS resulted in a triggering event during the second quarter of 2007 that required the useful life of the statutory exemption intangible asset to be reassessed as finite-lived and a corresponding impairment analysis to be performed.  Based on that analysis, the Company recognized an impairment loss of $4.9 million in the second quarter of 2007 in the hospitals segment to reduce the carrying value of this intangible asset to its revised estimate of fair value based on the impact of the change in regulations.  This reduced carrying value represents the asset’s new cost basis for financial reporting purposes.  The Company computed the fair value of the statutory exemption intangible asset using a present value technique and the Company’s projections of cash flow expected to be generated over the intangible asset’s remaining estimated useful life.  Starting on May 1, 2007, the Company began amortizing the remaining $0.5 million carrying value of the intangible asset on a straight-line basis over the asset’s remaining estimated useful life.  As of December 31, 2008 and 2007, the intangible asset had a remaining carrying value of approximately $0.2 million and $0.3 million, respectively.

On December 29, 2007, the 2007 Medicare, Medicaid and SCHIP Extension Act was signed into law.  The Act provides that the 25% Rule will not be applied to grandfathered LTACHs, such as the Company’s LTACH in New Orleans, through at least December 31, 2010.  Statement 142 prohibits the reversal of the Company’s previously recognized $4.9 million impairment loss.

In March 2007, the Company and St. Luke’s Episcopal-Presbyterian Hospitals (“St. Luke’s Hospitals”) formed a jointly-owned entity, St. Luke’s Rehabilitation Hospital, LLC, which began developing a new 35-bed rehabilitation hospital facility in St. Louis, Missouri.  In December 2008, St. Luke’s Rehabilitation Hospital completed construction of the new facility and acquired the assets of St. Luke’s Hospitals’ existing 16-bed acute rehabilitation unit (“ARU”) in exchange for St. Luke’s Hospitals’ minority interest in the new entity.  The operations of the existing ARU were relocated to the new 35-bed hospital facility.  The Company maintains a controlling ownership interest in St. Luke’s Rehabilitation Hospital, LLC.  This transaction did not qualify as the purchase of a “business” based on the guidance in Statement 141 and Emerging Issues Task Force (“EITF”) Issue No. 98-3, “Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business.”  Therefore, under the guidance in Statement 142, the cost of the assets acquired from St. Luke’s Hospitals were allocated to the individual assets acquired based on their relative fair values and no goodwill arose from the transaction.

- 18 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

At December 31, 2008 and 2007, the Company had the following intangible asset balances (in thousands of dollars):

	December 31, 2008					December 31, 2007
	Gross					Gross
	Carrying		Accumulated			Carrying		Accumulated
	Amount		Amortization			Amount		Amortization
Amortizing Intangible Assets:
Noncompete agreements	$	1,850	$	(1,261	)	$	4,460	$	(1,449	)
Customer contracts and relationships		23,096		(10,042	)		23,096		(7,508	)
Trade names		9,683		(1,929	)		8,773		(1,276	)
Medicare exemption		454		(227	)		454		(113	)
Market access assets		5,720		(24	)		—		—
Certificates of need		142		(28	)		—		—
Lease arrangements		905		(205	)		905		(125	)
Total	$	41,850	$	(13,716	)	$	37,688	$	(10,471	)
Non-amortizing Intangible Assets:
Trade names	$	810				$	810

The market access assets were acquired in the transaction with St. Luke’s Hospitals noted above.  The assets were valued using a discounted cash flows analysis under the income approach.  The estimated value of the market access assets is attributable to the Company’s ability to gain access to and penetrate the former facility’s historical patient market.

Amortizing intangible assets have the following weighted average useful lives as of December 31, 2008:  noncompete agreements – 4.0 years; contractual customer relationships – 6.9 years; amortizing trade names – 15.6 years; Medicare exemption – 2.0 years; market access assets – 19.9 years; certificates of need – 2.4 years; and lease arrangements – 9.8 years.

Amortization expense incurred by continuing operations was approximately $3.7 million, $3.7 million and $2.8 million for the years ended December 31, 2008, 2007 and 2006, respectively.  Estimated annual amortization expense for the next 5 years is: 2009 – $3.9 million; 2010 – $3.5 million; 2011 – $2.9 million; 2012 – $2.4 million and 2013 – $2.2 million.

The changes in the carrying amount of goodwill for the years ended December 31, 2008 and 2007 are as follows (in thousands):

- 19 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements

December 31, 2008, 2007 and 2006

								Healthcare Management
	SRS (a)		HRS (b)		Hospitals			Consulting		Total
Balance at December 31, 2006	$	78,354	$	39,715	$	45,227		$	4,144	$	167,440
Purchase price adjustments
and allocations		1,065		—		12			—		1,077
Balance at December 31, 2007		79,419		39,715		45,239			4,144		168,517
Acquisitions		—		—		6,414			—		6,414
Dispositions		—		—		(3,566	)		—		(3,566	)
Balance at December 31, 2008	$	79,419	$	39,715	$	48,087		$	4,144	$	171,365

(a) Skilled Nursing Rehabilitation Services (SRS).

