UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

   
                          AMENDMENT NO. 1 TO FORM 10-K
                                       ON
                                   FORM 10-K/A
    

                            FOR ANNUAL AND TRANSITION
                               REPORTS PURSUANT TO
                             SECTIONS 13 OR 15(d) OF
                             THE SECURITIES EXCHANGE
                                   ACT OF 1934

                                   (MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934 [Fee Required]

                   For the fiscal year ended December 31, 1996
                                       OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934 [No Fee Required]

              For the transition period from ______ to __________.

                         Commission file number 0-21512

                           MARINER HEALTH GROUP, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                             06-1251310
 (State or other jurisdiction                                (I.R.S. employer
of incorporation or organization)                           identification no.)

              125 Eugene O'Neill Drive
               New London, Connecticut                             06320
      (Address of principal executive offices)                   (Zip code)

       Registrant's telephone number, including area code: (860) 701-2000

        Securities registered pursuant to Section 12(b) of the Act: None

           Securities registered pursuant to Section 12(g) of the Act:

                          Common Stock, $.01 Par Value
                                (Title of Class)

          Series A Junior Participating Preferred Stock Purchase Rights
                                (Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.


                                  YES X NO ___

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein,  and will not be contained,  to the best
of  registrant's  knowledge,  in  definitive  proxy  or  information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

   
The  aggregate  market  value  of the  Common  Stock,  $.01  par  value,  of the
registrant  held by  non-affiliates  of the  registrant  as of  April  28,  1997
(computed based on the closing price of such stock on The Nasdaq National Market
on April 28, 1997) was $200,855,955.08.

The  number  of  shares  of the  registrant's  Common  Stock,  $.01  par  value,
outstanding as of April 28, 1997 was 29,031,676 shares.
    


                                       3


ITEM 1.  BUSINESS


         Mariner  Health Group,  Inc.  ("Mariner" or the "Company") is a leading
provider  of  outcomes-oriented,  post-acute  health  care  services in selected
markets,  with a particular  clinical  expertise in the  treatment of short-stay
subacute patients in cost-effective  alternate sites. The Company's services and
products include  pre-acute care,  inpatient care,  comprehensive  inpatient and
outpatient  rehabilitation  services,  medical services and products  (including
institutional and home pharmacy  services,  respiratory and infusion therapy and
durable medical equipment),  home care and physician services. By providing this
continuum  of care in selected  markets,  the Company  believes  that it will be
better able to maintain quality of care and control costs while coordinating the
treatment of patients  from the onset of illness to recovery.  The Company seeks
to cluster  facilities and other  post-acute  health care services  around large
metropolitan  areas and major  medical  centers with large acute care  hospitals
from which to generate  post-acute  admissions.  Mariner  currently  operates 79
inpatient  facilities and four hospital units with an aggregate of approximately
10,668 beds and 48  outpatient  rehabilitation  clinics and  currently  provides
contract rehabilitation services within 429 skilled nursing facilities.

         Mariner has established standardized clinical programs based on defined
protocols to address the medical  requirements  of large groups of patients with
similar  diagnoses  in a  high-quality,  cost-effective  manner.  The  Company's
MarinerCare(R)  clinical  programs,  such as the  orthopedic  recovery,  cardiac
recovery and pulmonary  management  programs,  are short-stay  regimens based on
defined protocols that address the needs of subacute patients. Subacute patients
are medically stable and generally require three to six hours of skilled nursing
care per day.  MarinerCare programs typically involve 20 to 45 days of inpatient
care and utilize  the  Company's  nursing,  rehabilitation,  pharmacy  and other
ancillary medical services, with patients generally discharged directly to their
homes. Mariner is also developing  standardized clinical home care programs. The
Company believes that careful  adherence to its clinical  programs enables it to
produce  consistent and measurable  clinical and financial outcomes for patients
and payors and to conduct  clinical  programs  consistently in all of its sites.
Using a case management  approach,  patients' progress is carefully monitored so
that the  appropriate  level of care is being delivered at the right time and in
the appropriate setting under the applicable clinical program.  Mariner believes
that its standardized  approaches to delivering care and measuring  outcomes are
particularly  attractive  to managed  care  organizations  and large  payors and
positions the Company to contract with payors on a case rate or capitated basis.



BACKGROUND

         Traditionally,  patients  recuperating from a major injury,  surgery or
illness  remained in general acute care hospitals  until they were  sufficiently
well to return home. Such stays are relatively expensive, reflecting the cost of
extensive  on-site equipment and services that, while necessary for hospitals to
accomplish  their primary  mission,  are not necessary for the  recuperation  of
medically stable  post-acute  patients.  

         Over the past ten years,  hospitals have come under increasing pressure
to reduce the length of patient stays as a means of containing costs.  Employers
have  begun  using   managed  care   providers,   such  as  health   maintenance
organizations and preferred  provider  organizations,  to limit  hospitalization
costs by controlling  hospital  utilization and by negotiating  discounted fixed
rates for hospital  services.  Traditional  third-party  indemnity insurers have
begun to limit  reimbursement to pre-determined  amounts of reasonable  charges,
regardless of actual costs, and to increase the co-payments  required to be paid
by patients,  thereby requiring  patients to assume more of the cost of hospital
care. In 1983,  Congress sought to contain Medicare hospital costs by adopting a
system based on prospectively  determined  prices (the "PPS system") rather than
payment of actual costs plus a specified profit. Under the PPS system, hospitals
generally  receive a specified  reimbursement  rate  regardless  of how long the
patient remains in the hospital or the volume of ancillary  services  ordered by
the  attending  physician.  The  emergence  of managed  care  providers  and the
implementation  of the PPS system have provided  hospitals  with an incentive to
discharge patients more quickly.

         The  increasing  desire of payors and  managed  care  organizations  to
transfer  medically  stable  patients  out of  relatively  expensive  acute care
hospitals to less  expensive  sites has provided a significant  opportunity  for
alternate  site health  care  providers.  Specialty  long-term  care  hospitals,
rehabilitation  hospitals,  skilled  nursing  facilities  and



                                       4


home health care  providers  have all been used to reduce the lengths of patient
stays at more expensive general acute care hospitals. Mariner believes that many
traditional health care providers are not well positioned to efficiently provide
health care services to patients who are medically stable and recuperating  from
a major injury, surgery or illness.



MARINER'S STRATEGY

         Mariner's  goal is to be the  lowest  cost  provider  of  high-quality,
post-acute  health care  services in its markets with a  particular  emphasis on
short-stay  subacute  patients.  The Company believes that being the lowest cost
provider will significantly  enhance its ability to respond to potential changes
in reimbursement programs and managed care competition, including its ability to
contract with payors on a case rate or capitated basis.

Mariner's strategies to achieve this goal include the following:

         Patient-Focused  Programmatic Care. Mariner has developed  standardized
clinical programs based on defined protocols to address the medical requirements
of  large  groups  of  patients  with  similar   diagnoses  in  a  high-quality,
cost-effective  manner at  alternate  site  treatment  settings.  Each  clinical
program incorporates an interdisciplinary approach to care and treatment with an
intense  focus  on  rehabilitation  and  lifestyle  retraining  with the goal of
guiding  patients to the best possible  recovery in the shortest  period of time
and  improving  patients'  overall  functional  ability.  The  Company  is  also
designing  its  MarinerCare  programs to include home health  care.  The Company
believes that careful  adherence to these clinical programs enables it to better
produce  consistent  clinical and financial outcomes for patients and payors and
to implement clinical programs consistently in all its sites.

         Outcomes  and Case  Management.  The  ability to measure  clinical  and
financial  outcomes  is central  to  Mariner's  delivery  of care.  Mariner  has
implemented a program to measure patients  functional  ability on admission,  at
discharge and, for certain patients,  six weeks after discharge.  Each patient's
rehabilitation  potential is evaluated using a standardized  measurement system,
which rates a patient's  independence in performing a number of basic activities
of daily living.  This rating system permits Mariner to initially assess whether
the patient will benefit from the Company's programs, document the severity of a
patient's  initial  impairment and measure the outcome and cost of the patient's
recuperation.  Using  a  case  management  approach,  a  patient's  progress  is
continually  monitored so that the appropriate  level of care is being delivered
at the right time and in the appropriate  setting under the applicable  clinical
program.  Mariner believes that its  standardized  approaches to delivering care
and measuring outcomes are particularly attractive to managed care organizations
and large  third-party  payors because they facilitate such  organizations'  and
payors'  increasing  desire to be provided with outcomes data in order to manage
and  contain  costs.  The  Company   currently  plans  to  spend   approximately
$25,000,000 in 1997 to upgrade its  information  systems in order to enhance its
ability to collect  clinical  and  financial  outcomes  information  on a timely
basis.

         Regional  Post-Acute  Networks of Care.  Mariner is organized into five
regions: Florida, Central,  Northeast,  Mid-Atlantic and Southwest. By providing
directly a broad continuum of care within a region,  Mariner positions itself to
coordinate  the treatment of patients from the onset of illness to recovery.  By
providing this continuum of care in selected markets,  the Company believes that
it will be better able to maintain  quality of care,  control  costs and attract
managed care organizations and third-party payors.

         Partnering  with  Key  Referral  Sources.  Utilizing  its  standardized
clinical programs,  regional post-acute networks of care and outcomes management
approach,  Mariner seeks to allow patients and payors to coordinate all of their
post-acute  health  care  with  Mariner.  By  entering  into  arrangements  with
physicians,  payors and managed care  organizations,  as well as skilled nursing
facilities and other  traditional  health care  providers,  the Company seeks to
position itself to obtain referrals of patients who would benefit from Mariner's
clinical programs and to contract with payors on a case rate or capitated basis.



                                       5


         Commitment to Employee Training.  Through Mariner  University,  Mariner
employees  participate  in extensive  Company-sponsored  training  programs that
focus on Mariner's business philosophy,  reimbursement guidelines,  teamwork and
execution.  The Company's success depends on its ability to deliver standardized
services  throughout  its markets and to maintain a high quality  level of care.
Thus,  Mariner is committed to an intense and on-going training process designed
to ensure the integrity and consistency of its clinical programs.

         Market Driven Development. The Company introduces its clinical programs
in  strategically  selected  metropolitan  areas  throughout  the United States.
Mariner  targets  areas with strong  potential  demand for its  services and the
potential for the Company to establish  relationships  with leading local health
care  providers and payors.  The Company  typically  establishes a presence in a
market by acquiring,  leasing or managing one or more inpatient facilities. Once
Mariner enters a target market, it seeks to establish other sites and expand the
range of health care services it provides in that market.


         As part of its  expansion  strategy,  Mariner  may  acquire  additional
health care facilities and businesses.  Potential acquisition candidates include
individual  inpatient  facilities,  businesses that operate  multiple  inpatient
facilities and other health care services  businesses.  The Company continuously
identifies  and evaluates  potential  acquisition  candidates  and in many cases
engages in discussions and negotiations regarding potential acquisitions.  There
can be no assurance that any of the Company's  discussions or negotiations  will
result in an acquisition.  Further, if Mariner makes any acquisitions, there can
be no  assurance  that it will be able to operate  any  acquired  facilities  or
businesses  profitably  or  otherwise   successfully   implement  its  expansion
strategy.



MARINER CLINICAL PROGRAMS AND SERVICES

         MARINERCARE(R) PROGRAMS

         Each   MarinerCare   program  is   designed   to  address  the  medical
requirements  of  a  large  group  of  patients  with  similar  diagnoses  in  a
high-quality,   cost-effective   manner.   MarinerCare  programs  are  inpatient
short-stay  regimens  based on defined  protocols  and utilize  various  medical
services  provided  by  Mariner.  These  programs  are  focused  on the needs of
patients  who are  recuperating  from a major  injury,  surgery or illness,  and
incorporate specific patient admission,  evaluation and discharge criteria,  and
standardized  treatment  protocols and regimens,  which have been developed over
several years based on the Company's clinical experience.  Using these criteria,
the Company  evaluates which patients would benefit most from its programs prior
to their admission. Upon admission, a care plan and projected discharge date are
established for each patient. Throughout a patient's inpatient stay, the Company
carefully monitors and evaluates the patient's progress and makes adjustments to
the  patient's  treatment.  Educating  patients  regarding  their  ailments  and
treatments also comprises a part of each program. MarinerCare programs typically
involve  inpatient  treatment  periods  of 20  to  45  days.  At  its  inpatient
facilities,  the Company offers a mix of MarinerCare  programs tailored to serve
the demands of the local  markets.  In the  facilities it acquires,  the Company
intends to focus  increasingly on treating  subacute  patients and  implementing
appropriate MarinerCare programs or other clinical programs.

         The Company currently offers the following MarinerCare programs:

         Orthopedic  Recovery.  Patients  who  are  recovering  from  orthopedic
surgery (such as joint  replacements or amputations) or serious fractures may be
admitted into this  MarinerCare  program as early as three days after surgery or
injury. These patients typically require comprehensive rehabilitation, including
physical or occupational therapies,  following stabilization of their conditions
or after surgery, and may require traction or fixation devices.

 


                                       6


        Cardiac  Recovery.  Patients who are recuperating from heart attacks or
heart surgery,  or associated  complications,  are provided with the nursing and
rehabilitation  services  necessary  to  enable  them  to  enter  an  outpatient
rehabilitation program.

         Pulmonary  Management.  Patients  with acute or chronic  lung  disease,
including  those  with  tracheotomies  and  those  who are on  ventilators,  are
provided  with  short-term   intensive   programs  of  pulmonary,   physical  or
occupational therapies.

         Vascular and Wound Management. Patients who are recovering from surgery
for  circulatory  problems  or from  difficult-to-heal  wounds or burns  receive
services  designed  to further  the healing  process,  such as  state-of-the-art
dressing techniques, specialized bed therapies, nutritional support and physical
or occupational therapies.

         Oncology Management. Patients who have undergone surgery, chemotherapy,
radiation,  immunotherapy  or hormone therapy as a result of cancer are provided
with a  range  of  services,  including  pain  management  and  nutritional  and
psychological support.

         Stroke  Recovery.  Patients who are recovering from strokes and require
treatment  for related  neurological  and physical  problems are provided with a
range of services, including physical, occupational and speech therapy.

         Medically  Complex.  Under this program,  Mariner treats  patients with
medical  complications  that  prolong  their  recuperative  period  from a major
illness. These secondary complications must be resolved or brought under control
before their  primary  diagnosis  can be  addressed.  These  patients  typically
require many ancillary  services and  therapies.  The goal of this program is to
return patients to their homes with or without support  services or to have them
re-enter an acute care hospital for additional surgery or treatment.

    MARINER REHABILITATION PROGRAMS

         Mariner rehabilitation  programs are designed to assist skilled nursing
facilities in providing comprehensive  rehabilitation services and in attracting
patients  who  would  benefit  from  these  services.  The  Company  provides  a
contracting  facility  with the  physical,  occupational  and speech  therapists
necessary to provide  comprehensive  rehabilitation  services to the  facility's
patients.  In  selected  facilities,   the  Company  also  provides  MarinerCare
rehabilitation  programs  which include case  management  and quality  assurance
services,  as well as  coordination  of admissions  functions  with key referral
services.  The Company also offers  consulting  services  regarding managed care
reimbursement  and cost containment  strategies to these  facilities,  including
reimbursement  analysis  and  assistance,  preparation  of atypical  filings and
interim rate requests and subacute feasibility  analysis. By utilizing Mariner's
rehabilitation  programs,  the Company believes that skilled nursing  facilities
are able to offer a cost  effective  rehabilitation  program which will make the
facilities  service package more attractive to managed care  organizations.  The
Company  currently  provides  rehabilitation  programs  for 429 skilled  nursing
facilities.

         In implementing a facility's rehabilitation programs, therapists screen
each  patient in the  facility  to assess  and  identify  those with  functional
problems. A therapist, together with the patient's attending physician and staff
of the facility, designs a plan of care with specific long and short-term goals.
Therapists with  specializations  appropriate  for the patient's  condition meet
with the  patient on a regular  basis and render the  prescribed  rehabilitation
services.  The Company's admissions  coordinators assist the facility in working
with local  hospitals,  payors and managed  care  organizations  to identify and
admit  patients who can benefit  from the  facility's  rehabilitation  services.
Services  are  typically  rendered in a dedicated  room  located in the facility
which is equipped with rehabilitation equipment.

         In addition to providing  comprehensive  rehabilitation services at its
inpatient facilities and other skilled nursing facilities,  the Company operates
48  outpatient  rehabilitation  clinics  located in  metropolitan  areas.  These
clinics primarily provide routine physical and occupational  therapy to patients
who suffer from  injuries  received in the  workplace,  accidents  and  athletic
endeavors and are capable of being treated on an outpatient basis.

    OTHER INPATIENT SERVICES

         In Mariner's inpatient  facilities,  all patients receive basic medical
services,  including nursing care,  special diets,  nutritional  supplements and
various  medical  equipment.  Inpatient  care is provided by registered  nurses,
licensed practicing nurses and certified nurses aides under the supervision of a
Director  of  Nursing.  Each  facility  also  contracts  with a  local  licensed
physician to serve as its medical director, and establishes relationships with a



                                       7



number of  independent  local  specialists,  who are  available  to care for the
facility's patients. Each of Mariner's facilities provides a broad range of case
management  services over the course of treatment,  including admission into the
Company's  MarinerCare  programs,  ongoing  medical  evaluation,  social service
needs,  specialty  equipment  requirements,   outcomes  measurement,   discharge
planning and arrangement for home care.

    MEDICAL PRODUCTS AND SERVICES

         As part of its strategy of  providing a continuum of care,  the Company
also offers the following products and services in selected markets:

         Pharmacy Services.  Mariner provides  pharmaceutical goods and services
customized to meet the needs of its patients,  and pharmacy  consulting services
designed to evaluate,  guide and monitor the  administration of medication.  The
Company currently has pharmacy operations in six states.

         Infusion Therapy.  The Company provides infusion  therapies,  including
hydration, total parenteral nutrition, antibiotic,  peritoneal dialysis and pain
management therapies. Infusion therapies are often required in treating patients
with  chronic  infections,  digestive  disorders,  cancer and chronic and severe
pain.

         Medical Equipment and Supplies.  Mariner provides  specialized  medical
equipment and supplies, including ventilators, oxygen concentrators,  diagnostic
equipment and various types of durable medical equipment. Equipment and supplies
are available to patients both in its inpatient facilities and at home.

         Clinical Respiratory  Services.  The Company provides clinical programs
for managing the  pulmonary  disease  process for patients with acute or chronic
lung diseases.  These services include  rehabilitation and provision of supplies
and equipment.

    HOME CARE

         The  Company  provides  skilled  nursing,   rehabilitation,   pharmacy,
infusion  therapy and  respiratory  services and durable  medical  equipment and
supplies to individuals  needing such services in their homes,  allowing Mariner
to  continue  to meet the nursing  care needs of  patients  discharged  from its
facilities.

    PHYSICIAN SERVICES

         Mariner  provides   management   support  services  designed  to  allow
physicians to focus on the delivery of quality  patient care,  while the Company
manages the physicians'  practice. 





                                       8



SOURCES OF REVENUE

         The  following  table sets forth  certain  information  relating to the
sources of Mariner's revenue for the periods indicated:

<TABLE>
<CAPTION>
                                                                Year Ended December 31,

                                                                  Dollars in Thousands

                                1994                           1995                             1996
                                ----                           ----                             ----

                         $              %               $              %                $                %
                     ----------    ------------    ------------    -----------     -------------    -------------

<S>                   <C>                <C>          <C>                <C>           <C>                 <C>
Private Payors (1)    $141,709           54%          $177,479           50%           $221,446            37%

Medicare.............   68,302           26            102,713           29             217,271            37

Medicaid.............   54,133           20             74,614           21             152,092            26
                     ----------    ------------    ------------    -----------     -------------    -------------


Total.................$264,144         100%           $354,806         100%            $590,809          100%
                     ==========    ============    ============    ===========     =============    =============

</TABLE>
-----------------


(1)    Includes indemnity insurers, health maintenance organizations, employers,
       individuals  and other  non-governmental  payors,  payments  from skilled
       nursing facilities for services performed under rehabilitation management
       programs, and revenue classified as "other revenue."


         The sources and amounts of Mariner's patient revenues are determined by
a number of factors, including the capacities of its facilities, occupancy rate,
the mix of  patients  and the  rates of  reimbursement  among  payor  categories
(private,  Medicare  and  Medicaid).  Patient  length of stay is critical to the
level of reimbursement Mariner receives for each patient.  Shorter-term patients
generally have a larger number of potential payors than do longer-term patients,
who  generally  depend to a greater  extent on  Medicaid.  Reimbursement  levels
generally are linked to the level of care provided, and short-stay  recuperating
patients typically are more medically  demanding,  have higher acuity levels and
require greater ancillary services. In addition, Medicare and, in certain cases,
private payors,  typically cease  reimbursement after defined lengths of stay or
levels of  expenditure,  following  which Mariner is generally  dependent on the
patient's own resources or Medicaid for reimbursement.  Once admitted, a patient
can be discharged involuntarily only for limited reasons under Federal and state
laws, which generally do not include access to reimbursement or ability to pay.

   
    The Company's  rehabilitation program contracts typically have a term of one
year but frequently  include automatic renewals and in general are terminable on
notice of 30 to 90 days by either party. Under certain contracts,  Mariner bills
Medicare or another  third-party  payor  directly.  Under other  contracts,  the
Company is compensated on a fee for service basis and in general  directly bills
the  skilled  nursing  facility,  which  in  turn  receives  reimbursement  from
Medicare,  Medicaid,  private  insurance  or  the  patient.  Mariner  recognizes
payments  under these latter  contracts as payments from private  payors.  Under
these latter contracts, Mariner also generally indemnifies its customers against
reimbursement  denials by third-party payors for services provided by Mariner at
costs in excess of reasonable costs in such customer's market area. In addition,
Mariner  generally  indemnifies its customers against  reimbursement  denials by
third-party  payors  for  services  determined  not to be  medically  necessary.
Mariner has established internal documentation standards and systems to minimize
denials and typically has the right to appeal  denials at its expense.  However,
the Health Care Finance Administration ("HCFA") has recently proposed new salary
equivalency  guidelines.  Mariner is currently  evaluating  the effects of these
proposals;  however any final  analysis on the effects of such  guidelines  will
depend  upon  the   publication   of  final   rates  and  rules.   Historically,
reimbursement denials under these contracts have been insignificant; however, in
light of the changing  regulatory  environment,  there can be no assurance  that
this will continue in the future.
    

         Private Payors.  Private pay revenues include payments from individuals
and  contract  payors  who  pay  directly  for  services  without   governmental
assistance  and certain  payments from skilled  nursing  facilities for services
performed  under  rehabilitation  management  programs.  Contract payors include
indemnity  insurers,  health  maintenance   organizations,   preferred  provider
organizations, workers' compensation programs and other similar non-governmental
third-party payment sources. Payments from private payors are typically based on
negotiated  contracts or on  patient-specific  terms.  Typically,  private payor
contracts permit such  organizations  to place patients in Mariner's  facilities
for a negotiated per diem charge that varies with patient category, or for a per
diem base rate


                                       9


plus  Mariner's  charges  for  ancillary  services.  Certain of these  contracts
require  Mariner to provide  specified  health care  services for a set per diem
payment  rate.  These  contracts are generally  automatically  renewed  annually
unless a party provides written notice. In most of these contracts, either party
may  terminate  such contract  without cause on 90 days' written  notice or with
cause on 30 days' written notice. The amount Mariner charges to private patients
in its  facilities is not subject to regulatory  control in any of the states in
which Mariner operates facilities.

         Medicare.  Under Medicare,  the Federal government provides payment for
skilled  nursing  care,  room and board,  therapies,  drugs,  supplies and other
subacute  services provided by Mariner to eligible  patients  (generally,  those
over  age 65 and  certain  disabled  persons).  After  the  first  20  days of a
patient's stay,  Medicare patients are subject to a 20% co-payment,  all or some
of which may be paid by  private  payors,  Medicaid,  Medigap  insurance  or the
patient.  Medicare generally does not provide  reimbursement for inpatient stays
beyond the first 100 days, but may provide  reimbursement  for certain therapies
and supplies. Medicare provides Mariner with interim prospective payments during
the year,  which are subject to later  adjustment  to reflect  actual  allowable
costs.  These costs include the reasonable  direct and indirect costs (including
depreciation,  interest and  overhead)  of the  services  furnished at Mariner's
inpatient  facilities,  subject to prospectively  determined ceilings on routine
operating  costs  except  when the  facility  is  granted an  exception  for the
delivery of atypical services.  Medicare does not pay a rate of return on equity
capital. See "Government Regulation."