(b) Hospital Rehabilitation Services (HRS).

(8) Disposition and Discontinued Operation

Effective August 30, 2008, the Company completed the sale of equipment, goodwill, other intangible assets and certain related assets associated with its 38-bed inpatient rehabilitation hospital located in Midland, Texas (the “Midland hospital”) to HealthSouth Corporation for $7.2 million less direct selling costs.  This transaction was the result of a strategic review of the Midland-Odessa market.  Simultaneous with the sale, the Midland hospital transferred its operations and remaining patients to HealthSouth’s rehabilitation hospital also located in the Midland-Odessa area.  In connection with this transaction, the Company recognized a pre-tax gain related to the disposal of the Midland hospital assets of approximately $0.3 million in 2008.

The Midland hospital had been a component of the Hospital reporting unit since mid-2006, and its operations were integrated into the Hospital reporting unit.  Accordingly, the Company determined an appropriate allocation of goodwill for the Midland hospital based on its fair value relative to the overall fair value of the Hospital reporting unit.  The Company used a discounted cash flow technique to determine fair value, which resulted in approximately $3.6 million of goodwill being allocated to the Midland hospital.  Summarized below are the carrying amounts of the assets and liabilities of the Midland hospital that were sold effective August 30, 2008 (in thousands):

Assets:
Property and equipment, net	$	18
Goodwill		3,566
Intangible assets, net		2,154
Total assets	$	5,738
Liabilities:
Accrued salaries and wages	$	7
Total liabilities	$	7

The Midland hospital has been classified as a discontinued operation pursuant to the requirements of FASB Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  The operating results for this discontinued operation are shown in the following table (in thousands).  No interest expense has been allocated.

- 20 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

	2008			2007			2006
Operating revenues	$	3,962		$	7,125		$	3,231
Costs and expenses		5,471			8,791			4,477
Operating loss from discontinued operations		(1,509	)		(1,666	)		(1,246	)
Gain on disposal of assets of discontinued operations		321			—			—
Income tax benefit		463			619			541
Loss from discontinued operations	$	(725	)	$	(1,047	)	$	(705	)

At September 30, 2008, the Company remained a party to an operating lease agreement for the Midland hospital building with a term ending in 2013.  As a result of finding a new tenant, the landlord agreed to terminate the Company’s lease agreement in October 2008.  In connection with exiting the Midland hospital building, the Company incurred a total pre-tax charge of $1.1 million in the third quarter of 2008 to recognize a $0.7 million liability for broker fees and other fees associated with terminating the lease agreement and a $0.4 million loss to write-down the remaining fixed assets to their estimated fair value.  Payments to settle the liability were completed in 2008.  The $1.1 million charge is included in the $0.3 million net gain on the disposal of the Midland hospital assets.

(9) Long-Term Debt

On June 16, 2006, the Company entered into an Amended and Restated Credit Agreement with Bank of America, N.A., Harris, N.A., General Electric Capital Corporation, National City Bank, U.S.  Bank National Association, SunTrust Bank and Comerica Bank, as participating banks in the lending group.  The Amended and Restated Credit Agreement is a $175 million, five-year revolving credit facility that is expandable to $225 million upon the Company’s request, subject to the approval of the lending group and subject to continuing compliance with the terms of the Amended and Restated Credit Agreement.

The Amended and Restated Credit Agreement contains administrative covenants that are ordinary and customary for similar credit facilities.  The credit facility also includes financial covenants, including requirements for us to comply on a consolidated basis with a maximum ratio of senior funded debt to earnings before interest, taxes, depreciation and amortization (EBITDA), a maximum ratio of total funded debt to EBITDA and a minimum ratio of adjusted EBITDA to fixed charges.  As of December 31, 2008, the Company was in compliance with all debt covenants.  The annual commitment fees and interest rates to be charged in connection with the credit facility and the outstanding principal balance are variable based upon the Company’s consolidated leverage ratios.

As of December 31, 2008, the Company had approximately $7.2 million in letters of credit outstanding to its insurance carriers as collateral for reimbursement of claims.  The letters of credit reduce the amount the Company may borrow under its line of credit.  As of December 31, 2008, after consideration of the effects of restrictive covenants, the available borrowing capacity under the line of credit was approximately $90.7 million.