         After the first three full years of a  facility's  operation,  Medicare
reimbursement of routine operating costs is subject to a cap which is related to
regional health care costs.  Mariner has received an atypical services exception
for  certain  of its  facilities,  which  allows  payment  of the costs over the
ceiling. This exception requires annual Federal approval.

   
         Under  arrangements  in  which  the  Company  bills a  skilled  nursing
facility for its  rehabilitation  services on a fee for service basis,  Medicare
reimburses the facility based on a reasonable cost standard. Specific guidelines
exist for evaluating the reasonable  cost of physical,  occupational  and speech
therapy services. Medicare applies salary-equivalency  guidelines in determining
the reasonable cost of physical therapy  services,  which is the cost that would
be incurred if the therapist were employed by a nursing facility, plus an amount
designed to  compensate  the  provider  for certain  general and  administrative
overhead costs.  Medicare pays for occupational and speech therapy services on a
reasonable  cost  basis,  subject  to the  so-called  "prudent  buyer"  rule for
evaluating the  reasonableness of the costs. The Company's gross margins for its
physical   therapy  services  under  the  salary   equivalency   guidelines  are
significantly  less than for its speech and occupational  therapy services under
the "prudent buyer" rule. In addition, Mariner provides certain services between
subsidiary  companies,  some of which are charged at cost and others of whch are
charged at market  rates.  Subject to certain  exceptions,  Medicare's  "related
party rule" generally  requires that services  between  subsidiary  Companies or
other entities  deemed to be related under the rule be charged at cost.  Mariner
believes  that the  services  that are  charged at market  rates  qualify for an
exception to Medicare's related party rule. There can be no assurance,  however,
that  HCFA  will  accept  Mariner's  position,  and the  Medicare  reimbursement
received  for such  services  may be subject to audit and  recoupment  in future
years.  In the event HCFA does not agree with the Company's  position,  any such
denial may result in a reduction  in  reimbursements  in future  periods,  which
could have a material  adverse  effect on the Company's  business and results of
operations.
    

         In  April  1995,  HCFA  issued  a  memorandum  to its  Medicare  fiscal
intermediaries  as a guideline to assess costs  incurred by inpatient  providers
relating  to payment of  occupational  and speech  language  pathology  services
furnished under  arrangements  that include  contracts between therapy providers
and inpatient  providers.  While not binding on the fiscal  intermediaries,  the
memorandum suggested certain rates to assist the fiscal intermediaries in making
annual "prudent buyer" assessments of speech and occupational therapy rates paid
by  inpatient  providers.  In  addition,  HCFA  has  published  proposed  salary
equivalency   guidelines   which  will  update  current   physical  therapy  and
respiratory therapy rates and establish new guidelines for occupational  therapy
and speech therapy.  Mariner is currently  evaluating these proposals;  however,
Mariner will not be able to determine  whether these new  proposals  will have a
material effect on its rehabilitation  operations until the publication of final
rates and rules. Through its  intermediaries, HCFA  is also subjecting  physical
therapy,  occupational  therapy  and  speech  therapy to a  heightened  level of
scrutiny  resulting  in  increasing  audit  activity.  A majority  of  Mariner's
provider  and  rehabilitation  contracts  provide  for  indemnification  of  the
facilities  for potential  liabilities  in  connection  with  reimbursement  for
rehabilitation services. There can be no assurance that actions ultimately taken
by HCFA with regard to  reimbursement  rates for such therapy  services will not
materially adversely affect the Company's results of operations.


   
         During 1996, the Company observed a nationwide  change in the practices
of its Medicare  fiscal  intermediaries  which, on behalf of HCFA, have begun to
aggressively and  retrospectively  change their position on previously  approved
costs. This change includes the  reclassification  of costs from reimbursable to
non-reimbursable   and  the   challenging   of  payment   for  costs  which  had
traditionally  been approved.  In response to these challenges of the payment of
Medicare  costs the Company  changed  its  estimate  of  required  reserves  and
provided  an  additional  $10,000,000  reserve  for  potential  lower  levels of
Medicare reimbursement.  While the Company believes the amount of its reserve to
be  sufficient,  there can be no assurance  that this amount will be adequate in
the  future.  Mariner  may  increase  the  amount  of its  reserve  based on the
practices of its fiscal  intermediaries,  and any such increase would  adversely
effect Mariner's results of operations.
    



                                       10



         Medicaid.   The  Medicaid   program  is  designed  to  provide  medical
assistance to  individuals  unable to afford  medical care.  Medicaid is a joint
Federal and state program in which states voluntarily participate. Reimbursement
rates, and reimbursement  methods and standards,  under the Medicaid program are
set by each participating  state (with Federal approval as to certain aspects of
the  reimbursement  methods and standards),  and rates and covered services vary
from state to state. In some of the states in which Mariner operates,  Mariner's
inpatient facilities are paid a per diem rate for providing services to Medicaid
patients based on the applicable  facility's reasonable allowable costs incurred
in providing services plus a return on equity, subject to cost ceilings for both
operating and fixed costs. In some states in which Mariner operates,  individual
facilities are  reimbursed,  in whole or in part, on a prospective  rate system.
Retroactive adjustments,  if any, are based on a recomputation of the rate based
upon a field audit of the submitted cost report. In other states,  each facility
is  assigned  a range of  rates  that  vary  depending  on  patient  acuity  and
historical  costs.  Certain  states are studying  methods for reducing  expenses
under their Medicaid  programs;  these initiatives could have a material adverse
effect on  Medicaid  rates  applicable  to Mariner or cause  delays in  payment.
Certain  states in which  Mariner  operates  have  undertaken  a study of acuity
levels and are considering changes in their reimbursement systems to take levels
of acuity into account.  Mariner cannot currently determine the potential effect
of any such changes.

         Audits,   Settlements   and  Reserves.   Under  current   reimbursement
regulations,  funds received under Medicaid and Medicare programs are subject to
audit with respect to proper application of the various payment formulas.  These
audits  can result in  retroactive  adjustment  of  payments  received  from the
program,  resulting in either amounts due to the government  agency from Mariner
or amounts due Mariner from the government agency. As a result of certain issues
raised by in recent audits,  in the third quarter of 1996,  the Company  changed
its  estimate of  required  reserves  and  provided  an  additional  $10,000,000
reserves on its  estimated  settlements  from third party  payors.  There can no
assurance that there will not be additional material adjustments in the future.



MARKETING AND PATIENT ADMISSION

    INPATIENT FACILITIES

         In marketing  MarinerCare  programs,  the Company pursues a two-pronged
strategy. It markets its facilities,  programs and services, first to payors and
managed care  organizations at the corporate level and, second, to professionals
responsible for  discharging  patients at local hospitals at the facility level.
At  the  corporate   level,   Mariner's   sales   personnel  seek  to  establish
relationships with payors and managed care  organizations,  who are increasingly
important  sources of referrals  for  subacute  patients.  The Company  develops
contractual  relationships  with  such  payors  and  organizations  on a  local,
regional and national basis.

         Each facility maintains admissions  coordinators who develop admissions
goals  based  on the  availability  of  resources  for  each of its  MarinerCare
programs and who call on acute care hospitals to evaluate patients for admission
to  Mariner's  facilities.   The  admissions   coordinators  work  closely  with
hospitals,  payors and  managed  care  organizations  to educate  them about the
Company's  facilities,  programs and services  and to determine  which  patients
would  benefit  from the  Company's  programs.  Patients  admitted to  Mariner's
facilities  are  generally  discharged  to the facility  from general acute care
hospitals.

    REHABILITATION PROGRAMS

         Mariner  markets  its   rehabilitation   programs  to  skilled  nursing
facilities primarily through regional administrators, who contact administrators
and  other  personnel  of  skilled  nursing  facilities.  The  Company  seeks to
demonstrate  to the  administrator  of a skilled  nursing  facility that Mariner
offers a complete solution to the facility's  rehabilitation services needs in a
cost-effective  manner.  Mariner emphasizes that its therapists are based at the
facility and do not move from site to site,  resulting  in improved  consistency
and continuity of patient care.  Depending on the facility's needs, Mariner will
also staff the facility's  rehabilitation  management program with case managers
and   admissions,   management  and  marketing   personnel,   and  will  provide
reimbursement and other management support services. These individuals work with
the  facility's  staff to attract  subacute  patients  whose  recovery  would be
benefited by intensive  rehabilitation  therapy,  with the goal of improving the
utilization of the facility's  rehabilitation  management program as well as the
facility's other services.





                                       11



QUALITY ASSURANCE

         Mariner has developed a comprehensive  quality assurance program at all
of its facilities and units. This program requires that each site meet Mariner's
standards,  which include  comprehensive  training requirements and satisfactory
results on patient  satisfaction  surveys.  Mariner's  quality assurance program
includes a training program for all new Mariner  employees and periodic training
programs  for clinical  personnel.  Mariner  believes  that its  utilization  of
standardized  protocols  facilitates  its  clinical  staffs'  training and skill
retention.

         Each facility is subject to audit by Mariner's  corporate  personnel at
least annually to review its compliance with Mariner's standards.  Also, Mariner
has  developed a patient  satisfaction  questionnaire  which is included in each
patient's discharge package.  Facility  administrators'  performance reviews and
bonuses  are  dependent  in part  upon the  results  of the  facility's  quality
assurance audit and its patient satisfaction questionnaires.



FACILITIES

         The following  table  provides  information  by state about each of the
facilities owned, leased and managed by the Company as of March 28, 1997:

<TABLE>
<CAPTION>

                         OWNED FACILITIES     LEASED FACILITIES       MANAGED FACILITIES                 TOTAL
                         FACILITIES   BEDS    FACILITIES   BEDS       FACILITIES    BEDS       FACILITIES      BEDS
<S>                         <C>      <C>          <C>      <C>           <C>         <C>          <C>          <C>
Florida Region
  Florida                    16      1,929          9      1,128            3        445           28          3,502
Southwest Region:
  Colorado                  ---        ---          2        237          ---        ---            2            237
  Kansas                      1        100        ---        ---          ---        ---            1            100
  Oklahoma                  ---        ---          1        161          ---        ---            1            161
  Texas                       6        952          5        685            1        146           12          1,783
Northeast Region:
  Connecticut                 2        250          1         90          ---        ---            3            340
  Massachusetts               6        748        ---        ---          ---        ---            6            748
Mid-Atlantic Region:
  Maryland                    7      1,191          3        576            2         53           12          1,820
  New Jersey                ---        ---        ---        ---            1         40            1             40
  Pennsylvania                2        205        ---        ---            1         30            3            235
  West Virginia               1        186        ---        ---          ---        ---            1            186
Central Region:
  Georgia                     1        165        ---        ---          ---        ---            1            165
   Illinois                   1        120        ---        ---          ---        ---            1            120
  Indiana                     1        100        ---        ---          ---        ---            1            100
  North Carolina              1        150        ---        ---          ---        ---            1            150
  Ohio                        1         93        ---        ---          ---        ---            1             93
  South Carolina              3        308        ---        ---          ---        ---            3            308
  Tennessee                   2        210          2        253          ---        ---            4            463
  Wisconsin                   1        117        ---        ---          ---        ---            1            117
                          ------    -------    -------    -------    ---------    -------     --------     ----------
Totals                       52      6,824         23      3,130            8        714           83         10,668
                          ======    =======    =======    =======    =========    =======     ========     ==========
</TABLE>


         The  Company  also owns its 80,000  square foot  headquarters  facility
located  in  New  London,  Connecticut.   The  Company's  leases  are  generally
long-term.  See "Management's Discussion and Analysis of Financial Condition and
Results  of  Operations--Liquidity  and  Capital  Resources"  in  Item 7 of this
Report.



                                       12





SIGNIFICANT DEVELOPMENTS IN 1996

     THE TRANSACTIONS WITH CONVALESCENT SERVICES, INC.

   
         On January 9, 1995, the Company,  Convalescent Services,  Inc. ("CSI"),
CSI's  stockholders  (the "CSI  Stockholders")  and certain of their  affiliates
entered into certain agreements  governing the merger (the "CSI Merger") of Blue
Corporation,  a Georgia  corporation and wholly owned  subsidiary of the Company
("Merger Sub"),  with and into CSI and the acquisition of certain related assets
(the "Transactions").  CSI operated subacute-oriented skilled nursing facilities
that provided restorative nursing care and specialty medical services, including
rehabilitation  programs,  respiratory  therapy,  infusion  therapy,  wound care
treatment and Alzheimer disease management. At the time, CSI operated 25 skilled
nursing  facilities,   one  rehabilitation  hospital  and  one  continuing  care
retirement community, with an aggregate of 3,801 beds (the "CSI Facilities").
The CSI Facilities are concentrated primarily in Florida and Texas.
    

         May 1995 Closing.  By late April 1995,  however, a number of conditions
to the closing of the CSI Merger had not been  satisfied.  On May 24, 1995,  the
parties  entered  into  agreements  reflecting  the  changes  to the  terms  and
conditions  of the proposed  Transactions  and  completed  certain  transactions
related to the proposed  Transactions (the "May 1995 Closing").  At the May 1995
Closing,  Mariner and CSI entered into a Management  Agreement (the  "Management
Agreement")  pursuant to which Mariner would manage all of CSI's  Facilities and
operations.  Under the  Management  Agreement,  Mariner  would receive a monthly
management fee equal to 6% of the gross operating revenue of the CSI facilities.
In addition, upon termination of the Management Agreement, Mariner would receive
a bonus  management  fee equal to the net  income of the  facilities  managed by
Mariner during the term of the Management Agreement, except that only 66% of the
net  income  of The  Westbury  Place and none of the net  income  of the  Haltom
Convalescent  Center would be included in determining the bonus  management fee.
The Management Agreement would terminate on the sooner of (1) the closing of the
Transactions,  (2) if Mariner's stockholders did not approve the issuance of the
5,853,658 shares of Common Stock in connection with the CSI Merger,  (3) January
2, 1996 or (4) if the proposed  Transactions  were terminated in accordance with
the applicable agreements.

         At the May 1995 Closing,  Mariner acquired substantially all the assets
of Convalescent Supply Services,  Inc. ("CSSI"),  a Georgia corporation owned by
Stiles A. Kellett, Jr. and Samuel B. Kellett (the "Kelletts"). Immediately prior
to its acquisition,  CSSI provided  enteral,  urological,  wound care and ostomy
products  to CSI's  facilities.  CSSI's  principal  assets  included a five-year
agreement to supply CSI's  facilities,  accounts  receivable,  inventories and a
partnership  interest in a joint  venture  that  provided  pharmacy  services in
Florida.  The purchase  price for CSSI's  assets was  $6,500,000 in cash and the
assumption of CSSI's trade payables.

         In  addition,  the Kelletts  purchased at the May 1995 Closing  certain
assets from CSI,  which assets are used by the Kelletts in their other  business
activities and included an airplane, two cars, certain leases for real property,
a condominium  and all leasehold  improvements  and all  personalty  incident to
CSI's office space in Atlanta,  Georgia,  in exchange for the  assumption of the
liabilities  related to such assets.  Finally,  Mr. Stiles A.  Kellett,  Jr. was
appointed as a director of the Company for a term ending at the Company's Annual
Meeting of  Stockholders in 1996. At the Annual Meeting of Stockholders in 1996,
Mr. Kellett was elected as a director of Mariner for a three-year term ending in
1999.

         January  1996   Closing.   On  January  2,  1996  the  CSI  Merger  was
consummated. As a result of the CSI Merger, CSI became a wholly owned subsidiary
of the Company.  The CSI Merger was effected by the filing of a  Certificate  of
Merger with the Secretary of State of Georgia on January 2, 1996.

         Pursuant to the CSI Merger Agreement, all of the issued and outstanding
shares of  capital  stock of CSI were  converted  into the right to  receive  an
aggregate of 5,853,656  shares of Mariner common stock,  $.01 par value ("Common
Stock"),  and  $7,000,000 in cash.  As a result of the CSI Merger,  the Kelletts
each received 2,072,696 shares of Common Stock.


                                       13


   
     The shares of Common  Stock  issued in the CSI Merger  were not  registered
under the  Securities  Act of 1933 (the  "Securities  Act")  and,  consequently,
constitute "restricted securities" as that term is defined in Rule 144 under the
Securities  Act.  Because  the  shares of Common  Stock  received  by the former
stockholders  of CSI (the "CSI  Stockholders")  in the CSI Merger are restricted
securities,  they may only be sold under Rule 144.  Under Rule 144, a person (or
persons whose shares are  aggregated)  who has  beneficially  owned  "restricted
securities"  for at  least  one  year,  including  persons  who  may  be  deemed
affiliates  of the  Company,  would be  entitled  to sell within any three month
period, subject to meeting certain manner of sale notices requirements, a number
of shares  that does not exceed the  greater of (i) one percent of the number of
shares of Common Stock then issued and  outstanding  and (ii) the average weekly
trading volume of the Common Stock during the four calender weeks  preceding the
filing of a Form 144 notice of sale with the Securities and Exchange Commission.
The CSI Stockholders  were able to sell under Rule 144 as of April 29, 1997, but
under the  Stockholders  Agreement  entered into between the Company and the CSI
Stockholders  (described  below),  relating to certain voting and stock transfer
matters,  the CSI  Stockholders  have agreed not to sell their  shares of Common
Stock until May 24, 1997. The Company and the CSI Stockholders have also entered
into a  Registration  Rights  Agreement  granting the CSI  Stockholders  certain
registration rights with respect to the Common Stock received by them in the CSI
Merger (described below).
    

         Also on January 2, 1996, Mariner acquired  substantially all the assets
of Meadow Rehab Corp., a Georgia corporation owned by the Kelletts ("MRC").  The
assets of MRC consisted of a 50% partnership  interest in IHS Rehab Partnership,
Ltd. ("IHS  Rehab"),  which leases the North Dallas  Rehabilitation  Hospital in
Dallas, Texas. CSI owns the remaining 50% partnership interest in IHS Rehab. The
purchase price for MRC's assets was  $1,600,000 in cash and the Company  assumed
MRC's outstanding indebtedness, which amounted to approximately $335,000.

         In addition,  Mariner  acquired the assets that constituted the skilled
nursing  facilities  known as Arlington  Heights  Nursing  Center in Fort Worth,
Texas, and Randol Mill Manor in Arlington, Texas. Prior to the CSI Merger, these
facilities  were  leased by CSI from  partnerships  owned by the  Kelletts.  The
purchase prices for these facilities  aggregated  approximately $9.7 million. In
addition,  the Company made  interest-free  loans to the partnerships that owned
Arlington  Heights Nursing Center and Randol Mill Manor,  with principal amounts
of $955,521 and $663,256,  respectively,  which mature on May 24, 1999 and 2000,
respectively. The Kelletts have agreed to guaranty the repayment of these loans.

         In  connection  with the CSI  Merger,  CSI  (which as of July 31,  1996
merged with and into another wholly owned subsidiary of Mariner,  Mariner Health
Care of Nashville,  Inc.) entered into leases on 14 skilled  nursing  facilities
(collectively, the "Leased Facilities") from partnerships owned or controlled by
the Kelletts (the "Lessors").  Each of the leases for the Leased Facilities (the
"Leases") has a base term of eight years and four months from January 2, 1996 as
well as a number of five-year  renewal  terms at the option of CSI,  except that
the Lease for Centerville  Care Center has a term of seven years and four months
with no renewal  terms.  Each lease  provides  for a fixed rent,  which will not
increase over the base or renewal terms of such Lease. The aggregate annual rent
for the Leased  Facilities is  approximately  $8,040,000.  In addition to paying
scheduled rent for each Leased  Facility,  CSI is required to pay all utilities,
insurance  and property  taxes and to maintain the Leased  Facility,  reasonable
wear and tear excepted.

   
         If the Company leases a Leased Facility for all optional renewal terms,
the Company may  purchase  such Leased  Facility at the end of the last  renewal
term for its fair market value,  as determined by agreement  between the Company
and the applicable Lessor or, absent such agreement,  by appraisal at such time.
For each Leased Facility other than Bethany Village Health Care Center and North
Dallas  Restorative  Care  Center,  the  Company  also will have the option (the
"Options")  to purchase the Leased  Facility for a fixed price during  specified
one-year periods for the applicable  Lease.  The Options are exercisable  during
specified  periods  between  1998  and  2010.  The  fixed  prices  are  based on
appraisals that estimate the fair market value of each Leased Facility as of the
date the Option for each Leased  Facility is first  exercisable.  The  aggregate
estimated fair market value as of the earliest  exercise date of the Options of,
and the aggregate  purchase price for, the 12 Leased  Facilities  subject to the
Options is  approximately  $59,585,000.  On May 24,  1995,  the  Company  made a
deposit of an aggregate of $13,155,000 with the Lessors for the Options.  If the
Company  exercises  an  Option  for a  Leased  Facility,  the  portion  of  such
$13,155,000  deposited  by the Company  for the Option for that Leased  Facility
will be  credited  toward the  purchase  price for that Leased  Facility.  If an
Option is not exercised during the applicable  exercise  period,  the applicable
portion  of such  deposit  will be  forfeited  by the  Company.  If an Option is
exercised,  approvals from health care regulatory authorities may be required to
consummate the purchase of the Leased Facility.
    

         Stockholders  Agreement.  Pursuant  to  the  terms  of  a  stockholders
agreement  (the   "Stockholders   Agreement")   between   Mariner  and  the  CSI
Stockholders,  the CSI  Stockholders  are prohibited  from selling any


                                       14



shares of Common Stock beneficially owned by them prior to May 24, 1997. Between
May 24, 1997 and May 24, 1998, the CSI  Stockholders are prohibited from selling
more than 50% of the shares of Common Stock  beneficially  owned by them.  After
May 24,  1998,  the CSI  Stockholders  may  sell  the  shares  of  Common  Stock
beneficially  owned by them  without  limitation  as to  volume  imposed  by the
Stockholders  Agreement.  Sales  of  such  shares  must  otherwise  be  made  in
compliance with the other terms of the Stockholders Agreement.

         The Stockholders Agreement prohibits each of Stiles A. Kellett, Jr. and
the trusts for the benefit of his family members that are CSI  Stockholders as a
group,  and  Samuel B.  Kellett  and the  trusts  for the  benefit of his family
members  that  are  CSI  Stockholders  as a  group,  from  acquiring,  directly,
indirectly  or as part of a group,  more than 12.5% of the total voting power of
the  outstanding  voting  securities  of the Company,  without the prior written
consent of the Company. The CSI Stockholders have also agreed not to (1) solicit
or  initiate  any offer or proposal  for a business  combination  involving  the
Company  or  any  of  its  subsidiaries,  or  involving  the  acquisition  of  a
substantial portion of any of their assets; (2) solicit, or become a participant
in any  solicitation  of,  proxies from any holder of voting  securities  of the
Company in connection  with any vote on any matter;  (3)  participate in a group
with respect to any voting securities of the Company,  other than the group that
currently  exists  among the CSI  Stockholders;  or (4) grant any  proxies  with
respect to any voting securities of the Company to any person, unless such proxy
specifies  that the person  holding the proxy shall vote in compliance  with the
Stockholders  Agreement (other than as recommended by the Board), or deposit any
voting  securities  of the  Company  in a voting  trust or enter  into any other
arrangement or agreement with respect to the voting thereof.

         In addition,  the CSI Stockholders have agreed to grant Mariner a right
of first refusal on any sale, transfer or other disposition of voting securities
of Mariner by a CSI Stockholder or any affiliate of a CSI Stockholder where such
sale,  transfer  or other  disposition  involves  voting  securities  of Mariner
representing  more than 1% of the then issued and  outstanding  shares of Common
Stock. The right of first refusal does not, however,  apply to sales,  transfers
or other  dispositions  of voting  securities  of Mariner in  registered  public
offerings  or in  transactions  pursuant  to Rule  144 or  Rule  145  under  the
Securities  Act,  if the  transferee  in such  transfer  is not known to the CSI
Stockholder.

         Under  the  Stockholders  Agreement,  an  agent  designated  by the CSI
Stockholders (the "Stockholders Agent") has the right to designate one person to
serve on Mariner's Board of Directors.  The director designee must be reasonably
acceptable to the Company. Mariner is obligated to use all reasonable efforts to
cause the  designee to be elected as a director.  Effective  as of June 2, 1995,
Mr. Stiles A. Kellett, Jr. was appointed as a director of the Company for a term
ending at the Company's annual meeting of stockholders in 1996, at which time he
was elected for a  three-year  term ending at the  Company's  Annual  Meeting of
Stockholders in 1999.