As of December 31, 2008 and 2007, long-term borrowings, including the current portion of long-term debt, were as follows (dollars in thousands):

- 21 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

	December 31,
		2008		2007
Borrowings under revolving credit facility; maturity date of June 16, 2011	$	57,000	$	68,500
Promissory note issued to sellers of Louisiana Specialty Hospital; stated interest rate of 7.5%; principal balance due on May 31, 2008		—		3,000
Promissory note issued to sellers of MeadowBrook; stated interest rate of 6%; principal payments due in semi-annual installments with the final payment due on August 1, 2008		—		3,000
		57,000		74,500
Less:  current portion		—		(9,500	)
	$	57,000	$	65,000

Borrowings under the credit facility are collateralized by substantially all of the Company’s assets and bear interest at either the lender’s prime rate or the London Interbank Offered Rate (“LIBOR”), at the Company’s option, plus applicable margins.  Our LIBOR contracts can vary in length from 30 to 180 days.  On December 28, 2007, the Company entered into an interest rate swap related to a portion of these borrowings.  The swap effectively fixes the interest rate on $25 million of the borrowings at 4.0% plus applicable margins.  After consideration of the swap, the weighted average interest rate on all borrowings under the credit facility was 3.2% at December 31, 2008.

The interest rate swap agreement expires in December 2009.  The Company has formally designated this swap agreement as a cash flow hedge and expects the hedge to be highly effective in offsetting fluctuations in the designated interest payments resulting from changes in the benchmark interest rate (LIBOR).  The fair value of this swap agreement was recorded in the consolidated balance sheets as a liability of $0.7 million and $0.1 million at December 31, 2008 and 2007, respectively.  The unrealized losses resulting from the change in the fair value of the interest rate swap have been reflected in other comprehensive income.  Over the next 12 months, the Company expects to reclassify approximately $0.7 million of these losses from accumulated other comprehensive income to interest expense as the related interest payments being hedged are made.

The Company’s long-term debt is scheduled to mature as follows (amounts in thousands):

2009	$	—
2010		—
2011		57,000
2012		—
2013		—
Total	$	57,000

Interest paid for 2008, 2007 and 2006 was $4.4 million, $7.6 million and $5.2 million, respectively. Included in the interest paid amounts are commitment fees on the unused portion of the revolving credit facility of $0.3 million, $0.2 million and $0.2 million for 2008, 2007 and 2006, respectively.

- 22 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

(10) Stockholders’ Equity

The Company has a stockholder rights plan pursuant to which preferred stock purchase rights were distributed as a dividend on each share of the Company’s outstanding common stock.  Each right, when exercisable, will entitle the holders to purchase one one-hundredth of a share of series B junior participating preferred stock of the Company at an initial exercise price of $150.00 per one one-hundredth of a share.

The rights are not exercisable or transferable until a person or affiliated group acquires beneficial ownership of 20% or more of the Company’s common stock or commences a tender or exchange offer for 20% or more of the stock, without the approval of the board of directors. In the event that a person or group actually acquires 20% or more of the Company’s stock, each holder of rights (other than the person consummating the transaction) will have the right to receive upon exercise of the rights shares of the Company’s common stock at one-half of the then-current market price per  share  of  the stock.  In addition, in the event that the Company consolidates or merges with another entity or the Company sells or otherwise transfers 50% or more of its consolidated assets or earnings power, each holder of rights (other than the person consummating the transaction) will have the right to receive upon exercise of the rights shares of the surviving or purchasing entity’s common stock at one-half of the then-current market price of the stock.

The series B preferred stock is non-redeemable and junior of any other series of preferred stock that the Company may issue in the future. Each share of series B preferred stock, upon issuance, will have a preferential dividend in the amount equal to the greater of $1.00 per share or 100 times the dividend declared per share on the Company’s common stock. In the event of a liquidation of the Company, the series B preferred stock will receive a preferred liquidation payment equal to the greater of $100 or 100 times the payment made on each share of the Company’s common stock. Each one one-hundredth of a share of series B preferred stock will have one vote on all matters submitted to the stockholders and will vote together as a single class with the Company’s common stock.

(11) Earnings per Share

Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding for the period.  Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity (as calculated utilizing the treasury stock method).  These potential shares include dilutive stock options and unvested restricted stock awards.

The following table sets forth the computation of basic and diluted earnings (loss) per share attributable to RehabCare stockholders (in thousands, except per share data).  The net earnings amounts presented below exclude income and losses attributable to noncontrolling interests in consolidated subsidiaries.