         The  provisions  of  the   Stockholders   Agreement   relating  to  the
Stockholders  Agent's right to designate a director and voting matters terminate
on the date on which the CSI  Stockholders  own less than 5% of the total voting
power of the outstanding voting securities of the Company.  All other provisions
of the Stockholders  Agreement  terminate (1) with respect to Stiles A. Kellett,
Jr.  and  the  trusts  for  the  benefit  of his  family  members  that  are CSI
Stockholders  as a group,  on the date on which  they own less  than 2.5% of the
total voting power of the outstanding voting securities of the Company,  and (2)
with  respect to Samuel B.  Kellett and the trusts for the benefit of his family
members that are CSI Stockholders as a group, on the date on which they own less
than 2.5% of the total voting power of the outstanding  voting securities of the
Company.

         Registration  Rights Agreement.  The CSI Stockholders are also entitled
to require the Company to register under the Securities Act the shares of Common
Stock issued to them in the Merger pursuant to a registration  rights  agreement
(the  "Registration  Rights  Agreement").   The  Registration  Rights  Agreement
provides that if the Company proposes to register shares of Mariner Common Stock
under the  Securities  Act at any time  after May 24,  1997,  subject to certain
exceptions,  the CSI  Stockholders  shall be  entitled  to include the shares of
Common  Stock  issued  to  them in the  Merger  in  such  registration.  If such
registration  involves an underwritten  public offering,  the CSI  Stockholders'
rights to include  shares is subject  to the  satisfaction  of the rights of the
Company's other stockholders who have contractual registration rights and to the
rights of the  managing  underwriter  of the  offering to exclude for  marketing
reasons some or all of the CSI Stockholders' shares from such registration.




                                       15



         The CSI  Stockholders  have the additional right under the Registration
Rights Agreement to require the Company to prepare and file on three occasions a
registration  statement under the Securities Act with respect to their shares of
Mariner  Common Stock.  This right is exercisable at any time after May 24, 1997
and, if the person  designated  by the  Stockholders  Agent to be nominated  for
election as a director of Mariner pursuant to the Stockholders  Agreement stands
for election and is not elected, once within 120 days after the meeting at which
such  designee is not  elected.  Except for  registrations  requested  after the
Stockholders  Agent's  designee  is not  elected,  Mariner  is not  required  to
register more than 50% of the shares of Mariner Common Stock to be issued in the
Merger between May 24, 1997 and May 24, 1998. The Company is required to use all
reasonable  efforts to effect such  registration,  subject to certain conditions
and  limitations.  Mariner is  generally  required  to bear the  expenses of all
registrations under the Registration Rights Agreement,  except for underwriter's
discounts and commissions or any stock transfer taxes attributable to the shares
being  offered  and  sold.   The  CSI   Stockholders'   right  to  request  such
registrations  will terminate when the CSI  Stockholders own less than 5% of the
total voting power of the outstanding voting securities of Mariner.

     CERTAIN OTHER COMPLETED ACQUISITIONS AND ARRANGEMENTS

         Premier.  In January 1996,  Mariner entered into an agreement to be the
preferred provider of subacute services to Premier,  which is one of the largest
hospital-health  care alliance in the United States.  As the preferred  subacute
provider, Mariner may contract individually with member hospitals and systems to
provide subacute services. Pursuant to this arrangement, a Premier affiliate was
granted  warrants  to  purchase  210,000  shares of Mariner  Common  Stock at an
exercise  price of $11.375  per share,  as well as warrants to purchase up to an
additional  1,890,000  shares of Mariner  Common  Stock over a five-year  period
depending  on  the   performance  of  the   arrangements   between  Mariner  and
Premier-affiliated  facilities.  None of such performance  based warrants became
exercisable  in fiscal  1996.  The  Company  recorded a charge of  approximately
$850,000  in the  first  quarter  of 1996 as a result  of the  210,000  warrants
granted. The Company will receive management fees under the agreements it enters
with  Premier-affiliated  facilities  based on a percentage  of such  facility's
revenues specified in the agreement.

         MedRehab Merger.  In March 1996, the Company  completed its merger (the
"MedRehab Merger") with MedRehab,  Inc.  ("MedRehab")  which, at the time of the
MedRehab Merger, provided contract physical medicine and rehabilitation services
to approximately 227 sites of which 149 were skilled nursing  facilities and the
remaining 78 sites included hospitals and schools.

         1996  Florida  Acquisition.  In May,  1996 the  Company  completed  its
acquisition of a company that operates seven skilled nursing  facilities and one
assisted living facility with an aggregate of 960 beds in Florida, Tennessee and
Kansas  (the "1996  Florida  Acquisition").  All of the  issued and  outstanding
shares of common stock of that company were  converted into the right to receive
an aggregate of  approximately  $28,050,000  in cash.  The Company  financed the
consideration  paid in the 1996  Florida  Acquisition  with a portion of the net
proceeds from the sale of its Senior Subordinated Notes and borrowings under its
Credit Facility.

         Jacksonville  Facility.  On  October 1, 1996,  the  Company  acquired a
163-bed  facility  in  Jacksonville,  Florida.  The  total  purchase  price  was
$9,850,000.  Mariner  funded the purchase price by assuming two HUD mortgages in
the aggregate principal amount of approximately $4,236,000. The Company borrowed
$6,500,000 under its Credit Facility to fund the remainder of the cash price and
to replace reserves required by the HUD mortgage agreements.

         Allegis.  In a  two-part  closing  consummated  on  October 1, 1996 and
November 1, 1996,  Mariner  acquired  certain assets of Allegis Health Services,
Inc.  ("Allegis")  and  certain  of  its  affiliates.  Under  the  terms  of the
acquisition agreement, the Company purchased five inpatient facilities,  assumed
two operating leases and one capital lease and purchased Allegis'  institutional
pharmacy  and  its  rehabilitation  program  management  subsidiary.  The  total
purchase price consisted of the assumption of approximately $12,000,000 in debt,
including the capital lease,  and  $98,000,000 in cash borrowed under its Credit
Facility.  The cash portion of the purchase  price was adjusted to  $100,000,000
based on a  multiple  of the net  operating  income of the  assets  acquired  as
defined in the purchase agreement.

         Additionally,  during the course of 1996,  Mariner entered into various
joint  venture  arrangements  for  the  provision  of  management  services  for
physicians;  commenced  operation of several new home health agencies in Florida
and other  states;  acquired  certificates  of need for  additional  home health
agencies;  and has acquired or  commenced  operations  of two new  institutional
pharmacies,  one of which was  acquired  in the  Allegis  acquisition  described
above.


                                       16


         For certain  information  regarding completed  acquisitions,  including
those described  above, see  "Management's  Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital  Resources" in Item
7 of this Report.

         As part of its  expansion  strategy,  Mariner  may  acquire  additional
health care facilities and businesses.  Potential acquisition candidates include
individual  inpatient  facilities,  businesses that operate  multiple  inpatient
facilities and other health care services  businesses.  The Company continuously
identifies  and evaluates  potential  acquisition  candidates  and in many cases
engages in discussions and negotiations regarding potential acquisitions.  There
can be no assurance that any of the Company's  discussions or negotiations  will
result in an acquisition.  Further, if Mariner makes any acquisitions, there can
be no  assurance  that it will be able to operate  any  acquired  facilities  or
businesses  profitably  or  otherwise   successfully   implement  its  expansion
strategy.  See "Management's  Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity  and Capital Resources" found in Item 7 to this
Report.

COMPETITION

         Mariner's  subacute care  facilities  compete  primarily on a local and
regional basis with other skilled care providers,  including general and chronic
care hospitals,  skilled nursing  facilities,  rehabilitation  centers and other
subacute care  providers.  Many of such providers  currently have  underutilized
facilities  and are expanding  into  subacute care by converting  some or all of
such  facilities  to subacute  care.  In  particular,  a number of nursing  care
facilities and general acute care hospitals are adding  subacute care units.  In
addition,  a number of services  provided by the Company  compete with  services
traditionally   provided  by  general  acute  care   hospitals,   rehabilitation
facilities and other providers.  Some competing providers have greater financial
resources  than those of the Company or may operate on a non-profit  basis or as
charitable organizations.  The degree of success with which Mariner's facilities
compete varies from location to location and depends on a number of factors. The
Company believes that the programs and quality of care provided,  the reputation
of its  facilities  and the level of its charges for  services  are  significant
competitive factors. Mariner seeks to meet competition through its patient focus
and the relatively low cost of its programs.

         Mariner's  competition in the  rehabilitation  business in most markets
reflects the fragmented nature of the rehabilitation  services  industry.  There
are numerous providers of contract rehabilitation services, some of which merely
provide a therapist  to a nursing  facility  and others of which  provide  total
rehabilitation  program  management  like  the  Company.  Most of the  Company's
clinics compete directly or indirectly with outpatient rehabilitation providers,
the  rehabilitation  therapy  departments of acute care  hospitals,  physicians'
offices, private physical therapy practices and chiropractors.


GOVERNMENT REGULATION

         The  Company  and the health  care  industry  generally  are subject to
extensive   Federal,   state   and   local   regulation   governing   licensure,
certification,   conduct  of  operations  and   participation  in  reimbursement
programs.  Political,  economic and  regulatory  influences  are  subjecting the
health  care  industry  in the United  States to  fundamental  change.  Numerous
proposals for comprehensive  reform of the nation's health care system have been
introduced  in Congress.  Many  potential  approaches  are under  consideration,
including controls on health care spending through  limitations on the growth of
private health insurance premiums and Medicare and Medicaid spending,  and other
fundamental changes to the health care delivery system. In addition, some of the
states in which Mariner  operates are considering or have adopted various health
care  reform  proposals.   The  Company  anticipates  that  Congress  and  state
legislatures will continue to review and assess alternative health care delivery
systems and payment  methodologies and public debate of these issues will likely
continue in the future. Due to uncertainties  regarding the ultimate features of
reform  initiatives and their enactment and  implementation,  the Company cannot
predict which, if any, of such reform  proposals will be adopted,  when they may
be adopted or what impact they may have on the Company.

         In addition,  both the  Medicare  and Medicaid  programs are subject to
statutory and regulatory  changes,  administrative  rulings,  interpretations of
policy, intermediary  determinations and governmental funding restrictions,  all
of which may  materially  decrease  the rate of program  payments to health care
facilities.  Since 1983, Congress has consistently attempted to limit the growth
of Federal  spending under the Medicare and Medicaid  programs.  The



                                       17


Company can give no assurance  that  payments  under such  programs  will in the
future  remain at a level  comparable  to the present  level or be sufficient to
cover the costs  allocable  to such  patients.  In  addition,  many  states  are
considering reductions in their Medicaid budgets.

         Certificate  of Need  Requirements.  Most  states in which the  Company
operates or is considering  expansion  possibilities have statutes which require
that prior to the  addition or  construction  of new beds,  the  addition of new
services,  the  acquisition  of certain  medical  equipment  or certain  capital
expenditures in excess of defined  levels,  a state agency must determine that a
need exists. These CON programs are designed to avoid duplication in health care
facilities.  CONs  usually are issued for a specified  maximum  expenditure  and
require  implementation of the proposed improvement within a specified period of
time.  Some states also require  obtaining an  exemption  from CON review,  or a
reclassification  of an existing CON, for  acquisitions  of existing health care
facilities.  Several states have instituted  moratoria on new CONs, or otherwise
stated their intent not to grant  approvals  for new beds.  Such  moratoria  may
adversely  affect the Company's  ability to expand in such states,  but may also
provide a barrier to entry to potential competitors.

         Where  required,  appropriate  CONs  are  obtained  for  the  Company's
facilities  and managed  units.  Depending  on the  licensure of the facility in
which it is  located,  a  managed  or  leased  unit may  operate  under the host
facility's  CON,  although  Mariner  may  seek a new CON to  enable  the unit to
participate in certain Federal and state health-related programs.

         Licensing.  The inpatient facilities operated or managed by the Company
must be licensed by state  authorities.  Each of the  facilities is so licensed.
Both  initial and  continuing  qualification  of a skilled  nursing  facility to
maintain such licensure and  participate  in the Medicare and Medicaid  programs
depend  upon  many  factors  including,  among  other  things,   accommodations,
equipment,  services, patient care, safety, personnel, physical environment, and
adequate  policies,   procedures  and  controls.  In  addition,   the  Company's
outpatient  rehabilitation  clinics,  pharmacy  services  and other  health care
services are generally  subject to regulation and, in many instances,  licensure
or certification requirements.

         Medicare and Medicaid  Certification.  In order to receive Medicare and
Medicaid  reimbursement,  a skilled  nursing  facility must meet the  applicable
requirements  of  participation  set forth by the United  States  Department  of
Health  and  Human  Services  ("HHS")  relating  to the  type of  facility,  its
equipment,  its  personnel  and its standards of medical care, as well as comply
with all state and local laws and regulations. In addition, Medicare regulations
generally require that entry into such facilities be through physician referral.
The Company  must offer  services  to  Medicare  and  Medicaid  recipients  on a
non-discriminatory  basis  and  may not  preferentially  accept  private  pay or
commercially   insured   patients.   In  addition,   the  Company's   outpatient
rehabilitation  clinics,  pharmacy  services and other health care  services are
generally   subject  to   applicable   Medicare   and   Medicaid   certification
requirements.

         Medicare Related Party Rule. Subject to certain exceptions,  Medicare's
related party rule generally  requires that services between related entities be
changed at cost. Mariner provides certain services between subsidiary companies,
some of which are  charged  at cost and  others of which are  charged  at market
rates.  Mariner  believes  that the  services  which are charged at market rates
qualify for an  exception to  Medicares's  related  party rule.  There can be no
assurance,  however,  that HCFA will endorse Mariner's position and the Medicare
reimbursement  received for such services may be subject to audit and recoupment
in future years.

         Inspections.   State  and  local  agencies   inspect  all  health  care
facilities  on a regular  basis to  determine  whether  such  facilities  are in
compliance with  governmental  operating and health standards and conditions for
participation in government  medical assistance  programs.  Such surveys include
reviews of patient  utilization  of health care  facilities  and  standards  for
patient care. If such an agency  determines that a facility fails to comply with
certain  regulatory  requirements,  it may, or may be required  to, take various
adverse  actions,  including the  imposition of fines,  temporary  suspension of
admission of new patients to the facility,  suspension or  decertification  from
participation   in  the   Medicare   or  Medicaid   programs   and,  in  extreme
circumstances, revocation of the facility's license.

         Fraud and Abuse  Laws.  Various  Federal  and state laws  regulate  the
relationship  between providers of health care services and physicians or others
able to refer  medical  services,  including  employment  or service  contracts,
leases and  investment  relationships.  These laws  include  the fraud and abuse
provisions of the Medicare and Medicaid and similar  state  statutes (the "Fraud
and Abuse Laws"), which prohibit the payment, receipt,  solicitation or offering
of any  direct or  indirect  remuneration  intended  to induce the  referral  of
Medicare or Medicaid  patients or for the  ordering or  providing of Medicare or
Medicaid covered  services,  items or equipment.  Violations of these provisions
may result in civil and criminal  penalties and/or exclusion from  participation
in the Medicare and Medicaid programs and from state programs containing similar
provisions  relating  to  referrals  of  privately  insured  patients.  HHS  has
interpreted these provisions broadly to include the payment of anything of value
to  influence  the  referral of Medicare  or Medicaid  business.  HHS has issued
regulations  which set  forth  certain  "safe  harbors,"  representing  business
relationships  and payments that can safely be undertaken  without  violation of



                                       18



the Fraud and Abuse Laws. In addition,  certain  Federal and state  requirements
generally prohibit certain providers from referring patients to certain types of
entities in which such provider has an ownership or investment  interest or with
which such  provider  has a  compensation  arrangement,  unless an  exception is
available.  The Company  considers  all  applicable  laws in planning  marketing
activities  and exercises care in an effort to structure its  arrangements  with
health care  providers to comply with these laws.  However,  because there is no
procedure for obtaining advisory opinions from government officials,  Mariner is
unable to provide  assurances  that all of its  existing or future  arrangements
will withstand  scrutiny  under the  anti-fraud  and abuse statute,  safe harbor
regulations  or other state or federal  legislation or  regulations,  nor can it
predict  the  effect of such  rules and  regulations  on these  arrangements  in
particular  or on Mariner's  operations  in general.  While certain of Mariner's
contracts  may not fall  within  the safe  harbors,  Mariner  believes  that its
business relationships comply with the Fraud and Abuse Laws.

INSURANCE

         Mariner  maintains  professional  liability  insurance,   comprehensive
general  liability  insurance  and  other  insurance  coverage  on  all  of  its
facilities.  Mariner  believes  that its  insurance  is  adequate  in amount and
coverage for its current operations.  See Note 15 of the Consolidated  Financial
Statements appearing in Item 8 of this Report.

EMPLOYEES

         As of December 31, 1996, Mariner employed approximately 14,000 full and
part-time  employees.  The  employees  at seven  of  Mariner's  skilled  nursing
facilities,   representing   approximately  8%  of  Mariner's  work  force,  are
represented  by labor unions.  Two of the Company's  union  contracts  expire in
1997,  on April 30,  1997 and July 30,  1997,  respectively.  Management  cannot
predict  the  impact  of   continued   or  increased   union   represention   or
organizational  activities  on its  future  operations.  Management  of  Mariner
considers the relationship between Mariner and its employees to be good.


         Mariner  competes with general acute care hospitals,  nursing homes and
other  care  facilities  for the  services  of  physicians,  registered  nurses,
therapists and other professional personnel.  From time to time, there have been
shortages in the supply of available  physicians,  registered nurses and various
types of therapists. Competition for licensed therapists is intense and turnover
is very high.  Mariner places  substantial  emphasis on recruiting and retaining
therapists,   employing  a  staff  of  recruiters   dedicated  to   identifying,
interviewing  and  hiring  therapists.  In  general,  therapists  prefer  clinic
employment  over  contract  services  employment,  primarily  because  a  clinic
practice generally involves less acutely ill patients.  The turnover in a clinic
practice  is  therefore  lower than in a  contract  practice.  Although  Mariner
believes  that it will be able to  attract  and  retain  sufficient  physicians,
nursing  personnel and  therapists to meet its needs,  there can be no assurance
that it will be able to do so.


ITEM 2.  PROPERTIES

         The  Company's  executive  offices  are  located at 125 Eugene  O'Neill
Drive,  New London,  Connecticut,  06320.  Information  regarding  other Mariner
properties appears under the heading "Facilities" in Item 1 of this Report.


ITEM 3.  LEGAL PROCEEDINGS


         As is  typical  in the  health  care  industry,  Mariner  is subject to
claims, investigations or legal actions from time to time in the ordinary course
of business. The Company's Massachusetts pharmacy operations are presently under
review for certain matters with respect to technical  requirements.  The Company
currently  believes  that the  outcome of such  review  will not have a material
adverse  effect on Mariner.  Mariner has also assumed  claims and legal  actions
brought against  certain of the companies which it has acquired,  which material
claims and legal  actions  are  covered  by  indemnification  agreements  by the
companies'  former  owners.  Mariner  believes  that all such claims and actions
currently  pending  against it either are  adequately  reserved for,  covered by
insurance or by  indemnification  or would not have a material adverse effect on
Mariner if decided in a manner unfavorable to Mariner.





                                       19


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         None.

       




                                       20


                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The Common  Stock is quoted on the  Nasdaq  National  Market  under the
symbol MRNR. The following table sets forth for the periods indicated,  the high
and low sales prices for the Common Stock:

1996                                              High                 Low

4th Quarter.................................    $15.250               $6.750
3rd Quarter.................................     19.750               13.625
2nd Quarter.................................     20.125               15.000
1st Quarter.................................     20.125               14.875


1995                                              High                 Low

4th Quarter.................................    $16.750               $8.875
3rd Quarter.................................     16.625               11.625
2nd Quarter.................................     19.750               11.250
1st Quarter.................................     21.750               17.250



         On March 25, 1997 the closing sale price of the Common Stock was $9.000
per share. As of March 25, 1997, there were  approximately 968 holders of record
of the Common Stock.

         Mariner has not paid any cash  dividends  on the Common  Stock and does
not anticipate paying any cash dividends in the foreseeable  future. The Company
currently  intends to retain future  earnings to fund the development and growth
of its business.  In addition,  certain provisions of Mariner's revolving credit
facility and the Indenture relating to the Company's 9 1/2% Senior  Subordinated
Notes  due  2006  restrict  or  prohibit  the  payment  of cash  dividends.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations--Liquidity  and Capital  Resources" in Item 7 of this Report and Note
10 of Notes to Consolidated Financial Statements in Item 8 of this Report.


ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA

         The selected  consolidated  financial  information  presented below for
each of the five  years  ended  December  31,  1996 has  been  derived  from the
Company's audited consolidated  financial statements.  The selected consolidated
financial   information   should  be  read  in  conjunction  with  "Management's
Discussion and Analysis of

                                       21


Financial  Condition and Results of Operations" and the  Consolidated  Financial
Statements  of the Company  and the notes  thereto  appearing  in Items 7 and 8,
respectively, to this Report.

<TABLE>
<CAPTION>
                                                                          YEAR ENDED DECEMBER 31,

                                                       1992            1993          1994          1995          1996
                                                       ----            ----          ----          ----          ----
                                                                    (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                   <C>            <C>           <C>           <C>           <C>     
STATEMENT OF OPERATIONS DATA:
Net patient service revenue(1)                        $169,132       $209,238      $260,357      $337,635      $578,755
Other income                                             1,279          1,568         3,787        17,171        12,054
                                                     ----------     ----------    ----------    ----------    ----------
Total operating revenue                                170,411        210,806       264,144       354,806       590,809
Operating expenses:
  Facility operating costs (2)                         130,803        167,785       208,691       276,633       459,127
  Corporate general and administrative (3)              17,961         34,902        30,935        39,830        52,500
  Depreciation and amortization                          6,282          6,843         8,091        11,397        21,376
  Interest expense, net                                 10,113          7,379         1,819         3,598        26,256
  Facility rent expense, net                               307          1,079         1,739         1,830         3,727
                                                     ----------     ----------    ----------    ---------- -- ----------
  Total operating expenses                             165,466        217,988       251,275       333,288       562,986
                                                     ----------     ----------    ----------    ---------- -- ----------
Operating income (loss)                                  4,945        (7,182)        12,869        21,518        27,823
Net gain (loss) on sale of assets                          415            364           932           (6)         (826)
                                                     ----------     ----------    ----------    ---------- -- ----------
Income (loss) before income taxes and                    5,360        (6,818)        13,801        21,512        26,997
extraordinary items
Net provision for income taxes                         (1,634)        (3,220)       (5,848)       (7,892)      (10,799)
                                                     ----------     ----------    ----------    ---------- -- ----------
Income (loss) from continuing operations before
extraordinary                                            3,726       (10,038)         7,953        13,620        16,198
  items
Extraordinary items                                      (439)        (5,882)          (86)       (1,138)           ---
                                                     ----------     ----------    ----------    ---------- -- ----------

Net income (loss)                                    $   3,287      $(15,920)     $   7,867     $  12,482     $  16,198
                                                     ==========     ==========    ==========    ==========    ==========
Income (loss) per common and common equivalent shares:
  Income (loss) from operations before
extraordinary items                                  $     .50      $   (.92)     $     .41     $     .60     $     .55
  Extraordinary items                                     (.07)         (.51)           ---          (.05)          ---
                                                     ----------     ----------    ----------    ---------- -- ----------
    Net Income (loss)                                $     .43      $  (1.43)     $     .41     $     .55     $     .55
                                                     ==========     ==========    ==========    ==========    ==========
Weighted average number of Common and Common
  equivalent shares outstanding                          5,917         11,608        19,251        22,755        29,210

</TABLE>

<TABLE>
<CAPTION>
                                                                          YEARS ENDED DECEMBER 31,

                                                       1992            1993          1994          1995          1996
                                                       ----            ----          ----          ----          ----

                                                                               (IN THOUSANDS)
<S>                                                  <C>            <C>           <C>           <C>            <C>     
BALANCE SHEET DATA:
Working capital                                      $  25,205      $  55,348     $  71,217     $  74,148      $ 68,154
Total assets                                           182,981        208,467       296,933       411,526       881,233
Long-term debt and capital lease obligations, less
current                                                 87,874         36,874        24,506       107,910       265,545
  portion
Subordinated debt                                       11,668          2,611         1,694         1,356       149,691
Convertible redeemable preferred stock (4)              24,097            790           891         1,030           ---
Nonconvertible redeemable preferred stock (5)            6,580            ---           ---           ---           ---
Total stockholders' equity                              21,205        127,229       228,148       242,392       324,788

</TABLE>
------------

(1) Includes a charge of $10,000,000 in  1996  related to additional reserves on
    Medicare receivables.

(2) Includes $4,333,000 related to a significant change in business focus at the
    Company's  Baltimore  facility in 1995.  See  "Management's  Discussion  and
    Analysis of Financial Condition and Results of Operations" in Item 7 of this
    Report.

(3) During  1994,  the  Company  recorded  a  charge  of  $9,327,000,  of  which
    $7,952,000  relates to the merger with Pinnacle Care Corporation,  which was
    accounted  for as a pooling  of  interests,  and  $1,375,000  relates to the
    accelerated   vesting  of  certain  stock  options.  Of  the  merger  costs,
    approximately  $4,627,000 was reserved for employee  severance,  payroll and
    relocation,   $2,878,000  was  reserved  for  transaction   costs  including
    investment  bankers',  legal and accounting fees,  $172,000 was reserved for
    customer relations, $150,000 for operations relocation, $66,000 for investor
    relations and $59,000 was reserved for employee relations.

    During 1995, the Company  accrued costs totaling  $8,073,000  related to the
    CSI Merger and the  consolidation of various regional and satellite  offices
    to the New London,  Connecticut office. Of this total charge,  approximately
    $3,691,000  related to severance and related payroll costs and approximately
    $4,382,000  related to  expenses  incurred to close the  Company's  regional
    offices.

    During 1996, the Company recorded a charge of $6,511,000 of which $5,661,000
    related to the merger  with  MedRehab,  Inc.  which was  accounted  for as a
    pooling of interests  and $850,000 was a charge for the warrants  granted to
    the Premier affiliate.



                                       22


(4) Converted  into  shares of Common  Stock upon the  closing of the  Company's
    initial public  offering of its common stock,  par value $.01 per share (the
    "Common Stock").

(5)  Redeemed during 1993.


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


FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISK

         This Report contains  forward-looking  statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities Exchange Act
of 1934,  including statements  regarding,  among other items, (i) the Company's
growth  strategies,   including  its  intention  to  make   acquisitions;   (ii)
anticipated  trends  in the  Company's  business  and  demographics;  (iii)  the
Company's  ability to continue to control  costs and  maintain  quality of care;
(iv) the  Company's  ability to respond to changes in  regulations;  and (v) the
Company's  ability to enter into contracts with managed care  organizations  and
other  payors.  These  forward-looking  statements  are  based  largely  on  the
Company's  expectations and are subject to a number of risks and  uncertainties,
certain of which are beyond the Company's  control.  Actual results could differ
materially  from these  forward-looking  statements  as a result of the  factors
described  below in "Risk  Factors"  including,  among others (i) changes in the
health  care  industry  as  a  result  of  political,   economic  or  regulatory
influences;  (ii) changes in regulations governing the health care industry; and
(iii)  changes  in the  competitive  marketplace.  In light of these  risks  and
uncertainties,  there can be no assurance that the  forward-looking  information
contained in this Report will in fact transpire.


OVERVIEW

    Mariner's net patient  service  revenue is derived  primarily from providing
inpatient health care services to subacute patients,  rehabilitation programs in
skilled nursing facilities,  outpatient  rehabilitation services in freestanding
clinics and other  post-acute  medical  services.  The growth in  Mariner's  net
patient  service  revenue and operating  profitability  depends on two principal
factors: (i) the shift by the Company toward treatment of short-stay,  medically
demanding  subaccute patients and away from less medically  demanding  patients,
and (ii)  the  addition  of a  variety  of  alternate  sites  and  expansion  of
post-acute health care services.  Subacute  patients  typically require three to
six hours of skilled  nursing  care per day,  in  contrast  to the more than six
hours of skilled  nursing care per day required by acute care hospital  patients
and the less  than two  hours of  custodial  nursing  care per day  required  by
traditional  nursing home  residents.  These  subacute  patients  typically  are
recuperating  from a major  injury,  surgery or illness and,  after a relatively
short transition period,  generally are discharged to their homes. The Company's
clinical programs,  including MarinerCare programs, have been designed for these
patients.

   
         During  1996,  as  a  result  of  the  CSI  Merger,  the  1996  Florida
Acquisition,  the Allegis acquisiton and other inpatient facility  acquisitions,
the  Company  added  41  facilities  with a total  of 5,915  beds.  Since  these
acquisitions,  the Company has focused these facilities increasingly on treating
medically  demanding  subacute patients.  With the existing patient  populations
acquired with these  facilities,  Mariner  currently  expects that a significant
length  of  time  may  be  required  before  such  patient   population  changes
sufficiently  to  require  a level  of  care,  and to  have a  length  of  stay,
comparable to that experienced in the Company's other  facilities.  As a result,
the addition of these facilities adversely affected the Company's 1996 operating
profitability  and overall operating  statistics.  See "Patient Focus" and "Site
Expansion".

    Patient Focus.  Mariner  believes that short length of patient stay and high
bed turnover  maximize net patient  service  revenue and operating  margins.  As
compared to less medically  demanding  patients,  short-stay  subacute  patients
generally  require more intense  skilled  nursing care and more  rehabilitation,
pharmacy and other  ancillary  medical  services.  The median length of stay for
patients  discharged in the applicable period from facilities owned or leased by
the Company  during the applicable  period  increased from 20 days in 1995 to 23
days in 1996. The bed turnover rate for the inpatient facilities owned or leased
by the Company during the applicable  period decreased from 2.7 times in 1995 to
2.1 times in 1996.  The  increase in median  length of stay and  decrease in bed
turnover rate from 1995 to 1996 resulted  principally  from the  acquisition  of
facilities in 1996.  Newly  acquired  facilities  generally  contain an existing
patient  population,  and  consequently  a  significant  length  of time  may be
required before such patient population changes  sufficiently to require a level
of care,  and to have a length of stay,  comparable to that  experienced  in the
Company's  existing  facilities.  In the  facilities the Company  acquires,  the
Company  intends  to  focus  on  treating  subacute  patients  and  implementing
appropriate MarinerCare programs or other clinical programs.
    

    The  Company's  focus  on  short-stay  subacute  patients  has  historically
provided the Company with an attractive  payor mix.  Short-stay  medical care is
covered  by a wider  range  of  payors,  including  indemnity  insurers,  health
maintenance  organizations,  employers,  Medicare and Medicaid,  while long-term
(more than 100 days) medical care  typically is covered by Medicaid.  Percentage
of revenue generated from Medicare and private payors decreased from 79% in 1995
to 74% in 1996. The decrease in payor mix from 1995 to 1996 resulted principally
from the result of the  acquisition of additional new facilities in 1996 which
were more heavily dependent on Medicaid reimbursment. 

    By  continuing  to  emphasize  short-stay  subacute  patients,  Mariner  has
historically increased the percentage of its revenue generated from Medicare and
private payors (including indemnity insurers, health maintenance  organizations,
employers and individuals) in newly acquired facilities.

    Even among the Company's  patients for whom  Medicaid is the primary  payor,
Mariner has focused  increasingly  on treating those  patients with  substantial
medical  problems  who require  three or more hours of skilled  nursing care per
day. Typically,  Mariner is reimbursed by Medicaid at substantially higher rates
for these  patients than for less medically  demanding  custodial care patients.
The net patient service  revenue  generated by the Company's  Medicaid  patients
decreased from $36,685 per bed in 1995 to $34,046 per bed in 1996. This decrease
was primarily due to the  geographic shift in the percentage of revenues derived
from  Florida and Texas which have lower  Medicaid  rates than the  Northeast or
Midwest regions.

   
         The  Company's  rehabilitation  programs  have also focused on subacute
patients in skilled  nursing  facilities  who require  intensive  rehabilitation
therapy over a short period. The number of rehabilitation  programs with skilled
nursing  facilities  decreased  from 440 as of  December  31,  1995 to 429 as of
December 31, 1996.
    

         Despite  this  decrease in programs,  revenue  from private  payors and
reimbursement  under  Medicare  have  increased as a percentage of total revenue
from these programs.

         In addition,  the Company has expanded the range of  post-acute  health
care  services it provides  directly in selected  local  markets in an effort to
treat patients  throughout  their recovery.  As a result,  the Company  receives
revenues from these  services both during a patient's  inpatient  stay and after
discharge.



                                       23


         As a result of these trends, Mariner's average revenue per occupied bed
per  year  decreased  from  $61,495  in 1995 to  $58,795  in 1996.  Revenue  per
rehabilitation  program  increased  from  $318,088  in 1995 to $412,265 in 1996.
These trends are illustrated in the following table:

   
<TABLE>
<CAPTION>
                                                         Years Ended December 31,

                                                1994            1995             1996
                                                ----            ----             ----
<S>                                           <C>             <C>              <C>
Inpatient Operations

  Licensed beds (1)                             3,114           4,397            9,962

  Average occupancy rates                         89%             88%              88%

  Median length of stay (2)                   25 days         20 days          23 days

  Bed turnover rate (3)                          2.6x            2.7x             2.1x

  Revenue per occupied bed per year (4):

    Private payors and Medicare (5)          $ 97,932        $101,863        $  93,189

    Medicaid                                 $ 36,254       $  36,685        $  34,046

    Company as a whole                       $ 60,126       $  61,495        $  58,795

  Percentage of average daily census:

    Private payors and Medicare (5)               39%             38%              42%

    Medicaid                                      61%             62%              58%

Rehabilitation Operations:

  Revenue per rehabilitation  program per    $234,800        $318,088        $ 412,265
  year (6)

  Outpatient clinic visits per year           297,699         272,423          221,128

Payor Mix (Company revenue as a whole):

  Private payors and Medicare (5)                 80%             79%              74%

  Medicaid                                        20%             21%              26%

-----------------
</TABLE>
    

(1)  Facilities owned and leased as of the end of the applicable period.

(2)  Based on those patients who were  discharged  during the applicable  period
     from facilities owned or leased by Mariner.

(3)  Represents  total  discharges  divided by average  number of licensed  beds
     during the applicable period.

(4)  Represents  applicable net patient  service  revenue divided by the average
     daily census of patients generating such revenue.

   
(5)  Private   payors   includes   indemnity   insurers,    health   maintenance
     organizations,  employers,  individuals and other non-governmental  payors,
     and for payor mix,  payments from skilled  nursing  facilities for services
     performed under  rehabilitation  management programs and revenue classified
     as "other revenue."  
    

(6)  Represents  aggregate  revenue from  rehabilitation  programs  with skilled
     nursing  facilities  during the  applicable  period  divided by the average
     number of such programs as of the end of the applicable period.





                                       24



         Site  Expansion.   Mariner  has  expanded  by  acquiring,  leasing  and
developing  freestanding inpatient facilities,  by entering into arrangements to
manage hospital-based  subacute units and to provide rehabilitation programs and
by  expanding  the other  post-acute  health  care  services  it  provides.  The
Company's site expansion is illustrated in the following table:



                                                        December 31,
                                              -------------------------------
                                              1994          1995         1996
                                              ----          ----         ----
Sites of Service:

Owned and leased freestanding inpatient         26            33           75(1)
facilities

Managed freestanding inpatient facilities 
and hospital-based units                         5            29(1)         8
  

Rehabilitation programs with skilled
nursing facilities                             447           440          429


Outpatient rehabilitation clinics               65            57           48


(1) Includes 23 skilled nursing facilities and one rehabilitation  hospital with
    an  aggregate  of 3,288 beds which became  owned or leased by the Company on
    January 2, 1996 upon  completion  of the CSI Merger. 

         Mariner acquires  established  skilled nursing  facilities and converts
them into  facilities  focusing  increasingly  on treating  medically  demanding
subacute patients.  Historically, net patient revenue and operating margins from
acquired inpatient facilities have increased gradually over a period of years as
MarinerCare  programs are  implemented,  and, as intensity of care and ancillary
service  requirements  increase,  length of patient stay decreases and payor mix
improves.  An acquired facility may contain an existing patient population,  and
consequently  a significant  length of time may be required  before such patient
population changes  sufficiently to require a level of care, and to have alength
of stay,  comparable to that experienced in the Company's  existing  facilities.
During this conversion  period,  Mariner would generally expect to realize lower
revenue for these  existing  patients  than could  otherwise be obtained for new
patients.  Facilities undergoing conversion are expected to continue to generate
increased net patient service revenue and operating  margins as they continue to
emphasize short-stay subacute patients.

         Mariner  also  develops  new  freestanding   inpatient  facilities  and
renovates  acute care  hospitals  which are  dedicated  primarily  to  providing
MarinerCare  programs  and other  services  to  subacute  patients.  Net patient
service  revenue and operating  margins  typically  increase  gradually at newly
opened facilities,  which have low initial occupancy rates. Because newly opened
facilities require a basic complement of staff on the day it opens regardless of
patient census,  these facilities  initially  generate  significant  losses.  As
patient census increases at a facility,  margins improve,  regardless of whether
the  patients  are  subacute or  medically  less  demanding.  Margins  typically
increase  at newly  opened  facilities  as  patient  and payor mix  improve  and
ancillary  service use increases.  These facilities  generally have taken six to
nine months before their revenues have been  sufficient to cover their operating
costs, and nine to fifteen months before they have contributed positively to the
Company's  net  earnings.  Leased units have  substantially  the same  operating
characteristics  as newly  opened  facilities  with less  significant  financing
costs.

         Managed freestanding  inpatient  facilities and hospital-based  managed
subacute care units typically provide  significantly  higher profit margins with
substantially  lower  revenue  than the  Company's  owned and leased  facilities
because the host  facility  generally  bears the related  operating  and capital
expenses  while  paying  the  Company  a  management  fee.  Unlike  freestanding
inpatient  facilities  owned or leased by the Company,  managed  facilities  and
units typically do not require significant  start-up costs or capital outlays by
the Company.

         The Company incurs start-up expenses for new rehabilitation programs as
therapists  are hired and necessary  equipment is acquired.  These  programs and
clinics  typically become  profitable  within six months of opening and generate
positive cash flow in 12 to 18 months.



                                       25

RESULTS OF OPERATIONS

         The following table sets forth certain consolidated financial data as a
percentage  of total  operating  revenue for the three years ended  December 31,
1994, 1995 and 1996, and the percentage changes in the dollar amounts of revenue
and expenses for 1995 as compared to 1994, and 1996 as compared to 1995.

<TABLE>
<CAPTION>
                                                     Percent of Revenue           Percentage Increase (Decrease)
                                                                                       1995           1996
                                                   Year Ended December 31,             Over           Over
                                                   -----------------------
                                           1994         1995          1996             1994           1995
<S>                                       <C>           <C>            <C>             <C>           <C>
Revenues:
Net patient service revenue(1)            98.6%         95.2%          98.0%           29.7%         71.4%
Other revenue                              1.4           4.8            2.0           353.4         (29.8)
                                        ----------    ----------    ----------
Total operating revenue                  100.0%        100.0%         100.0%           34.3%         66.5%
                                        ==========    ==========    ==========
Operating and administrative expenses:
Facility operating costs (2)              79.0          78.0           77.8            32.6          66.0
Corporate general & administrative (3)    11.7          11.2            8.9            28.8          31.8
Interest expense, net                      0.7           1.0            4.4            97.8         629.7
Facility rent expense, net                 0.7           0.5            0.6             5.2         103.7
Depreciation and amortization              3.1           3.2            3.6            40.9          87.6
                                        ----------    ---------     ----------
Total operating expenses                  95.2%         93.9%          95.3%           32.6%         68.9%
                                        ==========    ==========    ==========
</TABLE>
-----------------

(1)  Includes a charge of  $10,000,000 in 1996 related to additional reserves on
     Medicare receivables.

(2)  Includes a charge related to a significant  change in business focus at the
     Company's Baltimore facility of 1.2% for the year ended December 31, 1995.

(3)  Includes  merger and other  non-recurring  costs related to the merger with
     Pinnacle Care Corporation  amounting to 3.5% of total operating revenue for
     the year ended December 31, 1994.  Includes costs related to the CSI Merger
     and the  consolidation  of various  regional and  satellite  offices to the
     Company's  New  London,  Connecticut  office  amounting  to 2.3%  of  total
     operating revenue for the year ended December 31, 1995. Includes merger and
     other  non-recurring  costs related to the merger with  MedRehab,  Inc. and
     issuance  of  warrants  amounting  to 1.2% of  revenue  for the year  ended
     December 31, 1996.



         YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996

         Revenue.  Total operating  revenue  increased 34% from  $264,144,000 in
1994 to $354,806,000 in 1995 and 67% to $590,809,000 in 1996.

         Net patient service revenue increased by $77,278,000, or 30%, from 1994
to 1995 and by  $241,120,000,  or 71%, from 1995 to 1996. The increase from 1994
to 1995  resulted  primarily  from the inclusion of revenue  generated  from the
facilities  and businesses  acquired  during 1995, as well as the inclusion of a
full year of  revenue  from the  eight  facilities  acquired  during  1994.  The
increase in 1996 was due  primarily to the inclusion of all revenue from the CSI
Facilities that were acquired on January 2, 1996, the eight facilities  acquired
or leased in the 1996  Florida  Acquisition  and eight  facilities  acquired  or
leased  from  Allegis,  as well as  inclusion  of a full  year of  revenue  from
facilities  and  businesses  acquired  in 1995.  The  Company  also  experienced
increases in the use of ancillary medical services at its inpatient  facilities.
The  revenue  increases  in each of 1995  and  1996  were  partially  offset  by
reductions  due to the  cancellation  or  non-renewal  of contracts  for certain
rehabilitation programs.

         Other revenue  includes fees earned from contracts to manage  inpatient
subacute care units within selected health care facilities and in 1995, included
fees of $11,227,000  relating to the management of certain CSI  Facilities.  The
reduction  in  other  revenue  from  1995 to 1996  resulted  primarily  from the
termination of the  management  agreements  with certain of the CSI  Facilities,
which were acquired on January 2, 1996. See "Business--Significant  Developments
in 1996--Transactions  with Convalescent Services,  Inc." appearing in Item 1 to
this Report.

         Facility Operating Costs. Facility operating costs consist primarily of
employee  salaries,  wages and  benefits,  food,  ancillary  supplies,  pharmacy
supplies, plant operations,  and, in 1995, costs related to a significant change
in the business focus at the Company's Baltimore  facility.  Most clinical staff
and  rehabilitation  therapists  are paid an hourly  wage.  Salaries,  wages and
benefits  as a  percentage  of  revenue  are  higher at newly  opened  inpatient
facilities,  which  require a basic  compliment of staff on the day the facility
opens  regardless  of  the  patient  census,  than  at  pre-existing   inpatient
facilities.  As the patient  census  increases  and patient mix  improves at its
inpatient  facilities,  Mariner has  experienced  decreases  in these costs as a
percentage of revenue at such facilities.


                                       26


Various other types of operating expenses,  including medical supplies, pharmacy
supplies,   nutritional  support  services  and  expenses  associated  with  the
provision of ancillary services, vary more directly with patient census, as well
as with general rates of inflation.

         Facility  operating  costs  increased 33% from  $208,691,000 in 1994 to
$276,633,000  in 1995 and 66% to  $459,127,000  in 1996.  These  increases  were
principally  the  result of adding  new  facilities,  providing  more  ancillary
medical services and adding  therapists and aides to service new  rehabilitation
programs. In addition,  these costs included $4,333,000 related to a significant
change in focus at the Company's  Baltimore  facilities in 1995. As a percentage
of total operating revenue, these costs decreased from 79.0% in 1994 to 78.0% in
1995 and 77.8% in 1996.

         Corporate   General   and   Administrative.   Corporate   general   and
administration  expenses include the expenses of the Company's corporate office,
which  provides  marketing,  financial and management  services.  These expenses
increased  29%  from  $30,935,000  in 1994  to  $39,830,000  in 1995  and 32% to
$52,500,000  in 1996.  The  increases  were,  in part,  a result  of  additional
personnel  required to support the  facilities  acquired  during 1994,  1995 and
1996.

         During  1994,  the Company  recorded a charge of  $9,327,000,  of which
$7,952,000  related to the merger  with  Pinnacle  Care  Corporation,  which was
accounted  for  as a  pooling  of  interests,  and  $1,375,000  related  to  the
accelerated vesting of certain stock options. Of the merger costs, approximately
$4,627,000 was for employee  severance,  payroll and relocation,  $2,878,000 was
incurred  for  transaction  costs  including  investment  bankers',   legal  and
accounting  fees,  $172,000 for  customer  relations,  $150,000  for  operations
relocation, $66,000 for investor relations and $59,000 for employee relations.

         The charge for the options relates to a change in vesting  criteria for
100,000  options  granted in 1992. As a result of these  changes,  these options
become  exercisable  during the second  quarter of 1994,  thereby  requiring the
charge in the second quarter.

         During 1995, the Company accrued costs totaling  $8,073,000  related to
the merger with CSI and the  consolidation  of various  regional  and  satellite
offices  to  the  New  London,   Connecticut   office.  Of  this  total  charge,
approximately  $3,691,000  related to severance  and related  payroll  costs and
approximately  $4,382,000  related to expenses  incurred to close the  Company's
regional offices.

         During  1996,  the  Company  recorded a charge of  $6,511,000  of which
$5,661,000  related to the merger with  MedRehab  which was  accounted  for as a
pooling of interests  and $850,000 was a charge for the warrants  granted to the
Premier affiliate.  Of the charge related to the MedRehab merger,  approximately
$2,825,000 was for employee  severance,  payroll and relocation,  $1,143,000 for
transaction  costs,  $1,061,000  to write-off  abandoned  property and software,
$382,000 for  relocation  of  operations,  $200,000 for customer  relations  and
$50,000 for employee relations.

         As a  percentage  of total  operating  revenue,  corporate  general and
administrative expenses were 12% in 1994, 11% in 1995 and 9% in 1996.

         Interest  Expense,   Net.  Net  interest  expense  increased  98%  from
$1,819,000 in 1994 to $3,598,000 in 1995 and 630% to  $26,256,000  in 1996.  The
increases  were due to additional  borrowings  which were primarily used to fund
acquisitions.

         Facility Rent Expense,  Net. Net rent expense increased from $1,739,000
in 1994 to $1,830,000 in 1995, and  $3,727,000 in 1996.  The increases  resulted
from the lease  costs  associated  with new leases  entered in  connection  with
certain acquisitions during 1996.

         Depreciation and  Amortization.  Depreciation and amortization  expense
increased  41%  from  $8,091,000  in 1994 to  $11,397,000  in  1995,  and 88% to
$21,376,000  in 1996,  principally  as a result of the increase in the number of
facilities as a result of acquisition activities,  the opening of new facilities
and businesses, and the completion of facility renovations.

         Provision  for Income Taxes.  During 1996,  Mariner's tax rate reflects
the  reversal of a  valuation  allowance  on certain  deferred  tax assets.  The
Company  believes that it will be able to take  advantage of these assets before
they  expire  and has  reflected  this in its tax  rate  in  1996.  The  Company
currently  expects the  effective  tax rate to increase  from 40% to 44% in 1997
due, primarily, to the effect of non-deductible goodwill associated with certain
acquisitions.



                                       27


         Extraordinary  Items. In 1994 Mariner incurred $86,000 of extraordinary
losses,  net of income tax  benefit,  related  to early  repayment  of  mortgage
obligations.

         In 1995, the Company  amended certain  significant  terms of its Credit
Facility.  As a  result  of the  amendment,  the  Company  has  charged  off its
remaining unamortized deferred financing fees of $1,836,000 with a resulting tax
benefit of $698,000.


                                       28



LIQUIDITY AND CAPITAL RESOURCES

         Mariner  has  financed  its   operations,   acquisitions   and  capital
expenditures  primarily  from cash provided by operations  and the proceeds from
stock  issuances and  borrowings.  As of December 31, 1996,  working capital and
cash and cash equivalents were $68,154,000 and $4,616,000, respectively.