- 23 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

	Year Ended December 31,
		2008			2007			2006
Numerator:
Earnings from continuing operations, net of tax	$	19,430		$	13,706		$	7,985
Loss from discontinued operations, net of tax		(725	)		(1,047	)		(705	)
Net earnings	$	18,705		$	12,659		$	7,280
Denominator:
Basic weighted average common shares outstanding		17,583			17,226			17,008
Effect of dilutive securities:
stock options and restricted stock awards		215			233			235
Diluted weighted average common shares outstanding		17,798			17,459			17,243
Basic earnings per common share:
Earnings from continuing operations, net of tax	$	1.11		$	0.80		$	0.47
Loss from discontinued operations, net of tax		(0.05	)		(0.07	)		(0.04	)
Net earnings	$	1.06		$	0.73		$	0.43
Diluted earnings per common share:
Earnings from continuing operations, net of tax	$	1.09		$	0.79		$	0.46
Loss from discontinued operations, net of tax		(0.04	)		(0.06	)		(0.04	)
Net earnings	$	1.05		$	0.73		$	0.42

For fiscal 2008, 2007 and 2006, outstanding stock options totaling approximately 0.9 million, 1.3 million and 1.4 million potential shares, respectively, were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive.

(12) Employee Benefits

The Company has an Employee Savings Plan, which is a defined contribution plan qualified under Section 401(k) of the Internal Revenue Code, for the benefit of its eligible employees.  All employees who are at least 21 years of age are immediately eligible to participate in the plan.  Each participant may contribute from 2% to 20% of his or her annual compensation to the plan subject to limitations on the highly compensated employees to ensure the plan is nondiscriminatory.  Contributions made by the Company to the Employee Savings Plan are at rates of up to 50% of the first 4% of employee contributions.  Expense in connection with the Employee Savings Plan for 2008, 2007 and 2006 totaled $4.0 million, $3.9 million and $2.7 million, respectively.

The Company maintains nonqualified deferred compensation plans for certain employees.  Due to changes in the Internal Revenue Code impacting deferred compensation arrangements, the Company froze its plan, which became ineligible to receive future deferrals, on December 31, 2004.  To ensure compliance with Internal Revenue Code section 409A, a new plan was developed and implemented on July 1, 2005.  Under the 2005 plan, participants may defer up to 70% of their base salary and up to 70% of their cash incentive compensation.  Amounts for both plans are held by a trust in investments that are designated by participants but remain the property of the Company until distribution.  At December 31, 2008 and 2007, $2.8 million and $3.6 million, respectively, were payable under the nonqualified deferred compensation plans and approximated the value of the trust assets owned by the Company.

- 24 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

(13) Commitments

The Company is obligated under non-cancelable operating leases for the facilities that support the Company’s hospitals, administrative functions and other operations.  Future minimum lease payments at December 31, 2008 for those leases having an initial or remaining non-cancelable lease term in excess of one year are as follows (amounts in thousands):

2009	$	13,344
2010		13,961
2011		13,429
2012		13,166
2013		13,122
Thereafter		111,622
Total	$	178,644

Rent expense for 2008, 2007 and 2006 was approximately $12.9 million, $12.2 million and $10.1 million, respectively.   As of December 31, 2008, the Company expected to receive future minimum rentals under noncancelable subleases of approximately $3.0 million.

The Company was not a party to any material open construction contracts as of December 31, 2008.

(14) Income Taxes

The components of income tax expense (benefit), excluding discontinued operations, are as follows (in thousands):

		Year Ended December 31,
		2008		2007		2006
Federal – current	$	7,111	$	1,485	$	6,663
Federal – deferred		3,329		6,493		(975	)
State		1,535		120		442
	$	11,975	$	8,098	$	6,130

A reconciliation between expected income taxes, computed by applying the statutory Federal income tax rate of 35% to earnings from continuing operations before income taxes, and actual income tax is as follows (in thousands):

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

		Year Ended December 31,
		2008			2007			2006
Expected income taxes	$	10,297		$	7,499		$	4,932
Tax effect of interest income from municipal bond obligations exempt from federal taxation		(1	)		(8	)		(72	)
State income taxes, net of federal income tax benefit		974			160			152
Tax effect of losses attributable to noncontrolling interests not deductible by the Company		695			132			8
Increase in valuation allowance		—			—			1,091
Other, net		10			315			19
	$	11,975		$	8,098		$	6,130

The tax effects of temporary differences that give rise to the deferred tax assets and liabilities are as follows (in thousands):

	December 31,
	2008			2007
Deferred tax assets:
Allowance for doubtful accounts	$	5,439		$	3,838
Accrued insurance, vacation, bonus and deferred compensation		8,348			9,890
Net operating loss carryforward/capital loss carryforward		184			2,405
Stock based compensation		1,993			1,176
Other		4,717			3,843
Total gross deferred tax assets		20,681			21,152
Valuation allowance		(75	)		(350	)
Net deferred tax assets		20,606			20,802
Deferred tax liabilities:
Acquired goodwill and intangibles		10,500			6,971
Depreciation and amortization		1,913			1,807
Other		1,623			1,536
Total deferred tax liabilities		14,036			10,314
	$	6,570		$	10,488

At December 31, 2008, RehabCare had unused state net operating loss carryforwards and federal capital loss carryforwards which resulted in a deferred tax asset of $184,000.  These carryforwards expire on various dates between 2009 and 2026.