         Mariner has a $250,000,000  senior secured  revolving  credit  facility
with a syndicate of banks (the "Credit  Facility").  As of December 31, 1995 and
1996,   principal   balances   outstanding   under  the  Credit   Facility  were
approximately $64,500,000 and $132,000,000,  respectively, and letters of credit
outstanding  under this facility were $2,612,000 and  $5,499,000,  respectively.
Mariner has used,  and intends to continue to use,  borrowings  under the Credit
Facility to finance the acquisition and development of additional  subacute care
facilities and related businesses, and for general corporate purposes, including
working   capital.   Mariner's   obligations   under  the  Credit  Facility  are
collateralized  by a pledge of the stock of its  subsidiaries and are guaranteed
by all of the  Company's  subsidiaries.  In  addition,  the Credit  Facility  is
secured by mortgages on certain of the Company's inpatient facilities, leasehold
mortgages on certain inpatient  facilities  leased by the Company,  and security
interests  in  certain  other  properties  and  assets  of the  Company  and its
subsidiaries.  The Credit  Facility  matures on April 30, 1999 and  provides for
prime or LIBOR-based interest rate options. The borrowing  availability and rate
of  interest  varies  depending  upon  specified  financial  ratios.  The Credit
Facility also contains covenants which, among other things,  require the Company
to  maintain  certain  financial  ratios  and  impose  certain   limitations  or
prohibitions  on the Company with  respect to the  incurrence  of  indebtedness,
liens and capital  leases;  the payment of dividends  on, and the  redemption or
repurchase  of, its  capital  stock;  investments  and  acquisitions,  including
acquisitions of new facilities;  the merger or consolidation of the Company with
any person or entity and the  disposition of any of the Company's  properties or
assets.

         On April 4, 1996,  the Company sold  $150,000,000  aggregate  principal
amount of its 9-1/2% Senior Subordinated Notes due 2006 (the "Notes"). The Notes
mature on April 1, 2006. The Notes are unsecured senior subordinated obligations
of Mariner and, as such,  are  subordinated  in right of payment to all existing
and future senior  indebtedness  of Mariner,  including  indebtedness  under the
Credit Facility.  From the net proceeds of approximately  $144,456,000  from the
sale of the Notes,  $131,000,000 was used to repay all outstanding  indebtedness
under the Credit  Facility  (including  interest and certain other fees) and the
remainder  was used to pay a portion of the purchase  price for the 1996 Florida
Acquisition. The Notes contain certain covenants, including, among other things,
covenants with respect to the following matters: (i) limitation on indebtedness;
(ii) limitation on restricted  payments;  (iii)  limitation on the incurrence of
liens; (iv) restriction on the issuance of preferred stock of subsidiaries;  (v)
limitation on transactions  with affiliates;  (vi) limitation on sale of assets;
(vii) limitation on other senior subordinated indebtedness; (viii) limitation on
guarantees by  subsidiaries;  (ix) limitation on the creation of any restriction
on the ability of the  Company's  subsidiaries  to make  distributions;  and (x)
restriction on mergers,  consolidations and the transfer of all or substantially
all of the assets of the Company to another person.  The Notes were issued under
an Indenture dated as of April 4, 1996 by and among the Company and State Street
Bank and Trust Company, as trustee (the "Indenture").

         Accounts   receivable   (net  of  allowances)   were   $92,537,000  and
$126,938,000 at December 31, 1995 and 1996, respectively.  Estimated settlements
due from third-party  payors aggregated  $12,915,000 and $18,912,000 at December
31, 1995 and 1996, respectively. The number of days sales in accounts receivable
and estimated  settlements due from third-party payors was approximately 96 days
at  December  31,  1995 and 78 days at  December  31,  1996.  The  decrease  was
primarily due to (i) the  acquisition of  receivables in the Allegis  aquisition
and (ii) the  $10,000,000  increased  reserve  for  potential  lower  levels  of
Medicare reinbursement. The decrease also resulted from improved collections and
the completion of centralization of the billing functions.

         In January 1996,  Mariner  completed the CSI Merger and its acquisition
of certain  related  assets.  In the merger,  all of the issued and  outstanding
shares of  capital  stock of CSI were  converted  into the right to  receive  an
aggregate of 5,853,656  shares of the Company's  Common Stock and  $7,000,000 in
cash. In connection with the CSI Merger,  Mariner  acquired  certain assets that
are related to CSI's  business  from  affiliates  of CSI's  stockholders  for an
aggregate  of  approximately  $17,694,000  in cash and  loaned an  aggregate  of
$1,619,000  to the  partnerships  that sold certain  assets to the  Company.  In
addition,  the Company acquired options to purchase 12 of the facilities  leased
by CSI from  affiliates  of CSI's  stockholders  at fair  market  value and made
nonrefundable  deposits of an aggregate of  $13,155,000  with the lessors of the
facilities subject to such options. The options are exercisable during specified
periods  between 1998 and 2010. The aggregate  estimated fair market value as of
the earliest


                                       29


exercise  date of the  options,  and the  aggregate  purchase  price for, the 12
facilities subject to the options is approximately $59,585,000 (which includes a
deposit of $13,155,000  already paid by the Company).  Mariner financed the cash
consideration  payable in these  transactions  with borrowings  under the Credit
Facility.

         On March 1, 1996, the Company  completed the MedRehab  Merger.  Mariner
issued an aggregate of  approximately  2,312,500  shares of its Common Stock for
all of MedRehab's  outstanding  capital  stock and options to purchase  MedRehab
capital stock in a merger that is being accounted for as a pooling of interests.
In addition,  the Company prepaid an aggregate principal amount of approximately
$14,000,000  of  MedRehab's  outstanding  indebtedness  at  the  closing  of the
MedRehab  Merger.  The Company repaid this  indebtedness  with funds it borrowed
under the Credit Facility.  Certain former MedRehab  stockholders  exercised the
right to require the Company to repurchase  their shares of Mariner Common Stock
for approximately $1,326,000.

         In March 1996,  Mariner acquired a primary care physician  organization
in the Orlando,  Florida area. In this transaction,  Mariner issued an aggregate
of 48,722 shares of its Common Stock and paid an aggregate of $1,500,000 in cash
which was financed under the Credit Facility.

         In May, 1996 the Company  completed the 1996 Florida  Acquisition which
involved seven skilled nursing  facilities and one assisted living facility with
an aggregate of 960 beds in Florida, Tennessee and Kansas. All of the issued and
outstanding  shares of common stock were  converted into the right to receive an
aggregate  of  approximately  $28,050,000  in cash.  The  Company  financed  the
consideration  paid in the 1996  Florida  Acquisition  with a portion of the net
proceeds from the sale of the Notes and borrowings under the Credit Facility.

         On  October  1,  1996,  the  Company  acquired  a 163-bed  facility  in
Jacksonville,  Florida. The total purchase price was $9,850,000.  Mariner funded
the purchase  price by assuming two HUD  mortgages  in the  aggregate  principal
amount of approximately  $4,236,000.  The Company borrowed  $6,500,000 under its
Credit  Facility to fund the remainder of the cash portion of the purchase price
and to replace reserves required by the HUD mortgage agreements.

         In a two-part  closing  consummated  on October 1, 1996 and November 1,
1996,  Mariner acquired certain assets of Allegis and certain of its affiliates.
Under  the  terms of the  acquisition  agreement,  the  Company  purchased  five
inpatient  facilities,  assumed two  operating  leases and one capital lease and
purchased  Allegis'   institutional  pharmacy  and  its  rehabilitation  program
management subsidiary. The total purchase price of $110,000,000 consisted of the
assumption of $12,000,000 in debt,  including the capital lease, and $98,000,000
in cash.  Under the terms of the agreement,  $103,000,000  of the purchase price
was paid at the  closings  during  the  fourth  quarter  of 1996.  Approximately
$98,000,000  of that amount plus certain  closing  costs was borrowed  under the
Credit  Facility.  The  remaining  $2,000,000  was paid upon  attaining  certain
financial  performance  conditions for 1996.  This amount was borrowed under the
Credit Facility.

         From January 1, 1997 through March 25, 1997,  the Company also borrowed
approximately $ 43,200,000  under the Credit Facility  primarily to fund working
capital requirements.

         The Company  intends to expand its clinical  programs in  strategically
selected  metropolitan  areas  throughout  the United  States.  The Company also
intends to expand its pharmacy,  home health care and outpatient  rehabilitation
services.  In addition to acquiring individual  facilities,  Mariner may acquire
businesses that operate  multiple  facilities or ancillary  health care services
businesses.   The  Company  continuously   identifies  and  evaluates  potential
acquisition candidates and in many cases engages in discussions and negotiations
regarding  potential  acquisitions.  There can be no  assurance  that any of the
Company's discussions or negotiations will result in an acquisition. Further, if
the Company makes any  acquisitions,  there can be no assurance  that it will be
able to operate any acquired  facilities or  businesses  profitably or otherwise
successfully  implement  its  expansion  strategy.   Mariner  currently  has  no
agreements with respect to any acquisition.

         The Company's  capital  expenditures  for the years ended  December 31,
1995 and 1996 were approximately $11,943,000 and $22,502,000,  respectively. The
Company  has   currently   budgeted   approximately   $75,000,000   for  capital
expenditures during 1997. The Company's  currently planned capital  expenditures
include  approximately  $25,000,000  for  upgrading  the  Company's  information
systems, approximately $25,000,000 for expansion of existing facilities, as well
as the costs of maintaining the Company's  inpatient  facilities and offices and
approximately $25,000,000 for the construction of three new inpatient sites. The
Company currently estimates that


                                       30


it spends  approximately  $300 per bed per year for maintenance of its inpatient
facilities.

         Mariner believes that its future capital  requirements will depend upon
a number of factors,  including cash  generated from  operations and the rate at
which it acquires additional  inpatient facilities or other health care services
businesses  and the  rate at  which  it adds  rehabilitation  programs.  Mariner
expects  to fund such  capital  expenditures  with  borrowings  under its Credit
Facility and cash from operations. Mariner currently believes that the cash from
operations and borrowings  under the Credit  Facility will be sufficient to meet
its needs through at least December 31, 1997.


RECENTLY ISSUED PRONOUNCEMENTS

         During  1997,  the  Financial  Accounting  Standards  Board issued FASB
Statement No. 128, "Earnings Per Share." This standard is designed to impove the
earnings  per share  ("EPS")  information  provided in financial  statements  by
simplifying  the existing  computational  guidelines,  revising  the  disclosure
requirements,  and increasing the  comparability of EPS data on an international
basis.  The Company  will  implement  the new standard in its fiscal year ending
December 31, 1997. The impact of the implementation of this standard has not yet
been determined.



                                       31



IMPACT OF INFLATION

         The health  care  industry  is labor  intensive.  Wages and other labor
costs are especially sensitive to inflation.  Increases in wages and other labor
costs as a result of  inflation,  or increases in federal or state minimum wages
without a corresponding  increase in Medicare and Medicaid  reimbursement rates,
could adversely impact the Company.




                                       32




                                  RISK FACTORS

         Except for the historical  information  contained  herein,  the matters
contained in this Report include  forward-looking  statements that involve risks
and  uncertainties.  The following  factors,  among  others,  could cause actual
results to differ materially from those contained in forward-looking  statements
made in this Report and  presented  elsewhere by  management  from time to time.
Such  factors,  among  others,  may  have a  material  adverse  effect  upon the
Company's business, results of operations and financial condition.

DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYORS

         Mariner derives a significant  portion of its revenue from the Medicaid
and Medicare programs.  In the years ended December 31, 1994, 1995 and 1996, the
Company  derived 20%,  21%, and 26%  respectively,  of its revenue from Medicaid
programs and 26%, 29%, and 37%, respectively,  of its revenues from the Medicare
program.   These   programs  are  subject  to  retroactive   rate   adjustments,
administrative  rulings and government  funding  restrictions,  all of which may
decrease the level of program  reimbursements to the Company.  Funds received by
the Company from the  Medicare and Medicaid  programs are subject to audit which
can result in the Company having to refund overpayments.  In addition, there can
be no assurance that  facilities  owned,  leased or managed by Mariner now or in
the future that participate in the Medicare and Medicaid programs will initially
meet or continue to meet the requirements for  participation in the Medicare and
Medicaid programs. Legislation and regulations have been proposed on the federal
and state levels that would have the effect of  materially  limiting or reducing
reimbursement  levels for the Company's  programs and services.  Mariner  cannot
predict  whether any of these  proposals  will be adopted  or, if  adopted,  the
effect  (if any) such  proposals  will  have on the  Company.  Furthermore,  the
Company has observed a nationwide change in the practices of its Medicare Fiscal
Intermediaries  which,  on behalf of HCFA,  the federal agency  responsible  for
administering   the   Medicare   program,   have  begun  to   aggressively   and
retrospectively  change their position on previously approved costs. This change
includes the reclassification of costs from reimbursable to non-reimbursable and
the challenging of payment for costs which had traditionally  been approved.  In
response  to  these   challenges  of  the  payment  of  Medicare   costs  on  an
industry-wide  basis,  the Company has provided  additional  reserve amounts for
potential lower levels of Medicare reimbursement.

         In addition,  Mariner  provides  certain  services  between  subsidiary
companies,  some of which are  charged at cost and others of whch are charged at
market rates.  Mariner  believes  that the services  which are charged at market
rates qualify for an exception to Medicare's related party rule. There can be no
assurance,  however,  that HCFA will endorse Mariner's position and the Medicare
reimbursement  received for such services may be subject to audit and recoupment
in future years.

         In  April  1995,  HCFA  issued  a  memorandum  to its  Medicare  fiscal
intermediaries  as a guideline to assess costs  incurred by inpatient  providers
relating  to payment of  occupational  and speech  language  pathology  services
furnished under  arrangements  that include  contracts between therapy providers
and inpatient  providers.  While not binding on the fiscal  intermediaries,  the
memorandum suggested certain rates to assist the fiscal intermediaries in making
annual "prudent buyer" assessments of speech and occupational therapy rates paid
by inpatient providers.  In addition, HCFA is in the process of promulgating new
salary  equivalency  guidelines  which will update current  physical therapy and
respiratory therapy rates and establish new guidelines for occupational  therapy
and speech  therapy.  Mariner  will not be able to determine  whether  these new
proposals will have a material effect on its rehabilitation operations until the
publication  of final  rates and  rules.  HCFA  through  its  intermediaries  is
subjecting  physical  therapy,  occupational  therapy  and  speech  therapy to a
heightened level of scrutiny resulting in increasing audit activity.  A majority
of Mariner's provider and rehabilitation  contracts provide for  indemnification
of the facilities for potential  liabilities in connection  with  rehabilitation
services.  The Company's gross margins for its physical  therapy  services under
Medicare's salary  equivalency  guidelines are  significantly  less than for its
speech and  occupational  therapy  services  which are  currently  reimbursed by
Medicare  under the  prudent  buyer  standard.  There can be no  assurance  that
actions  ultimately  taken by HCFA with regard to  reimbursement  rates for such
therapy services will not materially  adversely affect the Company's  results of
operations. See "Business--Sources of Revenue" in Item 1 of this Report.

         In addition to reducing  revenue  from  federal and state  payors,  the
imposition of more stringent reimbursement guidelines or a decrease in the level
of Medicare or Medicaid  reimbursement for these services could adversely affect
the ability of skilled  nursing  facilities or other health care  providers that
depend  on  Medicare  or   Medicaid   reimbursement   to  pay  the  Company  for
rehabilitation  program  services  and may cause such  facilities  to reduce the
rates  that  they  are  willing  to pay  the  Company  for  such  services.  Any
significant  decrease  in  Medicare or  Medicaid  reimbursement  levels,  or the
imposition of significant  restrictions on participation in Medicare or Medicaid
programs, could have a material adverse effect on the Company. Certain states in
which  Mariner  operates  have  undertaken  a study  of  acuity  levels  and are
considering changes in their reimbursement systems to take levels



                                       33


of acuity into account.  Accordingly,  there can be no assurance  that the rates
paid to Mariner by  Medicare,  Medicaid,  private  payors or by skilled  nursing
facilities  under  rehabilitation  programs  will  continue  to be  adequate  to
reimburse   the  Company  for  the  costs  of  providing   services  to  covered
beneficiaries.  Mariner  has also agreed  under  certain of its  contracts  with
private  payors  (and  intends  to  continue  to agree  as part of its  business
strategy) to provide certain health care services to covered  patients on a case
rate or capitated basis. See "Management's  Discussion and Analysis of Financial
Condition   and   Results  of   Operations"   in  Item  7  of  this  Report  and
"Business--Sources of Revenue" in Item 1 of this Report.

FLUCTUATION OF QUARTERLY RESULTS OF OPERATIONS

         The Company's operating revenue and net income generally fluctuate from
quarter to quarter. The fluctuation is related to several factors including: the
timing  of  Medicaid   rate   increases,   changes  in  the  level  of  Medicare
reimbursement,  the timing of  acquisitions  in  operating  results of  acquired
facilities, overall census, payor mix, acuity levels, seasonal census cycles and
the number of working days in a given quarter. In addition, a significant amount
of the Company's operating expenses are relatively fixed in the short term. As a
result,  if projected  revenues are not  realized in the  expected  period,  the
Company's  operating results for that period could be adversely  affected.  Such
quarterly  fluctuations  may result in  volatility in the price of the Company's
Common Stock.

HEALTH CARE REFORM

         Current  political,  economic and  regulatory  influences are likely to
lead to  fundamental  changes in the health care industry in the United  States.
Numerous  proposals for comprehensive  reform of the nation's health care system
have  been  introduced  over the past few  years  in  Congress.  Many  potential
approaches are under  consideration,  including controls on health care spending
through  limitations  on the growth of private  health  insurance  premiums  and
Medicare and Medicaid spending and other fundamental  changes to the health care
delivery system.  In addition,  some of the states in which the Company operates
are  considering or have adopted  various  health care reform  proposals and are
considering reductions in their state Medicaid budgets. Mariner anticipates that
Congress and state  legislatures will continue to review and assess  alternative
health care delivery systems and payment methodologies and that public debate of
these issues will likely continue in the future. Due to uncertainties  regarding
the  ultimate   features  of  reform   initiatives   and  their   enactment  and
implementation,  the  Company  cannot  predict  which,  if any,  of such  reform
proposals will be adopted, when they may be adopted or what impact they may have
on the Company.  In  addition,  the cost and service  considerations  which have
generated  proposals  for health  care  reform  have also  resulted  in, and are
expected to continue to result in,  strategic  realignments  and combinations in
the health care industry which may, over time, have a significant  impact on the
Company's strategic  direction and operating results.  There can be no assurance
that future  legislation,  health  care or  budgetary,  or other  changes in the
administration or  interpretation of governmental  health care programs will not
materially adversely affect the results of operations of Mariner.  Concern about
the potential  effects of the proposed reform  measures have  contributed to the
volatility  of prices in  securities  of  companies  in health  care and related
industries,  including the Company,  and may  similarly  affect the price of the
Company's Common Stock in the future.

         Included in President Clinton's 1998 Budget  proposals are  significant
changes  to the  Medicare  payment  system.  Proposals  that  are  under  active
consideration  include,  prospective  payment  for both  Home  Care and  Skilled
Nursing  Facilities, and bundling of post acute care services.  These, and other
proposals  which  are  being  considered,  could  have a  significant  effect on
payments  to the entire  healthcare  industry,  including  Mariner.  Each of the
legislative   proposals  offered  by  the  President  provides  for  significant
reductions in the overall rate of Medicare and Medicaid  spending  growth. These
proposals  are subject to approval and  amendment  by Congress,  and the Company
cannot predict their impact on the Company or its operations at this time. There
is active  discussion  concerning the foregoing and balancing of the federal and
state  budgets,  and the form of any  final  legislation  enacted  could  differ
significantly from current proposals.

         Aspects of certain of the health care proposals,  such as reductions in
funding  of  the   Medicare  and  Medicaid   programs,   potential   changes  in
reimbursement regulations by HCFA for contract therapy services,  containment of
health care costs,  proposals to reimburse  health care providers on a basis not
linked to costs on an interim  basis that


                                       34


could include a short-term freeze on prices charged by health care providers and
greater state flexibility in the  administration  of Medicaid,  could materially
adversely affect the Company.

UNCERTAINTY OF REGULATION

         The  Company  and the health  care  industry  generally  are subject to
extensive federal, state and local regulation governing licensure and conduct of
operations at existing facilities,  construction of new facilities,  acquisition
of existing facilities,  addition of new services, certain capital expenditures,
reimbursement  for services  rendered and disposal of medical waste.  Changes in
applicable  laws and  regulations  or new  interpretations  of existing laws and
regulations  could have a material adverse effect on licensure,  eligibility for
participation,  permissible  activities,  operating  costs  and  the  levels  of
reimbursement  from  governmental  and other sources.  There can be no assurance
that regulatory  authorities  will not adopt changes or new  interpretations  of
existing  regulations  that could adversely  affect the Company.  The failure to
maintain or renew any required  regulatory  approvals or licenses  could prevent
the Company from offering existing services or from obtaining reimbursement.  In
certain circumstances,  failure to comply at one facility may affect the ability
of the Company to obtain or maintain  licenses or approvals  under  Medicare and
Medicaid programs at other facilities.

         Recently  effective  provisions  of the  regulations  adopted under the
Omnibus Budget  Reconciliation Act of 1987 ("OBRA"),  as amended,  have expanded
remedies available to HCFA to enforce  compliance with the detailed  regulations
mandating  minimum  health  care  standards  and may  significantly  affect  the
consequences  to the Company if annual or other HCFA facility  surveys  identify
noncompliance  with these  regulations.  Remedies  include  fines,  new  patient
admission moratoriums,  denial of reimbursement,  federal or state monitoring of
operations,  closure of facilities  and  termination  of provider  reimbursement
agreements. In the ordinary course of its business, the Company receives notices
from time to time of deficiencies for failure to comply with various  regulatory
requirements.  Although the Company  reviews such notices and takes  appropriate
corrective action,  there can be no assurance that the Company's facilities will
be able to remedy the  deficiencies in all situations or remain  continuously in
compliance with regulatory  requirements.  Adverse actions against a facility by
applicable  regulatory  agencies may adversely affect the facility's  ability to
continue to operate, the ability of the Company to provide certain services, and
the facility's  eligibility to participate in the Medicare or Medicaid programs.
These  actions  may  adversely  affect the  Company's  business  and  results of
operations.

         The  Company is also  subject to  federal  and state laws which  govern
financial and other arrangements between health care providers. These laws often
prohibit  certain  direct and indirect  payments or  fee-splitting  arrangements
between health care providers, including physicians, that are designed to induce
or encourage the referral of patients to, or the recommendation of, a particular
provider  for medical  products  and  services.  These laws  include the federal
"Stark  legislations"  which prohibit any remuneration for physician  referrals,
and, with limited exceptions, physician ownership of ancillary service providers
and the federal  "antikickback  law" which  prohibits,  among other things,  the
offer, payment,  solicitation,  or receipt of any form of remuneration in return
for the referral of Medicare and Medicaid patients.  The Office of the Inspector
General  of the  Department  of Health and Human  Services,  the  Department  of
Justice and other federal  agencies  interpret these fraud and abuse  provisions
liberally and enforce them aggressively.  Recently federal laws and initiatives,
including  the   Kennedy/Kassebaum   Act  and  Operation   Restore  Trust,  have
significantly expanded the federal government's  involvement in curtailing fraud
and  abuse  and  increased  the  monetary   penalties  for  violation  of  these
provisions.  In addition,  some states restrict certain  business  relationships
between  physicians  and other  providers of health care  services.  Many states
prohibit business  corporations from providing,  or holding  themselves out as a
provider of,  medical  care.  Possible  sanctions  for violation of any of these
restrictions  or  prohibitions  include  loss of  licensure  or  eligibility  to
participate in reimbursement  programs (including Medicare and Medicaid),  asset
forfeitures and civil and criminal  penalties  (including  monetary  penalties).
These  laws vary from  state to state,  are  often  vague and have  seldom  been
interpreted by the courts or regulatory agencies. From time to time, the Company
has sought guidance as to the interpretation of these laws;  however,  there can
be no  assurance  that such  laws will  ultimately  be  interpreted  in a manner
consistent with the practices of the Company.

         Many  states have  adopted  certificate  of need or similar  laws which
generally require that the appropriate state agency approve certain acquisitions
or capital  expenditures  in excess of defined  levels and determine that a need
exists for certain new bed additions,  new services, and the acquisition of such
medical equipment or capital  expenditures or other changes prior to beds and/or
services  being  added.  Many  states  have  placed  a  moratorium  on  granting
additional  certificates  of need or otherwise  stated their intent not to grant
approval  for new beds.  To the



                                       35


extent  certificates  of  need or  other  similar  approvals  are  required  for
expansion  of  Company  operations,  either  through  facility  acquisitions  or
expansion or provision of new services or other changes, such expansion could be
adversely  affected  by  the  failure  or  inability  to  obtain  the  necessary
approvals,  changes in the standards  applicable to such  approvals and possible
delays associated with the expenses of obtaining such approvals.

         The Company's  pharmacy business is also subject to inspection by state
agencies  regarding record keeping,  inventory  control and other aspects of the
pharmacy business.

         The  Company is unable to predict the future  course of federal,  state
and local regulation or legislation,  including  Medicare and Medicaid  statutes
and  regulations.  Further  changes  in the  regulatory  framework  could have a
material adverse effect on the financial results of the Company's operations.

DIFFICULTY OF INTEGRATING RECENT ACQUISITIONS; MANAGEMENT OF GROWTH

         The  successful  integration  of the  businesses  Mariner  acquires  is
important to the Company's future performance. The anticipated benefits from any
of these  acquisitions may not be achieved unless the operations of the acquired
businesses  are  successfully  combined  with  those of the  Company in a timely
manner.  The integration of the Company's recent and proposed  acquisitions will
require substantial attention from management. The diversion of the attention of
management,  and any difficulties  encountered in the transition process,  could
have a material adverse effect on Mariner's  revenue and operating  results.  In
addition,  the process of  integrating  the various  businesses  could cause the
interruption  of, or a loss of  momentum  in, the  activities  of some or all of
these  businesses,  which could have a material  adverse effect on the Company's
operations  and financial  results.  There can be no assurance that Mariner will
realize any of the anticipated benefits from these acquisitions.

         The Company's  growth has placed a significant  burden on the Company's
management,  operating personnel, financial and operating systems. The Company's
ability  to manage its growth  effectively  and  assimilate  the  operations  of
acquired  facilities or businesses,  or newly expanded or developed  facilities,
will require it to continue to attract,  train, motivate,  manage and retain key
employees and to expand its operational and financial systems. If the Company is
unable  to manage  its  growth  effectively,  it could be  materially  adversely
affected.

EXPANSION RISKS AND IMPACT ON FUTURE OPERATING RESULTS

         Mariner's  strategy  includes  expanding by  establishing  or acquiring
additional  freestanding subacute care facilities,  managing subacute care units
within general acute care hospitals and acquiring ancillary health care services
businesses.  As part of its strategy,  the Company may acquire  businesses  that
operate  one  or  more  freestanding  inpatient  facilities  or  rehabilitation,
pharmacy,  home care, medical equipment and other health care businesses.  There
is significant  competition for acquisition and expansion  opportunities  in the
Company's   businesses.   As  this   competition   intensifies  due  to  ongoing
consolidation  in the health care industry,  the costs of  capitalizing  on such
opportunities  may  increase.  Mariner  competes for  acquisition  and expansion
opportunities  with  companies  that have  significantly  greater  financial and
management resources. There can be no assurance that the Company will be able to
compete  successfully for these  opportunities,  operate the acquired businesses
profitably or otherwise implement successfully its expansion strategy. Mariner's
expansion  will  depend on its  ability to create  demand in new markets for its
clinical programs and to staff new facilities and  rehabilitation  programs,  as
well as on the  availability  of facilities and  businesses  for  acquisition or
management. Such expansion and growth place significant demands on the Company's
financial and  management  resources.  If Mariner is unable to manage its growth
effectively,  the quality of its services, its ability to recruit and retain key
personnel  and its  results of  operations  could be  materially  and  adversely
affected.  See "Management's  Discussion and Analysis of Financial Condition and
Results of Operations" in Item 7 of this Report.

         An acquired  facility may contain an existing  patient  population and,
consequently,  a significant  length of time may be required before such patient
population changes sufficiently to require a level of care, and to have a length
of stay,  comparable  to that  provided in the  Company's  existing  facilities.
During this conversion  period,  Mariner would generally expect to realize lower
reimbursement rates for these existing patients than could otherwise be obtained
for new patients.  If the Company  acquires a business  that  operates  multiple
facilities,  the time required to convert the acquired  facilities may be longer
than that required to convert individual  facilities.  As a result, the expected
lower reimbursement  rates could persist for a longer period,  having a material
adverse effect on the Company's operating results.  Further, the effort required
to make such newly acquired facilities more comparable to the Company's existing
facilities may place significant  demands on Mariner's  financial and management
resources.

         The Company may also open new freestanding inpatient facilities,  which
typically  have low initial  occupancy  rates.  Because newly opened  facilities
require a basic  complement of staff on the day the facility opens regardless of
the patient census, these facilities  initially generate  significant  operating
losses.


                                       35


         As a result of these factors, as well as expansion into new markets and
the  addition  of  ancillary  services,  Mariner  could  experience  significant
fluctuations in operating results. See "Management's  Discussion and Analysis of
Financial Condition and Results of Operations" in Item 7 of this Report.

LEVERAGE

         As of December 31, 1996, the Company had approximately  $423 million of
outstanding  indebtedness  (not including debt under  operating  leases),  which
represented 57% of its total capitalization.  In addition,  the Company had $113
million  of  availability  under  the  Credit  Facility.  In 1996,  the  Company
requested  that its  lenders  increase  the size of the Credit  Facility to $250
million,  extend the  maturity of the Credit  Facility  and  further  reduce the
restrictions  which  the  Credit  Facility  imposes  on  the  operations  of the
Company's  business.  This  request was  approved by the  lenders.  Although the
Company's cash flow from operations has been sufficient to meet its debt service
obligations in the past, there can be no assurance that the Company's  operating
results will continue to be sufficient for the Company to meet its  obligations.
The  Company's  ability  to comply  with the  terms of the Notes and the  Credit
Facility,  to make cash  payments with respect to the Notes and under the Credit
Facility and to satisfy its other debt or to refinance  any of such  obligations
will depend on the future performance of the Company,  which in turn, is subject
to prevailing  economic  conditions  and financial and other factors  beyond its
control.

         The degree to which the  Company  is  leveraged  could  have  important
consequences  to  the  holders  of  the  Company's  securities,   including  the
following:  (i)  the  Company's  ability  to  obtain  additional  financing  for
acquisitions,   capital  expenditures,  working  capital  or  general  corporate
purposes  may be  impaired  in the  future;  (ii) a  substantial  portion of the
Company's  cash  flow  from  operations  must be  dedicated  to the  payment  of
principal and interest on the Notes and borrowings under the Credit Facility and
other indebtedness,  thereby reducing the funds available to the Company for its
operations and other purposes; (iii) certain of the Company's borrowings are and
will continue to be at variable rates of interest,  which exposes the Company to
the risk of increased  interest rates; and (iv) the Company may be substantially
more leveraged than certain of its competitors, which may place the Company at a
relative  competitive  disadvantage  and make the  Company  more  vulnerable  to
changing market conditions and regulations.

RESTRICTIONS IMPOSED BY INDEBTEDNESS

         The Credit Facility  contains a number of covenants  that,  among other
things,  restrict the ability of the Company to incur  additional  indebtedness,
pay dividends,  prepay  subordinated  indebtedness,  dispose of certain  assets,
enter  into  sale  and  leaseback  transactions,   create  liens,  make  capital
expenditures and make certain investments or acquisitions and otherwise restrict
corporate  activities.  In addition,  under the Credit Facility,  the Company is
required to satisfy specified financial covenants,  including total indebtedness
to cash flow,  total  senior  indebtedness  to cash flow and  minimum  net worth
tests. The ability of the Company to comply with such provisions may be affected
by events beyond the  Company's  control.  The breach of any of these  covenants
could result in a default  under the Credit  Facility.  In the event of any such
default,  depending  on the  actions  taken  by the  lenders  under  the  Credit
Facility, the Company could be prohibited from making any payments on the Notes.
In addition,  such lenders could elect to declare all amounts borrowed under the
Credit  Facility,  together with accrued  interest,  to be due and payable.  The
Credit  Facility is secured by the capital stock of the  Company's  subsidiaries
and certain other assets of the Company's subsidiaries,  and if the Company were
unable to repay  borrowings  under the Credit  Facility,  the lenders  under the
Credit  Facility (the "Banks") could proceed  against their  collateral.  If the
Banks or the holders of any other secured  indebtedness were to foreclose on the
collateral securing the Company's obligations to them, it is possible that there
would be insufficient  assets  remaining after  satisfaction in full of all such
indebtedness  to  satisfy in full the  claims of the  holders of the Notes.  The
Indenture  subjects  the Company to certain  restrictive  covenants,  including,
among  other  things,  covenants  with  respect to the  following  matters:  (i)
limitation  on  indebtedness;  (ii)  limitation on  restricted  payments;  (iii)
limitation  on the  incurrence  of liens;  (iv)  restriction  on the issuance of
preferred stock of subsidiaries; (v) limitation on transactions with affiliates;
(vi) limitation on sale of assets; (vii) limitation on other senior subordinated
indebtedness;  (viii) limitation on guarantees by subsidiaries;  (ix) limitation
on the creation of any restriction on the ability of the Company's  subsidiaries
to make  distributions;  and (x) restriction on mergers,  consolidations and the
transfer  of all or  substantially  all of the assets of the  Company to another
person. In addition,  the loan instruments governing the indebtedness of certain
of the Company's  subsidiaries contain certain restrictive covenants which limit
the payment of dividends and  distributions,  and the transfer of assets to, the
Company and require such subsidiaries to satisfy specific financial


                                       37


covenants.  See "Management's Discussion and Analysis of Financial Condition and
Results  of  Operations--Liquidity  and  Capital  Resources"  in  Item 7 of this
Report.

DEPENDENCE ON KEY PERSONNEL; DEMAND FOR PERSONNEL

         Mariner  believes  that  it  has  benefited   substantially   from  the
leadership  and  experience  of  its  executive  officers  and  members  of  its
management  team.  If such  executive  officers  were to leave the Company,  the
Company's  business  and results of  operations  could be  materially  adversely
affected.  Further,  the Company's growth strategy is dependent in large part on
its ability to attract and retain  management,  marketing and other personnel at
its  facilities.  From time to time,  there have been shortages in the supply of
available  registered nurses and various types of therapists.  Mariner's ability
to provide  rehabilitation  services is  dependent on its ability to recruit and
retain  licensed  therapists.  The  Company  competes  with  general  acute care
hospitals,  skilled  nursing  facilities,   rehabilitation  hospitals,  contract
rehabilitation  companies  and other health care  providers  for the services of
physicians,  registered  nurses,  therapists and other  professional  personnel.
There can be no  assurance  that the Company  will be able to attract and retain
the qualified  personnel necessary for its business and planned growth. The loss
of a significant  number of members of this  management  team, or the failure to
attract or retain the qualified personnel necessary for its business and planned
growth,  could have a material  adverse  effect on the  Company's  business  and
results of operations.  See  "Business--Employees" and "Management" in Item 1 of
this Report.

COMPETITION

         The health care industry is highly  competitive.  Mariner competes with
general  acute  care  hospitals,  skilled  nursing  facilities,   rehabilitation
hospitals,  contract  rehabilitation  companies and other health care providers.
Many  of  the  Company's  competitors  have  underutilized  facilities  and  are
expanding  into  subacute  care by  converting  some of  their  facilities  into
subacute  units.  In particular,  a number of nursing care  facilities and acute
care hospitals are adding subacute  units.  The Company's  facilities  generally
operate in  communities  that are also served by competing  facilities,  some of
which  may be newer or  offer  more  programs.  Many of these  competitors  have
significantly  greater  resources  than  the  Company  and are  affiliated  with
institutions  or chains that are larger and have greater  access to capital than
the Company or operate on a non-profit or  charitable  basis.  Cost  containment
efforts,  which encourage more efficient utilization of hospital services,  have
resulted in decreased hospital occupancy in recent years. These cost containment
efforts,  as well as the prospect of health care  reform,  have also caused many
health care  providers to combine  with other  health care  providers to achieve
greater  efficiencies and to reduce costs. The Company expects this trend, which
may    increase    competition    in   its    markets,    to    continue.    See
"Business--Competition" in Item 1 of this Report.

DEPENDENCE ON CONTRACT RENEWALS

         The  Company  provides  rehabilitation  program  services  pursuant  to
contracts with skilled nursing facilities and other parties. These contracts are
generally  for  terms of one year and  cancelable  on 30 to 90 days'  notice  by
either  party.  The number of  rehabilitation  contracts  with  skilled  nursing
facilities  has decreased from 447 as of December 31, 1994 to 429 as of December
31, 1996. In addition, each year a number of contracts have been canceled or not
renewed by the Company or its clients.  In March 1996, the Company completed the
MedRehab  Merger,  which added  physical  medicine and  rehabilitation  services
contracts  for   approximately   227  sites   (including  149  skilled   nursing
facilities).  The decision by a significant  number of Mariner's skilled nursing
facility  clients to cancel or not renew these  contracts  could have a material
adverse effect on the Company's  results of operations.  See  "Business--Mariner
Clinical Programs and Services."

POTENTIAL VOLATILITY OF STOCK PRICE

         There  has  been  significant   volatility  in  the  market  prices  of
securities  of  health  care  companies.   Mariner   believes  factors  such  as
legislative and regulatory  developments  and quarterly  variations in financial
results could cause the market price of the Company's  Common Stock to fluctuate
substantially. In addition, the stock market has experienced volatility that has
particularly  affected the market prices of many health care service  companies'
stocks and that often has been  unrelated to the operating  performance  of such
companies.  These  market  fluctuations  may  adversely  affect the price of the
Company's Common Stock.




                                       38



CONTROL BY SIGNIFICANT STOCKHOLDERS

         As of March 25,  1997 and based on their most recent  filings  with the
Commission  on Schedule  13D, one  stockholder  group (the former owners of CSI)
reported beneficial ownership  representing 20.8% of the Company's Common Stock.
As a result  of such  holding  and one  seat on the  board  of  directors,  this
stockholder group may have the ability to exert  significant  influence over the
outcome of all matters  submitted to the  Company's  stockholders  for approval,
including the election of directors.

ANTI-TAKEOVER   PROVISIONS;   STOCKHOLDER  RIGHTS  PLAN;  POSSIBLE  ISSUANCE  OF
PREFERRED STOCK

         The Company's  Stockholders  Rights Plan and certain  provisions of the
Company's  certificate of  incorporation  and by-laws may make it more difficult
for a third party to acquire,  or discourage  acquisition bids for, the Company.
In  addition,  in the event of a change of  control,  the Credit  Facility  also
contains an event of default upon a "change of control" as defined therein which
obligates the Company to repay  amounts  outstanding  under the Credit  Facility
upon an  acceleration  of the  indebtedness  issued  thereunder.  Further,  if a
"change in control" (as defined in the Indenture)  should occur,  each holder of
the Notes has the right to require that the Company purchase such holder's Notes
at a purchase price in cash equal to 101% of the principal amount of such Notes,
plus accrued and unpaid  interest  thereon  through the date of purchase.  These
provisions could limit the price that certain  investors might be willing to pay
in the future for shares of the Company's  Common Stock. In addition,  shares of
Mariner's   preferred  stock  may  be  issued  in  the  future  without  further
stockholder  approval  and upon such terms and  conditions,  having such rights,
privileges and preferences,  as the Board of Directors may determine. The rights
of the  holders of the  Company's  Common  Stock will be subject  to, and may be
adversely  affected by, the rights of any holders of preferred stock that may be
issued in the  future.  Mariner  has no  present  plans to issue  any  shares of
preferred  stock.  The  Company may also issue  additional  shares of its Common
Stock in the future  without  further  stockholder  approval.  The  issuance  of
preferred  stock or  additional  shares of the  Company's  Common  Stock,  while
providing  desirable  flexibility in connection with possible  acquisitions  and
other corporate purposes,  could have the effect of making it more difficult for
a third party to  acquire,  or  discouraging  a third  party from  acquiring,  a
majority of the outstanding voting stock of the Company.

SUBORDINATION

         The Notes are senior  subordinated  obligations  of the Company and, as
such,  are  subordinated  in right of payment to all existing and future  senior
indebtedness of the Company,  including  indebtedness under the Credit Facility.
The Notes  rank pari  passu with all  senior  subordinated  indebtedness  of the
Company  and will  rank  senior to all other  subordinated  indebtedness  of the
Company.  The Notes will also be  effectively  subordinated  to all existing and
future  liabilities  of the  Company's  subsidaries.  As of March 27, 1997,  the
aggregate  amount of senior  indebtedness of the Company and indebtedness of the
Company's  subsidiaries  (excluding  intercompany  indebtedness) that would have
effectively  ranked  senior to the Notes would have been  approximately  $ 285.1
million. In addition, under the Indenture, the Company would have been permitted
to borrow up to an  additional $ 101.5  million  under the Credit  Facility and,
provided  certain  tests  are  met,  will be able to  borrow  additional  senior
indebtedness. In the event of a bankruptcy, liquidation or reorganization of the
Company or in the event that any default in payment of, or the  acceleration of,
any debt occurs,  holders of senior indebtedness of the Company will be entitled
to payment in full from the  proceeds of all assets of the Company  prior to any
payment of such proceeds to holders of the Notes.  In addition,  the Company may
not make any  principal  or  interest  payments  in  respect of the Notes if any
payment default exists with respect to senior  indebtedness or any other default
on Designated  Senior  Indebtedness (as defined in the Indenture) occurs and the
maturity of such indebtedness is accelerated,  or in certain circumstances prior
to such  acceleration for a specified period of time,  unless, in any case, such
default has been cured or waived,  any such  acceleration  has been rescinded or
such  indebtedness  has been  repaid  in  full.  Consequently,  there  can be no
assurance  that the Company  will have  sufficient  funds  remaining  after such
payments to make payments to the holders of the Notes.

HOLDING COMPANY STRUCTURE

         Substantially all of the Company's assets are held by its subsidiaries.
As a result,  the Company's rights,  and the rights of its creditors  (including
holders  of the  Notes)  to  participate  in the  distribution  of assets of any
subsidiary upon such subsidiary's  liquidation or reorganization will be subject
to the prior claims of such  subsidiary's  creditors,  except to the extent that
the Company is itself  reorganized  as a creditor of such  subsidiary,  in which
case the  claims of the  Company  would  still be  subject  to the claims of any
secured  creditor of such  subsidiary and of any holder of  indebtedness of such
subsidiary  senior  to that  held by the  Company.  As of  March  27,  1997  the
Company's   subsidiaries   would  have  had  approximately   $141.6  million  of
indebtedness (excluding intercompany  indebtedness and indebtedness  outstanding
under the Credit  Facility  which is guaranteed  by the Company's  subsidiaries)
outstanding.

         The Notes are  obligations  exclusively of the Company.  The Notes will
not be guaranteed by any of the Company's subsidiaries.  Since the operations of
the Company are currently  conducted  through  subsidiaries,  the Company's cash
flow and its ability to service its debt, including the Notes, is dependent upon
the  earnings  of  its  subsidiaries  and  distributions  to  the  Company.  The
subsidiaries  are seperate and distinct  legal  entities and have no obligation,
contingent or otherwise, to pay amounts due pursuant to the Notes or to make any
funds availible therefor.  In addition,  all of the Company's  subsidiaries have
guaranteed the obligations of the Company under the Credit  Facility.  Moreover,
the payment of dividends  and the making of loan  advances to the Company by its
subsidiaries  are  contingent  upon the earnings of those  subsidiaries  and are
subject  to various  business  considerations  and,  for  certain  subsidiaries,
restrictive   loan  covenants   contained  in  the  instruments   governing  the
indeptedness of such subsidiaries, including covenants which restrict in certain
circumstances  the payment of dividends  and  distributions  and the transfer of
assets to the Company.


ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA




                                       39





                        REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
    MARINER HEALTH GROUP, INC.

         We have audited the consolidated financial statements and the financial
statement   schedule  of  Mariner  Health  Group,  Inc.  and  subsidiaries  (the
"Company")  listed in Item 14(a) of this Form 10-K.  These financial  statements
and the financial  statement  schedule are the  responsibility  of the Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements and the financial statement schedule based on our audits.

         We conducted our audits in accordance with generally  accepted auditing
standards. Those standards require that we plan and perform the audits 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  financial  statements  referred to above  present
fairly, in all material respects, the consolidated financial position of Mariner
Health Group,  Inc. and  subsidiaries  as of December 31, 1995 and 1996, and the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended  December 31, 1996 in conformity  with generally
accepted  accounting  principles.  In addition,  in our opinion,  the  financial
statement  schedule  referred to above, when considered in relation to the basic
financial  statements  taken  as a  whole,  presents  fairly,  in  all  material
respects, the information required to be included therein.


                                                     COOPERS & LYBRAND L.L.P.

Boston, Massachusetts
February 7, 1997


                                       40



                   MARINER HEALTH GROUP, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

                (IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)


<TABLE>
<CAPTION>
                                                                                  DECEMBER 31,          DECEMBER 31,
                                                                                     1995                    1996
                                                                                     ----                    ----
                                              ASSETS
<S>                                                                             <C>                  <C>            
Current assets:
  Cash and cash equivalents                                                     $         4,086      $         4,616
  Accounts receivable, less allowance for doubtful accounts
    of $10,078 and $11,872 respectively                                                  92,537              126,938
  Estimated settlements due from third-party payors                                      12,915               18,912
  Prepaid expenses and other current assets                                               6,757                8,880
  Deferred income tax benefit                                                             9,918               11,008
                                                                               -----------------    -----------------
     Total current assets                                                               126,213              170,354
Property, plant and equipment, net                                                      174,486              386,425
Goodwill, net of accumulated amortization of $19,084 and $10,561,
  respectively                                                                           78,212              280,803
Intangible and other assets, net of accumulated amortization of
  $6,550 and $5,813, respectively                                                        30,144               20,991
Restricted cash and cash equivalents                                                      1,198                2,885
Deferred income tax benefit                                                               1,273               19,775
                                                                               -----------------    -----------------
     Total assets                                                               $       411,526      $       881,233
                                                                               =================    =================

                             LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Current maturities of long-term debt and capital lease obligations            $         5,156      $         8,030
  Accounts payable                                                                       10,904               31,024
  Accrued payroll                                                                         6,072                9,944
  Accrued vacation                                                                        5,053                8,235
  Other accrued expenses                                                                 22,808               41,141
  Deferred income taxes                                                                     987                   25
  Other liabilities                                                                       1,085                3,801
                                                                               -----------------    -----------------
     Total current liabilities                                                           52,065              102,200
Long-term debt and capital lease obligations                                            107,910              415,236
Deferred income taxes                                                                     6,007               18,073
Deferred gain                                                                             2,122                1,955
Other long-term liabilities                                                               1,030               18,981
                                                                               -----------------    -----------------
      Total liabilities                                                                 169,134              556,445

Commitments and contingencies (Note 15)      

Stockholders' equity :

Common stock,  $.01 par value;  50,000,000  shares  authorized;  22,540,008  and
  28,978,225 issued and outstanding at December 31, 1995 and
  1996, respectively                                                                        225                  290
Additional paid-in capital                                                              246,660              312,786
Unearned compensation                                                                      (15)                  (8)
Retained earnings (accumulated deficit)                                                 (4,478)               11,720
                                                                               -----------------    -----------------
     Total stockholders' equity                                                         242,392              324,788
                                                                               -----------------    -----------------
       Total liabilities and stockholders' equity                               $       411,526      $       881,233
                                                                               =================    =================
</TABLE>


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




                                       41



                   MARINER HEALTH GROUP, INC. AND SUBSIDIARIES


                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                                                               YEARS
                                                                                         ENDED DECEMBER 31,
          
                                                                                1994             1995              1996
                                                                                ----             ----              ----
<S>                                                                         <C>              <C>               <C>        
Net patient service revenue                                                 $   260,357      $    337,635      $   578,755
Other revenue                                                                     3,787            17,171           12,054
                                                                           -------------    --------------    -------------
Total operating revenue                                                         264,144           354,806          590,809
                                                                           -------------    --------------    -------------

Operating expenses:
  Facility operating costs                                                      208,691           276,633          459,127
  Corporate, general and administrative                                          30,935            39,830           52,500
                                                                           -------------    --------------    -------------
                                                                                239,626           316,463          511,627
  Interest expense                                                                1,917             4,440           26,853
  Interest income                                                                   (98)             (842)            (597)
  Facility rent expense, net                                                      1,739             1,830            3,727
  Depreciation and amortization                                                   8,091            11,397           21,376
                                                                           -------------    --------------    -------------
Total operating expenses                                                        251,275           333,288          562,986
Operating income                                                                 12,869            21,518           27,823
Net gain (loss) on sale of assets                                                   932               (6)            (826)
                                                                           -------------    --------------    -------------
Income before income taxes and extraordinary items                               13,801            21,512           26,997
Net provision for income taxes                                                   (5,848)           (7,892)         (10,799)
                                                                           -------------    --------------    -------------
Income before extraordinary items                                                 7,953            13,620           16,198
Extraordinary items                                                                 (86)           (1,138)              ---
                                                                           -------------    --------------    -------------
Net income                                                                  $     7,867      $     12,482      $    16,198
                                                                           =============    ==============    =============

Net income per common and common equivalent share:
  Income from continuing operations before extraordinary items              $      0.41      $       0.60     $       0.55
  Extraordinary items                                                               ---             (0.05)             ---
                                                                           -------------    --------------    -------------
  Net income                                                                $      0.41      $       0.55      $      0.55
                                                                           =============    ==============    =============

Weighted average number of common and common equivalent shares
outstanding                                                                      19,251            22,755           29,210
                                                                           =============    ==============    =============


</TABLE>
               The accompanying notes are an integral part of the
                       consolidated financial statements.