The Company is required to establish a valuation allowance for deferred tax assets if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.  Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. After consideration of all evidence, both positive and negative, management concluded that it was more likely than not that the Company will not realize a portion of its deferred tax assets and that a valuation allowance of $0.1 million and $0.4 million was necessary as of December 31, 2008 and 2007, respectively.  For the years ended December 31, 2008, 2007, and 2006, the net increases (decreases) in the valuation allowance were $0.3 million, $(15.5) million, and $1.1 million, respectively. The valuation allowance decrease in 2007 primarily relates to the Company’s adoption of FASB Interpretation No.  48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

The Company adopted the provisions of FIN 48 on January 1, 2007.  This Interpretation requires financial statement recognition of a tax position taken or expected to be taken in a tax return, if that position is more likely than not of being sustained upon examination, based on the technical merits of the position.  Based on the accounting standards that existed prior to FIN 48, the Company had not recognized a $14.4 million potential tax benefit in its financial statements at December 31, 2006 for the losses incurred in connection with the Company’s former investment in InteliStaf.  In accordance with the provisions of FIN 48, the Company evaluated the technical merits of its uncertain tax positions.  The Company believes it will more likely than not obtain a tax deduction for the full amount of the losses incurred on its investment in InteliStaf.  Based on that evaluation, the Company recorded a $14.4 million reduction in its liability for unrecognized tax benefits and a $14.4 million increase to its January 1, 2007 balance of retained earnings to recognize the cumulative effect of applying FIN 48.  This cumulative-effect adjustment represents the difference between the net amount of assets and liabilities recognized in the statement of financial position prior to the application of FIN 48 and the net amount of assets and liabilities recognized as a result of applying FIN 48.

The following table provides a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2008 and 2007 (in thousands):

		2008			2007
Balance at beginning of year	$	308		$	396
Increase as a result of tax positions taken in prior years		7			136
Increase as a result of tax positions taken in the current year		212			20
Lapse of applicable statute of limitations		(79	)		(244	)
Balance at end of year	$	448		$	308

As of December 31, 2008, the Company had approximately $0.4 million of unrecognized tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate.  The Company currently does not expect any significant changes to unrecognized tax positions within the next twelve months.

The Company’s practice is to recognize interest related to unrecognized tax benefits as a component of interest expense and penalties related to unrecognized tax benefits as a component of selling, general and administrative expenses.

RehabCare and its subsidiaries file income tax returns for U.S. federal income taxes and various state income taxes.  The Company is no longer subject to U.S. federal income tax examination for years prior to 2005 by virtue of the statute of limitations.  The Company’s 2006 federal income tax return is currently being examined by the IRS.

Income taxes paid by the Company for 2008, 2007 and 2006 were $6.7 million, $0.5 million and $2.4 million, respectively.

(15) Investments in Unconsolidated Affiliates

On February 2, 2004, the Company consummated a transaction with InteliStaf Holdings, Inc. (“InteliStaf”) pursuant to which InteliStaf acquired all of the outstanding common stock of the Company’s StarMed staffing business in exchange for approximately 25% of the common stock of InteliStaf on a fully diluted basis.  The Company recorded its initial investment in InteliStaf at its fair value of $40 million, as determined with the assistance of a third party valuation firm.  During 2005, InteliStaf incurred significant operating losses even though the healthcare staffing industry as a whole showed signs of recovery.  The Company reviewed its investment for impairment in accordance with requirements of APB Opinion No.  18.  “The Equity Method of Accounting for Investments in Common Stock.”  Based on this review, the Company concluded that an other than temporary decline in the value of the Company’s investment had occurred in the fourth quarter of 2005.  This impairment combined with the Company’s share of InteliStaf’s operating losses reduced the carrying value of the Company’s investment in InteliStaf to $2.8 million at December 31, 2005.

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

On March 3, 2006, the Company elected to abandon its interest in InteliStaf.  This decision was made for a variety of business reasons including InteliStaf’s continuing poor operating performance, the disproportionate percentage of Company management time and effort that was being devoted to this non-core business and an expected income tax benefit to be derived from the abandonment.  In the first quarter of 2006, the Company wrote off the $2.8 million remaining carrying value of its investment in InteliStaf.  This write-off was recorded as part of equity in net loss of affiliates on the accompanying consolidated statement of earnings for the year ended December 31, 2006.

The following is a summary of InteliStaf’s results of operations for the period from January 1, 2006 to February 28, 2006 (dollars in thousands):

	January 1 to
	February 28,
	2006(1)
	(unaudited)
Net operating revenues	$	43,113
Operating loss		(727	)
Net loss		(1,465	)

(1) The Company abandoned its shares in InteliStaf on March 3, 2006.  Financial statements as of that date were not readily available.  Accordingly, the Company has presented financial information through February 28, 2006.  The Company does not believe that financial information for InteliStaf through March 3, 2006 would be materially different than the information reported above.