                                       42



                   MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                     YEARS ENDED DECEMBER 31,

                                                                           1994             1995                  1996
                                                                           ----             ----                  ----
<S>                                                                    <C>                <C>                  <C>      
Cash flows from (for) operating activities:
  Net income                                                           $    7,867         $   12,482           $  16,198
  Adjustments  to reconcile  net income to net cash  provided by
  (used in) operating activities:
    Depreciation and amortization                                           8,125             11,418              22,274
    Amortization of deferred gain                                           (905)            (1,468)               (167)
    Loss on facility closure                                                  ---              1,801                826
    Extraordinary item-loss due to early retirement of debt                   143              1,138                ---
    Non-recurring charges                                                   1,375                ---                 850
    (Gain) loss on disposal of assets                                       (508)                 20               1,061
    Earnings from partnerships                                              (123)               (14)                 ---
    Provisions for losses on accounts receivable                            1,338              3,698               2,738
    Changes in operating assets and liabilities:
      Increase in accounts receivable                                    (17,063)           (40,787)            (24,848)
      (Increase) decrease in estimated settlements from third
          party payors                                                    (2,578)            (7,156)                 235
      (Increase) decrease in prepaid expenses and other current
          assets                                                            (830)            (3,397)               1,059
      Decrease in income taxes receivable                                    731                ---                 ---
      Increase (decrease) in accounts payable                               (970)              3,778              10,968
      Increase (decrease) in accrued liabilities                           11,383              6,884             (4,779)
      Decrease in other current liabilities                               (2,515)              (166)             (6,921)
      Increase in deferred income taxes                                   (4,321)              (824)              6,313
                                                                   ---------------    ---------------     ---------------
           Net cash provided by (used in) operating activities              1,149           (12,593)             25,807
                                                                   ---------------    ---------------     ---------------

Cash flows for investing activities:
  Purchase of property, plant and equipment                               (8,875)           (11,943)            (22,502)
  Proceeds from sale of plant, property and equipment                         ---                ---               3,080
  Increase in other assets                                                  (766)            (3,210)            (35,500)
  Payments related to prior acquisitions                                   ---              1,055                 ---
  Decrease in restricted cash                                                 ---                756                   4
  Cash paid for acquisitions, net of cash acquired                       (60,134)           (52,389)           (168,697)
  Purchase deposits                                                           ---           (19,500)                 ---
                                                                   ---------------    ---------------     ---------------
       Net cash used in investing activities                             (69,775)           (85,231)           (223,615)
                                                                   ---------------    ---------------     ---------------

Cash flows from financing activities:
  Drawings on line of credit                                               47,250             80,775             217,481
  Proceeds from debt offering, net                                            ---                ---             149,666
</TABLE>


                                       43


                   MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (CONTINUED)

<TABLE>
<CAPTION>
   
                                                                                     YEARS ENDED DECEMBER 31,

                                                                       1994                1995                  1996
                                                                       ----                ----                  ----


<S>                                                                 <C>                  <C>                  <C>
  Repayments of debt                                                     (64,610)           (17,921)           (173,063)
  Proceeds from issuance of stock, net of offering costs                   83,634                ---                 ---
  Exercise of stock options                                                   995              1,008               3,887
  Shares issued under employee stock purchase plan                            ---                400                 310
  Other increases from financing activities                                   564                439                  57
                                                                ------------------    ---------------     ---------------
          Net cash provided by financing activities                        67,833             64,701             198,338
                                                                ------------------    ---------------     ---------------
Increase (decrease) in cash and cash equivalents                            (793)           (33,123)                 530
Cash and cash equivalents at beginning of year                             38,002             37,209               4,086
                                                                ------------------    ---------------     ---------------
Cash and cash equivalents at end of year                         $         37,209      $       4,086      $        4,616
                                                                ==================    ===============     ===============
    
</TABLE>


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



                   MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
                (IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)


<TABLE>
<CAPTION>
                                                      COMMON STOCK      PREFERRED STOCK


                                                                                                           RETAINED
                                                                             ADDITIONAL                    EARNINGS
                                                PAR                  PAR      PAID-IN      UNEARNED      (ACCUMULATED
                                  SHARES       VALUE   SHARES        VALUE    CAPITAL     COMPENSATION     DEFICIT)     TOTAL

<S>                              <C>        <C>       <C>          <C>      <C>            <C>            <C>          <C>     
Balance at December 31, 1993     15,410,463 $   154   2,136,332    $    21  $152,102       $  (221)       $ (24,827)   $127,229
Net income                                                                                                    7,867       7,867
Conversion of Preferred Stock    2,136,332       21  (2,136,332)       (21)
Conversion of subordinated debt    556,070        6                            6,474                                      6,480
Exercise of options                180,418        2                              993                                        995
Exercise of warrants                49,286        1                              202                                        203
Accelerated vesting of stock                                                   1,375                                      1,375
options
Shares purchased under
  Employee Stock Purchase Plan       5,711                                        95                                         95
Tax benefit arising from
exercise of                                                                      294                                        294
  employee stock options
Issuance of Common Stock         4,027,538       40                           83,536                                     83,576
Cancellation of options                                                          (86)           86                           --
Amortization of stock plan                                                                      34                           34
expense                                              
                                 ----------------------------------------------------------------------------------------------
Balance at December 31, 1994     22,365,818     224         ---       ---    244,985          (101)       (16,960)      228,148
Net income                                                                                                 12,482        12,482
Exercise of options                140,201        1                            1,013                                      1,014
Shares purchased under
  Employee Stock Purchase Plan      32,365                                       400                                        400
Issuance of Common Stock             1,624                                        3                                           3
Tax benefit arising from
  exercise of employee stock                                                    326                                         326
options
Cancellation of options                                                         (67)           67                             ---
Amortization of stock plan           
expense                                                                                        19                            19
                                 ----------------------------------------------------------------------------------------------




Balance at December 31, 1995     22,540,008 $   225         ---        ---  $246,660       $  (15)        $  (4,478)   $242,392

Net income                                                                                                   16,198      16,198
Exercise of options                491,702        5                            3,882                                      3,887
Issuance of warrants                                                             850                                        850
Warrants exercised                  17,177                                        55                                         55
Shares purchased under
  Employee Stock Purchase Plan      26,958                                       310                                        310
Issuance of Common Stock         5,902,380       60                           59,576                                     59,636
Tax benefit arising from
  exercise of employee stock                                                   
  options                                                                      1,453                                      1,453
Amortization of stock plan                                                                                                
expense                                                                                          7                            7
                                 ----------------------------------------------------------------------------------------------
Balance at December 31, 1996     28,978,225 $   290        ---         ---  $312,786     $      (8)       $  11,720   $ 324,788
                                 ==============================================================================================

</TABLE>


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



                                      -45-


                   MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  NATURE OF BUSINESS

         Mariner  Health  Group,   Inc.  and  subsidiaries   ("Mariner"  or  the
"Company")  provides  post-acute health care services in selected markets with a
particular  clinical expertise in the treatment of short-stay  subacute patients
in  cost-effective  alternate sites.  Subacute patients are medically stable and
generally  require  between three to six hours of skilled  nursing care per day.
These  patients  typically  can benefit  from  standardized  clinical  programs,
require  extensive  ancillary  medical  services and are discharged  directly to
their homes.

         Mariner owns, operates and manages freestanding  inpatient  facilities,
provides  rehabilitation  program  management  services to other skilled nursing
facilities and operates outpatient  rehabilitation clinics,  pharmacies and home
health agencies.


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

         The consolidated  financial statements of Mariner have been prepared to
give retroactive effect to the merger of MedRehab, Inc. ("MedRehab" or "MRI") on
March  1,  1996,  of  which  was  accounted  for  as  a  pooling  of  interests.
Accordingly,  the  accompanying  consolidated  financial  statements  have  been
restated to include the  accounts  and  operations  of MedRehab  for all periods
presented.

Principles of Consolidation

         The  consolidated  financial  statements  include  the  accounts of the
Company.  All  significant  intercompany  accounts  and  transactions  have been
eliminated in consolidation.

Estimates Used in Preparation of Financial Statements

         The  preparation of financial  statements in conformity  with generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  effect 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.  Actual results could differ from those estimates.  Estimates
are used when accounting for the  collectibility  of receivables and third party
settlements,  depreciation and amortization,  employee benefit plans,  taxes and
contingencies.

Cash and Cash Equivalents

         Cash and cash  equivalents  consist of cash and short-term  investments
with original maturities of three months or less.

Net Patient Service Revenue

         Net  patient  service  revenue  includes  patient  revenues  payable by
patients,   amounts   reimbursable  by  third  party  payors  under   contracts,
rehabilitation  therapy service  revenues from  management  contracts to provide
services to  non-affiliated  skilled  nursing  facilities and other entities and
revenues  from the  Company's  medical  products and home health care  services.
Patient revenues payable by patients at the Company's facilities are


                                       46


recorded at  established  billing  rates.  Patient  revenues to be reimbursed by
contracts  with  third-party  payors are recorded at the amount  estimated to be
realized  under these  contractual  arrangements.  Revenues  from  Medicare  and
Medicaid are  generally  based on  reimbursement  of the  reasonable  direct and
indirect costs of providing  services to program  participants  or a prospective
payment system.  The Company  separately  estimates revenues due from each third
party  with  which it has a  contractual  arrangement  and  records  anticipated
settlements  with these parties in the contractual  period during which services
were rendered. The amounts actually reimbursable under Medicare and Medicaid are
determined  by  filing  cost  reports  which  are  then  subject  to  audit  and
retroactive  adjustment  by the payor.  Legislative  changes to state or federal
reimbursement  systems may also retroactively affect recorded revenues.  Changes
in  estimated  revenues  due in  connection  with  Medicare  and Medicaid may be
recorded by the Company subsequent to the year of origination and prior to final
settlement based on improved  estimates.  Such adjustments and final settlements
with  third  party  payors  are  reflected  in  operations  at the  time  of the
adjustment or settlement.

         In addition,  indirect costs  reimbursed under the Medicare program are
subject to regional  limits.  The Company's costs generally  exceed these limits
and accordingly, the Company is required to submit exception requests to recover
such excess  costs.  The Company  believes it will be  successful  in collecting
these  receivables,  however,  the failure to recover  these costs in the future
could materially and adversely affect the Company.

         The Company's rehabilitation management contracts typically have a term
of one year  but  frequently  include  automatic  renewals  and in  general  are
terminable on notice of 30 to 90 days by either party.  Under certain contracts,
Mariner  bills  Medicare  or another  third-party  payor  directly.  Under other
contracts,  the Company is compensated on a fee for service basis and in general
directly   bills  the  skilled   nursing   facility,   which  in  turn  receives
reimbursement from Medicare, Medicaid, private insurance or the patient. Mariner
recognizes  payments  under these  latter  contracts  as payments  from  private
payors.  Under these latter  contracts,  Mariner also generally  indemnifies its
customers  against  reimbursement  denials by  third-party  payors for  services
determined  not to be  medically  necessary.  Mariner has  established  internal
documentation  standards  and systems to minimize  denials and typically has the
right to appeal  denials at its  expense.  Historically,  reimbursement  denials
under these contracts have been  insignificant;  however, an increase in denials
could materially and adversely affect the Company.

         Under  arrangements  in  which  the  Company  bills a  skilled  nursing
facility for its  rehabilitation  services on a fee for service basis,  Medicare
reimburses the facility based on a reasonable cost standard. Specific guidelines
exist for evaluating the reasonable  cost of physical,  occupational  and speech
therapy services. Medicare applies salary-equivalency  guidelines in determining
the reasonable cost of physical therapy  services,  which is the cost that would
be incurred if the therapist were employed by a nursing facility, plus an amount
designed to  compensate  the  provider  for certain  general and  administrative
overhead costs.  Medicare pays for occupational and speech therapy services on a
reasonable  cost  basis,  subject  to the  so-called  "prudent  buyer"  rule for
evaluating the  reasonableness of the costs. The Company's gross margins for its
physical   therapy  services  under  the  salary   equivalency   guidelines  are
significantly  less than for its speech and occupational  therapy services under
the "prudent buyer" rule. In addition, Mariner provides certain services between
subsidiary  companies,  some of which are charged at cost and others of whch are
charged at market rates. Mariner believes that the services which are charged at
market rates  qualify for an exception to Medicare's  related party rule.  There
can be no assurance,  however, that HCFA will endorse Mariner's position and the
Medicare  reimbursement  received for such  services may be subject to audit and
recoupment in future years.

         In  April  1995,  HCFA  issued  a  memorandum  to its  Medicare  fiscal
intermediaries  as a guideline to assess costs  incurred by inpatient  providers
relating  to payment of  occupational  and speech  language  pathology  services
furnished under  arrangements  that include  contracts between therapy providers
and inpatient  providers.  While not binding on the fiscal  intermediaries,  the
memorandum suggested certain rates to assist the fiscal intermediaries in making
annual "prudent buyer" assessments of speech and occupational therapy rates paid
by inpatient providers.  In addition, HCFA is in the process of promulgating new
salary  equivalency  guidelines  which will update current  physical therapy and
respiratory therapy rates and establish new guidelines for occupational  therapy
and speech  therapy.  Mariner  will not be able to determine  whether  these new
proposals will have a material effect on its rehabilitation operations until the
publication of final rates and rules.  HCFA through its  intermediaries  is also
subjecting  physical  therapy,  occupational  therapy  and  speech  therapy to a
heightened level of scrutiny resulting in increasing audit activity.  A majority
of Mariner's provider and rehabilitation  contracts provide for  indemnification
of the facilities for potential liabilities in connection with reimbursement for
rehabilitation services. There can be no assurance that actions ultimately taken
by HCFA with regard to  reimbursement  rates for such therapy  services will not
materially adversely affect the Company's results of operations.


         During  1996,  the Company  observed a change in the  practices  of its
Medicare  fiscal  intermediaries  which,  on behalf of HCFA,  the federal agency
responsible for administering  the Medicare program,  have begun to aggressively
and  retrospectively  change their position on previously  approved costs.  This
change   includes   the   reclassification   of  costs  from   reimbursable   to
non-reimbursable   and  the   challenging   of  payment   for  costs  which  had
traditionally  been approved.  In response to these challenges of the payment of
Medicare  costs,  the Company  changed its  estimate  of required  reserves  and
provided  an  additional  $10,000,000  reserve  for  potential  lower  levels of
Medicare reimbursement.

Other Revenue

         Other  revenue  consists  primarily  of fees earned from  contracts  to
manage inpatient  sub-acute care units of non-affiliated  health care facilities
and, in 1995, includes fees of $11,227,000 relating to the management of certain
Convalescent  Services,  Inc.  ("CSI")  facilities.  A  director,   officer  and
stockholder  of CSI during 1995 was also a director  of the  Company  during the
period in which these fees were earned (see Note 3).

Facility Operating Costs

         Facility  operating costs include nursing  expenses for the years ended
December 31, 1994,  1995 and 1996 of  $35,039,000,  $50,738,000  and $69,950,000
respectively.  All other expenses included in facility  operating costs, such as
rehabilitation  and  ancillary  services,  administration,   dietary  and  plant
operations,  for  the  years  ended  December  31,  1994,  1995  and  1996, were
$173,652,000, $225,895,000 and $389,177,000, respectively.

Property, Plant and Equipment

         Property, plant and equipment are stated at cost. Betterments and major
renewals are capitalized  and included in property and equipment,  while repairs
and maintenance  are charged to expense as incurred.  Upon retirement or sale of
assets,  the  cost  of the  assets  disposed  of  and  the  related  accumulated
depreciation  are removed from the accounts,  and any resulting  gain or loss is
reflected in the statement of operations.



                                       47


         The  provision for  depreciation  is computed  using the  straight-line
method. Depreciation provisions are based on estimated useful lives as follows:

         Building and improvements -- 15-40 years

         Furniture and equipment -- 3-8 years

         Leasehold  rights and improvements -- Over the shorter of the remaining
         term of the lease or life of the asset

Goodwill, Intangibles and Other Assets

         Goodwill,  intangibles  and other assets  primarily  consist of amounts
identified in connection with certain facility acquisitions  accounted for under
the  purchase  method,  and  certain  deferred  costs  which  were  incurred  in
connection with various financings.

         In connection  with each of its  acquisitions,  the Company reviews the
assets  acquired and assesses  their  relative  fair value in  comparison to the
purchase price.  Goodwill results from the acquisition of certain facilities for
which the negotiated  purchase  prices exceed the allocations of the fair market
value  of  identifiable  assets.  The  Company's  policy  is  to  evaluate  each
acquisition  separately  and  identify an  appropriate  amortization  period for
goodwill  based on the acquired  property's  characteristics.  Goodwill is being
amortized using the straight-line  method generally over a 40 year period. Costs
incurred in obtaining  financing are amortized using the  straight-line  method,
over the term of the related financial obligation.

         During 1996, the Company wrote-off  approximately  $14,007,000 of fully
amortized  goodwill  and  approximately  $2,585,000  of  fully  amortized  other
intangible assets.Amortization expense related to goodwill and intangible assets
for the years ended December 31, 1994, 1995 and 1996 was $2,396,000, $3,112,000,
and $6,158,000, respectively.

         The Company  periodically  reviews the carrying value of its long-lived
assets (primarily property, plant and equipment and intangible assets) to assess
the  recoverability  of these  assets;  any  impairments  would be recognized in
operating  results if a permanent  diminution in value were to occur. As part of
this  assessment,  the Company  reviews the expected  future net operating  cash
flows  from  its  facilities,  as  well  as the  values  included  in any of its
facilities,  which have  periodically  been obtained in connection  with various
refinancings.

Income Taxes

         The Company follows the provisions of Statement of Financial Accounting
Standards No. 109 (SFAS No. 109),  "Accounting for Income Taxes," which requires
the use of the liability  method of accounting  for deferred  income taxes.  The
Company's  policies  regarding   depreciation  and  amortization  for  financial
reporting purposes differ from those used for tax purposes,  thereby giving rise
to deferred income taxes. For Federal income tax purposes, Mariner Health Group,
Inc. and its subsidiaries file a consolidated income tax return.

Net Income Per Common and Common Equivalent Share

         Net income per common and common  equivalent  share is calculated based
on net  income  divided  by the  weighted  average  number of common  and common
equivalent  shares  outstanding  during the year.  Fully  diluted net income per
common and common  equivalent  share has not been presented as amounts would not
differ significantly from those presented.

         During  1997,  the  Financial  Accounting  Standards  Board issued FASB
Statement  No. 128,  "Earnings  Per Share." This standard is designed to improve
the earnings per share ("EPS") information  provided in financial  statements by
simplifying  the existing  computational  guidelines,  revising  the  disclosure
requirements,  and increasing the  comparability of EPS data on an international
basis.  The Company  will  implement  the new standard in its fiscal year ending
December 31, 1997. The impact of the implementation of this standard has not yet
been determined. 



                                       48




Reclassifications

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


3.  MERGERS AND ACQUISITIONS

         During January 1994, the Company entered into a definitive agreement to
merge with Pinnacle Care Corporation. On May 10, 1994, Pinnacle Care Corporation
and its  subsidiaries  was merged with and into the Company.  Under terms of the
merger agreement,  4,857,143 shares of the Company's Common Stock were exchanged
for all the  outstanding  stock and options to purchase  stock of Pinnacle  Care
Corporation.  The merger was consummated  during the second quarter of 1994 in a
tax-free,  stock-for-stock transaction which has been accounted for as a pooling
of interests.

         Operating results of the separate  companies for the period immediately
preceding the acquisition are as follows:

<TABLE>
<CAPTION>
                                                 MARINER        PINNACLE          COMBINED
                                                 -------        --------          --------
<S>                                            <C>             <C>               <C>     
Three months ended March 31, 1994:
  Total revenue                                $  23,026       $ 23,951          $ 46,977
  Net income                                       1,230          1,366             2,596

</TABLE>

         The combined financial results presented above include adjustments made
to conform accounting policies of the two companies.  There were no intercompany
transactions between the two companies for the period presented.

         During 1994, the Company recorded general and administrative charges of
$9,327,000  of  which  $7,952,000  related  to  the  merger  with  Pinnacle  and
$1,375,000 related to the accelerated  vesting of certain stock options.  Of the
merger  costs,  approximately  $4,627,000  was expensed for employee  severance,
payroll and relocation,  $2,878,000 was expensed for transaction costs including
investment  bankers',  legal and  accounting  fees,  $172,000  was  expensed for
customer relations, $150,000 was expensed for operations relocation, $66,000 was
expensed for investor relations and $59,000 was expensed for employee relations.

         During 1994,  the Company  acquired  property,  plant and  equipment of
eight  facilities  with an  aggregate  of 892 beds.  The Company paid a total of
approximately $58,250,000,  using approximately $14,750,000 cash and $43,750,000
of borrowings under the revolving  credit  facility.  The acquisitions are being
accounted for under the purchase method of accounting. Accordingly, the purchase
prices have been allocated to the assets  acquired based on their fair value and
the  excess  purchase  price  totaling  $28,237,000  has been  accounted  for as
goodwill.

         Also during 1994, the Company  acquired a pharmacy and home health care
business in Connecticut. The consideration paid by the Company for this business
consisted of $3,655,000 in cash (of which approximately  $3,500,000 was borrowed
under the  revolving  credit  facility) and a $500,000 note payable in quarterly
installments  over  three  years  which  bears  interest  at 6% per  annum.  The
acquisition   was  accounted  for  under  the  purchase  method  of  accounting.
Accordingly,  the purchase price was allocated to assets acquired based on their
fair value. The excess of $3,087,000 has been accounted for as goodwill.

         In March  1995,  Mariner  acquired a 60-bed  skilled  nursing  facility
located in St.  Petersburg,  Florida for $2,500,000 in cash.  Goodwill  totaling
approximately $951,000 was recorded in connection with this transaction.

         A  definitive  agreement  to merge  with  Convalescent  Services,  Inc.
("CSI") had  originally  been  announced  on January 9, 1995.  At the time,  CSI
operated 25 skilled  nursing  facilities,  one  rehabilitation  hospital and one



                                       49


continuing care retirement community,  with an aggregate of 3,801 beds (the "CSI
Facilities").  The CSI  Facilities  are  concentrated  primarily  in Florida and
Texas.  Under  the  terms  of  the  definitive   agreement,   the  Common  Stock
consideration  was fixed at  5,853,658  newly  issued  shares of Mariner  Common
Stock.  On April 11, 1995,  Mariner  shareholders  voted to approve the proposed
combinations  with CSI. In the interim,  a number of conditions  relating to the
closing of this business combination had not been satisfied.