In January 2005, the Company paid $3.6 million for a 40% equity interest in Howard Regional Specialty Care, LLC (“HRSC”), which operates a freestanding rehabilitation hospital in Kokomo, Indiana.  The Company uses the equity method to account for its investment in HRSC.  The value of the Company’s investment in HRSC at the transaction date exceeded its share of the book value of HRSC’s stockholders’ equity by approximately $3.5 million.  This excess is being accounted for as equity method goodwill.  In February 2007, the Company invested an additional $1.1 million of cash in HRSC, and the majority owner invested an additional $1.7 million.  HRSC used these funds to meet its working capital needs and to acquire an outpatient rehabilitation business in Kokomo.  The carrying value of the Company’s investment in HRSC was $4.8 million and $4.7 million at December 31, 2008 and 2007, respectively.

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

(16) Severance and Restructuring Costs

In 2008, the Company eliminated approximately 60 corporate and division support positions in an effort to better align the Company’s support functions and reduce corporate and division overhead.   In connection with these efforts, the Company recognized a pre-tax charge of $2.3 million for employee severance costs including costs incurred under pre-existing severance plans.  This charge is reflected on the corporate and division selling, general and administrative expense lines of the Company’s consolidated statement of earnings for 2008.  The following table provides a roll-forward of the liability for accrued severance costs from January 1, 2008 through December 31, 2008 (amounts in millions):

	Employee
	Severance
	Costs
Balance, January 1, 2008		$	—
Accrual for severance costs			2.3
Payments			(0.9	)
Balance, December 31, 2008		$	1.4

As reported in Note 15, the Company sold its StarMed staffing division to InteliStaf on February 2, 2004.  In connection with this sale, the Company initiated a series of restructuring activities to reduce the cost of corporate overhead that had previously been absorbed by the staffing division.  All restructuring activities were completed by December 31, 2005 except for the payment of lease exit costs related to corporate office space that the Company ceased using in 2004.  However, in June 2006, as a result of increased corporate headquarters staffing to support recent acquisitions, the Company made the decision to begin using the office space again.  As a result, the Company reversed the remaining restructuring reserve of $191,000 to income in 2006.

(17) Related Party Transactions

The Company’s hospital rehabilitation services division recognized operating revenues for services provided to HRSC, the Company’s 40% owned equity method investment, of approximately $0.4 million and $2.6 million for the years ended December 31, 2007 and 2006, respectively.  In March 2007, the Company canceled its existing management services contract with HRSC as part of a plan to improve HRSC’s profitability.

The Company purchased air transportation services from 55JS Limited, Co. at an approximate cost of $510,000, $457,000 and $392,000 for the years ended December 31, 2008, 2007 and 2006, respectively.  55JS Limited, Co. is owned by the Company’s President and Chief Executive Officer, John Short.  The air transportation services are billed to the Company for hourly usage of 55JS’s plane for Company business.

(18) Fair Value Measurements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“Statement 157”).  This statement clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements.  Statement 157 does not require any new fair value measurements.  In February 2008, the FASB issued FASB Staff Position 157-2, “Effective Date of FASB Statement 157,” which deferred the effective date of Statement 157 to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis.  In accordance with this interpretation, the Company adopted the provisions of Statement 157 on January 1, 2008 with respect to the Company’s financial assets and financial liabilities.  The provisions of Statement 157 have not been applied to nonfinancial assets and nonfinancial liabilities.  The major categories of assets and liabilities that are measured at fair value, for which the Company will wait until 2009 to apply the provisions of Statement 157, are as follows:  reporting units measured at fair value in the first step of a goodwill impairment test under Statement 142 and long-lived assets measured at fair value for an impairment assessment under Statement 144.

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

The following table sets forth the information required by Statement 157 for the Company’s financial assets and financial liabilities which are measured at fair value on a recurring basis (amounts in thousands):

				Fair Value Measurements at December 31, 2008 Using:
	Carrying value at December 31, 2008			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Trading securities	$	2,810		$	2,810	$	—		$	—
Interest rate swap		(692	)		—		(692	)		—
Total	$	2,118		$	2,810	$	(692	)	$	—

The Company uses an income approach to value its liability for the outstanding interest rate swap agreement, which is discussed further in Note 9.  The fair value of the swap is estimated using a discounted cash flow model that takes into account observable inputs including the contractual terms of the swap and current market information as of the reporting date such as prevailing interest rates.

(19) Industry Segment Information

In the first quarter of 2009, the Company made certain changes to the structure of its internal organization.  These changes primarily consisted of making the Company’s skilled nursing rehabilitation services division responsible for oversight of the Company’s businesses that provide resident-centered management consulting services and staffing services for therapists and nurses.  Following these structural changes, the Company now operates in the following three business segments, which are managed separately based on fundamental differences in operations: program management services, hospitals and healthcare management consulting.  Program management services include hospital rehabilitation services (including inpatient acute and subacute rehabilitation and outpatient therapy programs) and skilled nursing rehabilitation services (including contract therapy in skilled nursing facilities, resident-centered management consulting services and staffing services for therapists and nurses).  The Company’s hospitals segment owns and operates six inpatient rehabilitation hospitals and five long-term acute care hospitals.  The healthcare management consulting segment consists of the Company’s Phase 2 Consulting business.

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

Virtually all of the Company’s services are provided in the United States.  Summarized information about the Company’s operations in each industry segment is as follows (in thousands).  The following information and relevant financial information in other footnotes herein have been restated to reflect the operational oversight changes as noted above.

		Operating Revenues									Operating Earnings (Loss)
		2008			2007			2006			2008			2007			2006
Program management:
Skilled nursing rehabilitation services	$	457,229		$	432,910		$	348,139		$	25,544		$	7,249		$	(1,206	)
Hospital rehabilitation services		165,658			164,102			179,798			21,997			22,893			23,661
Program management total		622,887			597,012			527,937			47,541			30,142			22,455
Hospitals		112,525			96,001			73,870			(13,903	)		(1,972	)		1,889
Healthcare management consulting		9,563			12,480			10,323			(957	)		465			39
Less intercompany revenues (1)		(1,878	)		(944	)		(568	)		N/A			N/A			N/A
Unallocated asset impairment (2)		N/A			N/A			N/A			—			—			(2,351	)
Unallocated corporate expenses (3)		N/A			N/A			N/A			—			—			(22	)
Restructuring charge		N/A			N/A			N/A			—			—			191
Total	$	743,097		$	704,549		$	611,562		$	32,681		$	28,635		$	22,201

		Depreciation and Amortization						Capital Expenditures
		2008		2007		2006		2008		2007		2006
Program management:
Skilled nursing rehabilitation services	$	6,835	$	8,777	$	6,888	$	3,824	$	2,530	$	4,747
Hospital rehabilitation services		2,641		4,104		4,740		1,032		442		1,403
Program management total		9,476		12,881		11,628		4,856		2,972		6,150
Hospitals		5,094		3,657		2,621		13,604		6,824		8,686
Healthcare management consulting		62		44		65		42		193		18
Total	$	14,632	$	16,582	$	14,314	$	18,502	$	9,989	$	14,854

		Total Assets
		as of December 31,
		2008		2007		2006
Program management:
Skilled nursing rehabilitation services	$	198,236	$	201,482	$	218,106
Hospital rehabilitation services		115,044		105,292		110,800
Program management total		313,280		306,774		328,906
Hospitals (4)		118,267		93,659		92,681
Healthcare management consulting		6,859		8,127		6,709
Total	$	438,406	$	408,560	$	428,296

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

(1) Intercompany revenues represent sales of services, at market rates, between the Company’s operating segments.

(2) Represents an impairment charge associated with the abandonment of a fixed asset that was never placed in service.  This fixed asset relates to an internal software development project.  See Note 5 for additional information.

(3) Represents certain expenses associated with the StarMed staffing business, which was sold on February 2, 2004.

(4) Hospitals segment total assets include the carrying value of the Company’s investment in HRSC.

(20) Quarterly Financial Information (Unaudited)

The following tables present the Company’s quarterly financial data.

	Quarter Ended
2008	December 31		September 30		June 30		March 31
		(in thousands, except per share data)
Operating revenues	$	194,178	$	182,626	$	183,919	$	182,374
Operating earnings		9,375		6,988		7,701		8,617
Earnings from continuing operations before income taxes		8,696		6,309		6,898		7,516
Net earnings attributable to RehabCare		5,703		3,998		4,496		4,508
Net earnings per share attributable to RehabCare:
Basic		0.32		0.23		0.26		0.26
Diluted		0.32		0.22		0.25		0.25

	Quarter Ended
2007	December 31		September 30		June 30		March 31
		(in thousands, except per share data)
Operating revenues	$	171,750	$	170,684	$	180,091	$	182,024
Operating earnings		9,102		8,233		5,399		5,901
Earnings from continuing operations before income taxes		7,642		6,291		3,844		3,650
Net earnings attributable to RehabCare		5,101		3,910		1,651		1,997
Net earnings per share attributable to RehabCare:
Basic		0.29		0.23		0.10		0.12
Diluted		0.29		0.22		0.09		0.12

Consistent with Note 1, the Company reclassified certain current year and prior year amounts to conform to the presentation required by Statement 160.  In addition, certain other current year and prior year amounts have been reclassified to present the results of operations for the Midland hospital as discontinued operations.

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REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

(21) Contingencies

The Company is currently not a party to any material pending legal proceedings.

In the ordinary course of our business, the Company is a party to a number of claims and lawsuits, as both plaintiff and defendant, which the Company regards as immaterial.  From time to time, and depending upon the particular facts and circumstances, the Company may be subject to indemnification obligations under its various contracts.  The Company does not believe that any liability resulting from such matters, after taking into consideration the Company’s insurance coverage and amounts already provided for, will have a material effect on the Company’s consolidated financial position or overall liquidity; however, such matters, or the expense of prosecuting or defending them, could have a material effect on cash flows and results of operations in a particular quarter or fiscal year as they develop or as new issues are identified.

During the month of September 2008, the business activities of certain Company-owned facilities and certain client-owned facilities in Louisiana, Texas and Florida were disrupted as a result of Hurricanes Gustav, Hanna and Ike.  The Company estimates the hurricanes had a negative impact on 2008 consolidated operating earnings of approximately $1.0 million, net of accrued business interruption insurance recoveries recorded during the period of $0.1 million.  These recoveries have been recorded on the operating expense line of the Company’s consolidated statement of earnings.  The Company may recognize additional recoveries after contingencies relating to the insurance claim have been resolved.

In 2007, the Company entered into a restated term loan agreement with Signature Healthcare Foundation (“Signature”).  The restated term loan agreement supersedes and replaces a line of credit agreement and loans previously made by RehabCare to Signature between 2003 and 2005.  Under the restated term loan agreement, Signature agreed to pay the entire unpaid principal amount of $1,420,000 to RehabCare upon demand by RehabCare after May 31, 2010.  In addition, Signature has agreed to pay interest on the outstanding principal balance on a quarterly basis at a rate equal to prime plus one percent.   The Company has recognized interest income by applying the loan’s contractual interest rate to the loan’s outstanding principal balance.  As of December 31, 2008, the outstanding principal balance under the term loan was $1,420,000, and Signature owed the Company approximately $6,000 in accrued but unpaid interest.  During the years ended December 31, 2008, 2007 and 2006, the Company recognized interest income on the various Signature loans of approximately $87,000, $109,000 and $85,000, respectively.

In 2008, Signature’s financial condition deteriorated, and it became probable that Signature would be unable to pay all the amounts due to the Company under the loan agreement.  Foreclosure on the loan’s underlying collateral was considered probable at December 31, 2008.  As required by FASB Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan,” the Company measured the loan’s impairment based on the estimated fair value of the collateral.  Because the estimated fair value of the collateral was less than the carrying value of the loan, the Company recognized a $535,000 charge in 2008 to increase its existing valuation allowance against the impaired loan.  This charge, which is included in the Company’s 2008 provision for doubtful accounts, reduced the carrying value of the note receivable to $580,000 as of December 31, 2008.

- 33 - -

REHABCARE GROUP, INC.

Notes to Consolidated Financial Statements (Continued)

December 31, 2008, 2007 and 2006

The proceeds of the loans to Signature were used by Signature to further the operations of its facilities which provide physical and occupational rehabilitation programs in outpatient and home health settings.  Since 2003, the Company has provided rehabilitation staffing services to Signature’s outpatient facilities and home health programs at rates that represent market value for the services provided.  The Company’s services are provided under a 5-year staffing services agreement, which is independent of the loan agreement except that termination of the staffing services agreement by Signature prior to the end of its initial term constitutes an event of default under the loan agreement.  As of December 31, 2008, the outstanding balance due from Signature under the staffing agreement was $1.1 million and the carrying value of the Company’s receivable, net of a specific allowance for doubtful accounts, was zero. See Note 22 for the latest developments.

(22) Subsequent Event

As mentioned in Note 21, the Company had provided loans to Signature Healthcare Foundation between 2003 and 2005.  The proceeds were used by Signature to further the operations of its facilities which provide physical and occupational rehabilitation programs in outpatient and home health settings.  In February 2009, the Company terminated its staffing agreement with Signature and took possession of Signature’s operating assets in full satisfaction of the Company’s receivables from Signature.  At December 31, 2008, the Company’s note receivable from Signature had a remaining carrying value of $580,000, which approximates the estimated fair value of the assets received from Signature.

(23) Noncontrolling Interests

Effective January 1, 2009, the Company adopted Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“Statement 160”).  The consolidated balance sheets have been restated to report noncontrolling interests as a component of equity and the consolidated statements of earnings have been restated to report the amounts of consolidated net income attributable to the parent and to the noncontrolling interest.  The Company’s adoption of the new standard also resulted in the presentation of separate consolidated statements of comprehensive income to report the amounts of consolidated comprehensive income attributable to the parent and to the noncontrolling interest.  The Company’s relevant financial information in the footnotes herein has been updated to reflect the changes required by Statement 160.

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