         Therefore  on May 24,  1995 (the "May 1995  Closing"),  Mariner and CSI
entered into a Management  Agreement (the "Management  Agreement"),  pursuant to
which Mariner managed all of CSI's  facilities and operations  until the closing
which occurred on January 2, 1996 (the "Closing"),  for a monthly management fee
equal to 6% of the gross  operating  revenue of CSI's  facilities.  In addition,
upon  termination  of  the  Management  Agreement,   Mariner  received  a  bonus
management  fee equal to the net  income of the  facilities  managed  by Mariner
during the term of the agreement  subject to certain  adjustments.  As a result,
Mariner  received  $11,227,000 of management fees from facilities  controlled by
Stiles A. Kellett,  Jr. and Samuel B. Kellett (the  "Kelletts") during  1995. Of
this amount,  $10,288,000 was from facilities  which were acquired by Mariner on
January 2, 1996. In addition,  Mariner acquired  substantially all the assets of
Convalescent Supply Services,  Inc., a Georgia corporation ("CSSI") owned by the
Kelletts, which provides enteral,  urological, wound care and ostomy products to
CSI's facilities. The purchase price of CSSI's assets was $6,500,000 in cash and
the  assumption  of CSSI's  trade  payables.  At the May 1995  Closing,  Mariner
acquired options to purchase 12 of the facilities  leased by CSI from affiliates
of the Kelletts at fair market value (the  "Options").  At the May 1995 Closing,
the Company also deposited an aggregate of  $15,000,000  to be credited  against
the purchase prices for two of the skilled nursing  facilities to be acquired at
the Closing and for the  facilities  which may be acquired  upon exercise of the
Options.  Mariner also paid a $4,500,000 deposit to the CSI stockholders,  which
was  credited by Mariner to the purchase  price paid in cash at the Closing.  On
January 2, 1996 the CSI Merger was  consummated.  As a result of the CSI Merger,
CSI became a wholly owned subsidiary of the Company. The total purchase price of
CSI was approximately $218,000,000, which consists of the assumption of debt and
capital leases of $110,000,000, $59,000,000 of common stock, $30,000,000 of cash
and  assumption  of  various  other  liabilities  of  $19,000,000.  Goodwill  of
approximately $82,000,000 was recorded in connection with this transaction.

         In June 1995,  Mariner  purchased a 150-bed skilled nursing facility in
Nashville,  Tennessee,  for a total purchase price of approximately  $8,500,000.
The purchase price was financed under the Company's  revolving  credit facility.
Approximately $2,400,000 of goodwill was recorded in this transaction.

         Also in June 1995, the Company purchased an 80,000 square foot building
in New London, Connecticut to serve as its corporate headquarters.  The purchase
price of the new building was  $3,050,000  and was financed  under the Company's
revolving  credit  facility.  The Company  completed its  relocation in October,
1995.

         In October  1995,  Mariner  completed  an  acquisition  of six  skilled
nursing  facilities  with an  aggregate  of 686  beds in  central  and  northern
Florida.  The purchase price for the transaction was  $42,800,000,  comprised of
$33,000,000 in cash and the assumption of debt in the amount of $9,800,000.  The
cash  portion of the  transaction  was  financed  through  borrowings  under the
Company's revolving credit facility.  The six facilities include two in Orlando,
and one each in Daytona,  Inverness,  Baker County and Melbourne.  Approximately
$14,300,000 of goodwill was recorded in this transaction.

         Also in October 1995, the Company  acquired an  institutional  pharmacy
operation based in Dallas,  Texas, for the total purchase price of approximately
$1,623,000.  The purchase  price was financed  through the  Company's  revolving
credit facility and issuance of a note to the seller.

         All of the 1995  acquisitions  were  accounted  for under the  purchase
method;  accordingly,  the  purchase  prices have been  allocated  to the assets
acquired based on their fair value with any excess accounted for as goodwill.

         During  1995,  the Company  accrued  general and  administrative  costs
totaling  $8,073,000  related to the merger  with CSI and the  consolidation  of
various regional and satellite offices to the New London, Connecticut office. Of
this total  charge,  approximately  $3,691,000  relates to severance and related
payroll costs and approximately $4,382,000 relates to expenses incurred to close
the regional offices.




                                       50


         On March 1, 1996,  the Company  consummated a merger with  MedRehab,  a
company  whose  primary  business is contract  rehabilitation  therapy.  Mariner
issued an aggregate of  approximately  2,312,500  shares of its Common Stock for
all of MedRehab's  outstanding  capital  stock and options to purchase  MedRehab
capital stock in a merger that was accounted for as a pooling of interests.

         Operating results for the separate companies for the period immediately
preceding the acquisition are as follows:


<TABLE>
<CAPTION>
                                                     MARINER        MEDREHAB     COMBINED
                                                     -------        --------     --------
<S>                                                 <C>             <C>           <C>      
Twelve months ended December 31, 1995:
  Total revenue                                     $ 298,049       $  56,757     $ 354,806
  Extraordinary items                                 (1,138)             ---       (1,138)
  Net income                                           11,535             947        12,482
</TABLE>

         The combined financial results presented above include adjustments made
to conform accounting policies of the two companies.  There were no intercompany
transactions between the two companies for the period presented.  As of December
31, 1996,  other accrued  expenses  includes  $2,009,000  which has been accrued
primarily to pay remaining scheduled severance amounts to certain employees.

         In March 1996,  Mariner acquired a primary care physician  organization
in the Orlando,  Florida area. In this transaction,  Mariner issued an aggregate
of 48,722 shares of its Common Stock and paid an aggregate of $1,500,000 in cash
which was financed under the Credit  Facility.  The Company has recorded a total
of $2.4 million in goodwill related to this transaction.

         In May 1996, the Company acquired seven skilled nursing  facilities and
one assisted living facility with an aggregate of 960 beds in Florida, Tennessee
and Kansas (the "1996 Florida  Acquisition").  All of the issued and outstanding
shares of common stock were  converted into the right to receive an aggregate of
approximately  $28,050,000 in cash. The Company financed the consideration  paid
in the 1996 Florida Acquisition with a portion of the net proceeds from the sale
of the Notes  and  borrowings  under  the  Credit  Facility.  Goodwill  totaling
approximately $38,000,000 was recorded in connection with this transaction.

   
         In the fourth quarter of 1996,  Mariner  consummated its acquisition of
certain assets of Allegis Health Services,  Inc.  ("Allegis") and certain of its
affiliates.  Under the terms of the acquisition agreement, the Company purchased
five inpatient  facilities,  assumed two operating  leases and one capital lease
and purchased Allegis'  institutional  pharmacy and its  rehabilitation  program
management subsidiary. The total purchase price of $110,000,000 consisted of the
assumption of $12,000,000 in debt,  including the capital lease of approximately
$5,000,000,  and  $98,000,000  in  cash.  Under  the  terms  of  the  agreement,
$103,000,000  of the purchase  price was paid at the closings  during the fourth
quarter of 1996.  Approximately  $98,500,000 of that amount plus certain closing
costs was borrowed under the Credit Facility.  The remaining $2,000,000 was paid
when certain financial performance conditions were met for 1996. Of this amount,
approximately  $1.6 million was paid in 1997 at which time goodwill was adjusted
to a total of $73.4 million for this transaction.
    

         On  October  1,  1996,  the  Company  acquired  a 163-bed  facility  in
Jacksonville,  Florida. The total purchase price was $9,850,000.  Mariner funded
the purchase  price by assuming two HUD  mortgages  in the  aggregate  principal
amount of approximately  $4,236,000.  The Company borrowed  $6,500,000 under its
Credit  Facility to fund the remainder of the cash portion of the purchase price
and to replace reserves  required by the HUD mortgage  agreements.  Of the total
purchase price, approximately $4.1 million was accounted for as goodwill.

         During 1996, all acquisition  were accounted for as purchase except for
the merger with MedRehab Inc. which was accounted for as a pooling of interests.
In  connection  with the CSI and 1996 Florida  Acquistions,  the Company  posted
additional  purchase  accounting  reserves  in the  fourth  quarter  of  1996 of
$9,000,000  consisting of $7,000,000 for third party  settlements and $2,000,000
for litigation.

4.  DISPOSITIONS OF FACILITIES

1994 TRANSACTION

         Effective  January 31, 1994, the Company  executed an agreement to sell
one of its  nursing  centers.  The  sale  price  was  $2,715,000  in the form of
$2,465,000 cash and a $250,000 note to be secured by a first lien on a leasehold
right the  purchaser has in connection  with a  sale-leaseback  financing of the
acquisition.  The sale resulted in a pretax loss of approximately  $115,000. For
the year ended December 31, 1994, the facility generated $403,000 of net patient
service revenue, and $202,000 of income from continuing operations before income
taxes,  extraordinary  items and  cumulative  effect  of  change  in  accounting
principle, respectively.



                                       51



5.  CONCENTRATION OF CREDIT RISK

         Financial   instruments  that   potentially   subject  the  Company  to
concentration of credit risk consist  primarily of temporary cash investments in
money market funds and repurchase  agreements  with a financial  institution and
trade  receivables.   Approximately  10%  and  24%  of  the  Company's  accounts
receivable  and  estimated  settlements  due from  third  party  payors are from
Medicaid  programs  and 21% and 31% are from  Medicare  programs at December 31,
1995 and 1996, respectively. There have been, and the Company expects that there
will continue to be, a number of proposals to limit  reimbursement  allowable to
skilled nursing  facilities.  Should the related government  agencies suspend or
significantly reduce  contributions to these programs,  the Company's ability to
collect on its receivables would be adversely affected. Management believes that
the remaining  receivable  balances from various payors,  including  individuals
involved in diverse activities, subject to differing economic conditions, do not
represent a concentration of credit risk to the Company.  Management continually
monitors  and  adjusts its  allowance  for  doubtful  accounts  and  contractual
allowances  associated  with its  receivables.  Federal law limits the degree to
which states are permitted to alter Medicaid programs.


6.  SALES LEASEBACK TRANSACTIONS

         The Company constructed two facilities which were purchased in 1993, at
the completion of the  construction  phase, by the real estate  investment trust
providing the financing.  The Company entered into operating lease  arrangements
for these  facilities  which  provided for minimum lease terms through July 1999
and January 2004, respectively, with extension rights available through 2019.

         In April 1993,  one of the  facilities was sold and leased back. A gain
on the sale  totaling  $1,815,000  was deferred and was being  amortized  over 7
years,  the term of the lease.  The Company  initiated a  significant  change in
business  focus at this  facility  during 1995.  The  facility was  purchased on
November 1, 1995. Effective January 1, 1996 a portion of the building was leased
to a long-term care company  unrelated to the Company.  The remaining portion of
the building is leased as office space. Upon effecting these  transactions,  the
Company recognized the remaining deferred gain of $1,135,000 which was offset by
the  write-off  of certain  capitalized  costs of  $2,887,000  for a net loss of
$1,752,000 which is included in facility operating expenses.

         In November 1993, the second  facility was sold and leased back. A gain
on the sale totaling $1,783,000 has been deferred and is being amortized over 10
years,  the term of the lease.  The  unamortized  amount of this  deferred  gain
totaled $1,244,000 at December 31, 1996.  Additional  deferred gains of $711,000
relate to prior Pinnacle transactions.


7.  PROPERTY, PLANT AND EQUIPMENT

         Property, plant and equipment consists of the following (in thousands):

                                                            DECEMBER 31,
                                                    1995                  1996
Land and improvements                             $    15,342       $   32,433
Building and improvements                             141,453          329,141
Furniture and equipment                                48,588           63,361
Leasehold rights and improvements                         429            2,841
Software                                                  ---            2,348
Construction in progress                                1,954            3,850
                                                  -----------       ----------
                                                      207,766          433,974
Less:  accumulated depreciation                       (33,280)         (47,549)
                                                  -----------       ----------
                                                  $   174,486       $  386,425
                                                  ===========       ==========



                                       52

         Depreciation  expense related to property,  plant and equipment for the
years ended  December 31, 1994,  1995 and 1996 was  $5,695,000,  $8,285,000  and
$15,218,000, respectively.

         Interest  costs   associated  with   construction  or  renovations  are
capitalized  in  the  period  in  which  they  are  incurred.  No  interest  was
capitalized during 1994, 1995, or 1996.

         Included in property, plant and equipment is equipment, furniture, land
and  buildings  under capital  leases with cost bases  totaling  $3,973,000  and
$94,582,000   at  December   31,  1995  and  1996,   respectively.   Accumulated
amortization  on equipment  under capital leases is  approximately  $188,000 and
$2,479,000  at  December  31,  1995  and  1996   respectively.   These  non-cash
transactions have been excluded from the consolidated statements of cash flows.


8.  RESTRICTED CASH AND CASH EQUIVALENTS

         Approximately  $1,198,000  and  $2,885,000  of the  Company's  cash  is
restricted for capital  improvements  and collateral  under the terms of various
financing  arrangements  at  December  31,  1995 and  1996,  respectively.  This
includes   amounts   related  to  debt  assumed  in   connection   with  certain
acquisitions.


9.  LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

         Long-term debt and capital lease obligations consist of the following:

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                                   ------------
                                                              1995               1996
                                                              ----               ----
                                                                  (IN THOUSANDS)
                                                                  --------------

<S>                                                     <C>                <C>           
Senior Subordinated Notes                               $           ---    $      149,691
                                                        
Revolving credit and term loan agreement                         64,500           132,000
Mortgage loans                                                   16,615            51,232
Tax exempt low floater with annual maturities of
    $395,000 through October 2010                                 5,875            5,480
Term loans and other                                             18,775            8,361
Capital lease obligations                                         7,301           76,502
                                                        ----------------    --------------
                                                                113,066          423,266
Current maturities of long-term debt                             (4,115)          (4,802)
Current portion of capital lease obligations                     (1,041)          (3,228)
                                                        ----------------    --------------
                                                        $    107,910        $    415,236
                                                        ================    ==============
</TABLE>

         On April 4, 1996,  the Company sold  $150,000,000  aggregate  principal
amount of its 9-1/2% Senior Subordinated Notes due 2006 (the "Notes"). The Notes
mature on April 1, 2006. The Notes are unsecured senior subordinated obligations
of Mariner and, as such,  are  subordinated  in right of payment to all existing
and future senior  indebtedness  of Mariner,  including  indebtedness  under the
Credit Facility.  The Notes contain certain  covenants,  including,  among other
things,  covenants  with respect to the  following  matters:  (i)  limitation on
indebtedness;  (ii) limitation on restricted  payments;  (iii) limitation on the
incurrence  of liens;  (iv)  restriction  on the issuance of preferred  stock of
subsidiaries; (v) limitation on transactions with affiliates; (vi) limitation on
the sale of assets; (vii) limitation on other senior subordinated  indebtedness;
(viii) limitation on guarantees by subsidiaries; (ix) limitation on the creation
of any  restriction  on  the  ability  of the  Company's  subsidiaries  to  make
distributions;  and (x) restriction on mergers,  consolidations and the transfer
of all or substantially all of the assets of the Company to another person.  The
Notes were issued under an Indenture  dated as of April 4, 1996 by and among the
Company and State Street Bank and Trust Company, as trustee (the "Indenture").



                                       53


         Mariner has a $250,000,000  senior secured  revolving  credit  facility
with a syndicate of banks (the  "Credit  Facility").  As of April 30, 1996,  the
Company entered into an amendment to the Credit Facility to increase the size of
the Credit Facility to $200,000,000  from  $175,000,000,  extend the maturity of
the Credit  Facility and reduce certain  restrictions  that the Credit  Facility
imposes on the  operations of the business of the Company and its  subsidiaries.
As of July 1, 1996 the terms were  amended to provide  for  borrowings  of up to
$250,000,000.  As of December 31, 1995 and 1996,  principal balances outstanding
under the  Credit  Facility  were  approximately  $64,500,000  and  $132,000,000
respectively,  and  letters  of credit  outstanding  under  this  facility  were
$2,612,000  and  $5,499,000,  respectively.  Mariner  has used,  and  intends to
continue to use, borrowings under the Credit Facility to finance the acquisition
and development of additional  subacute care facilities and related  businesses,
and  for  general  corporate  purposes,  including  working  capital.  Mariner's
obligations  under the Credit  Facility  are  collateralized  by a pledge of the
stock  of  its   subsidiaries  and  are  guaranteed  by  all  of  the  Company's
subsidiaries.  In addition, the Credit Facility is collateralied by mortgages on
certain of the Company's  inpatient  facilities,  leasehold mortgages on certain
inpatient  facilities leased by the Company,  and security  interests in certain
other  properties  and assets of the  Company and its  subsidiaries.  The Credit
Facility  matures  on April  30,  1999 and  provides  for  prime or  LIBOR-based
interest rate options.  The borrowing  availability  and rate of interest varies
depending upon specified  financial  ratios.  The Credit  Facility also contains
covenants  which,  among other things,  require the Company to maintain  certain
financial  ratios and impose certain  limitations or prohibitions on the Company
with respect to the incurrence of indebtedness,  senior indebtedness,  liens and
capital  leases;  the payment of dividends on, and the  redemption or repurchase
of, its capital stock;  investments and acquisitions,  including acquisitions of
new facilities;  the merger or  consolidation  of the Company with any person or
entity;  and the disposition of any of the Company's  properties or assets.  The
weighted average interest rate on the outstanding  balances at December 31, 1995
and 1996 was 6.43% and 7.13%, respectively.

         Term loans at December 31, 1995 and 1996 consist primarily of the notes
payable in  connection  with the January 1993  purchase of the contract  therapy
business,  the 1994 purchase of a pharmacy and home health care business, a term
note in  connection  with the  Heritage  Acquisition  (See Note 3), the MedRehab
merger, and an airplane.  A total of $4,670,000 of term loans are unsecured.  An
airplane  is  pledged as  collateral  on the note  given at the  purchase  date.
Interest accrues at rates ranging from 6% to 12%.

         At December 31, 1996,  mortgage loans  collateralized by the properties
included  $8,494,000  on one  facility  related to the  purchase of a previously
leased  facility,  $8,448,000 in mortgages  guaranteed by HUD,  $17,291,000  for
facilities acquired in the 1996 Florida  Acquisition,  $9,408,000 for former CSI
facilities,  $7,497,000  related  to  Allegis  facilities,  and  $94,000  for  a
condominium  acquired in the MedRehab  Merger.  These notes bear interest  rates
ranging from 8.0% to 11.5%,  with terms  expiring  from  August,  1998 to April,
2011.

         In November 1993, the Company  refinanced the certain debt  instruments
replacing  them with a Tax-Exempt  Low Floater  instrument  collateralized  by a
first mortgage on a nursing  facility and a five-year letter of credit issued by
a bank and  guaranteed  by the Company.  The interest  rate is set weekly by the
bank. At December 31, 1996, the rate was 3.75%.

         In addition,  the Company leases certain equipment,  land and buildings
under capital leases. Assets under capital leases are capitalized using interest
rates appropriate at the inception of each lease. (See Note 3).

         Aggregate  maturities of long-term  debt and capital lease  obligations
for the years ending after December 31, 1996 are as follows:

<TABLE>
<CAPTION>
                                          TOTAL            DEBT         CAPITAL LEASES

<C>                                    <C>               <C>            <C>          
1997                                   $    8,030        $    4,802     $       3,228
1998                                       13,766             5,999             7,767
1999                                      144,256           141,660             2,596
2000                                        9,733             7,038             2,695
2001                                       11,238             1,124            10,114
Thereafter                                236,243           186,141            50,102
                                      ------------     -------------    --------------
                                       $  423,266        $  346,764     $      76,502
                                      ============     =============    ==============

</TABLE>

                                       54

         Interest  paid for the years ended  December  31,  1994,  1995 and 1996
amounted  to   approximately   $2,075,000,   $3,599,000   and   $ 22,939,000.
respectively.



10.  INCOME TAXES

         The  provision  for income taxes  consists of the following at December
31, 1994, 1995 and 1996:


<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                                    ------------
                                                      1994            1995                  1996
                                                      ----            ----                  ----
                                                                   (IN THOUSANDS)
                                                                   --------------

<S>                                                <C>              <C>               <C>        
Deferred Federal income tax  benefit               $     3,673      $      704        $       963
Deferred state income tax  benefit                         648             120                280
Current Federal income tax provision                    (7,218)         (6,398)            (9,340)
Current state income tax provision                      (2,951)         (2,318)            (2,702)
                                                   -------------    -------------     --------------
Total provision for income taxes                   $    (5,848)     $   (7,892)       $   (10,799)
                                                   =============    =============     ==============
</TABLE>

         The  provision  for income  taxes is  reconciled  to the tax  provision
computed at the Federal statutory rate as follows:

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                               ------------
                                                      1994       1995           1996
                                                      ----       ----           ----

<S>                                                    <C>        <C>             <C>
Statutory rate                                         35%        35%             35%
State taxes, net of Federal effect                     14%         7%              7%
Reversal of deferred taxes at higher statutory rate    ---        (2%)           ---
Permanent differences                                  15%         ---             6%
Net operating loss carryforward utilization            ---        (1%)           ---
Change in valuation allowance                         (26%)        ---           (5%)
Other                                                    4%       (2%)           (3%)
                                                     --------     --------   ------------
                                                       42%        37%             40%
                                                     ========     ========   ============

</TABLE>


                                       55


         Deferred tax assets and  liabilities  are comprised of the following at
December 31, 1995 and 1996:

<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                          ------------
                                                        1995            1996
                                                        ----            ----
                                                          (IN THOUSANDS)
                                                          --------------
<S>                                                <C>               <C>       
Deferred tax assets:
  Reserves for receivables                         $      5,300      $    4,439
  Deferred revenue                                          840             500
  Merger costs                                            3,232             657
  Accrued expenses                                        2,973          22,761
  Federal NOL                                             1,095           1,631 
  Valuation allowance                                   (1,410)             ---
  Other                                                     558             795
                                                   -------------    ------------
                                                   $     12,588      $   30,783
                                                   -------------    ------------

Deferred tax liabilities:
  Fixed assets.                                    $      4,497      $   13,551
  Write-off of deferred costs                               610             601
  Goodwill                                                2,191           3,128
  Tax Lease                                                 ---             805
  Other                                                   1,093              13
                                                   -------------    ------------
                                                   $      8,391      $   18,098
                                                   -------------    ------------
Net deferred tax asset                             $      4,197      $   12,685
                                                   =============    ============

</TABLE>

         In connection with the merger with MedRehab, Inc., the Company acquired
significant  deferred income tax assets associated with MRI's net operating loss
("NOL")  carryforwards.  Because  of the  limitations  imposed  by the  Internal
Revenue  Code,  these NOLs can only be used to offset  income  generated  by the
former  MRI.  Since MRI was  expected to be in a tax loss  position  and has had
losses  in recent  years,  a  valuation  reserve  in the full  amount of the net
deferred  income tax assets was  established  at December 31, 1995 in accordance
with the Statement of Financial  Accounting  Standard No. 109,  "Accounting  for
Income  Taxes." The NOLs expire at various  times  through 2010. In 1996, it was
determined,  based on MRI's estimated profitability that it was more likely than
not that the NOLs could be utilized in 1996 and future years.  Accordingly,  the
valuation allowance was reversed at December 31, 1996.

         The  establishment  of reserves in conjunction  with the acquisition of
certain entities resulted in an increase to the long-term  deferred tax asset of
$16,193,000.  The  long-term  deferred tax liability was increased by $8,949,000
due to the acquisition of assets with a different tax basis.

         During 1994,  1995 and 1996, the Company paid Federal,  state and local
income  taxes  in  the  amounts  of  approximately  $5,528,000,  $7,333,000  and
$10,922,000  respectively.  As of December  31,  1996,  other  accrued  expenses
includes  $5,918,000 which has been accrued for Federal,  state and local income
taxes.


11.  STOCK OPTION PLANS

         The Company has five stock-based  compensation  plans. In October 1995,
the FASB issued SFAS 123, "Accounting for Stock-Based Compensation." SFAS 123 is
effective for periods  beginning after December 15, 1995. SFAS 123 requires that
companies  either  recognize  compensation  expense  for grants of stock,  stock
options,  and other equity instruments based on fair value, or provide pro forma
disclosure  of net income and earnings  per share in the notes to the  financial
statements.  The Company  adopted the disclosure  provisions of SFAS 123 in 1996
and has applied APB Opinion 25 and related interpretations in accounting for its
plans.  Accordingly,  no  compensation  cost has been  recognized  for its stock
option plans. Had compensation cost for the Company's  stock-based  compensation
plans been  determined  based on the fair value at the grant dates as calculated
in accordance with SFAS 123, the Company's net income and earnings per share for
the years ended  December  31, 1996 and 1995 would have been  reduced to the pro
forma amounts indicated below.

                              1996                            1995          
                       -------------------            ---------------------
                    Net Income   Earnings Per        Net Income   Earnings Per
                    ----------   ------------        ----------   ------------
                  (In thousands)     Share          (In thousands)     Share
                  --------------     -----          --------------     -----
   As                                             
Reported             $16,198         $0.55              $12,482        $0.55
                                                  
  Pro                                             
 forma               $13,337         $0.46              $ 9,707        $0.43
                                              

         The fair value of each stock  option is  estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted-average
assumptions:  an expected life of 5.5 years,  expected  volatility of 55%, and a
risk-free interest rate of 6.17%.

         Under the  Company's  plans,  the exercise  prices of options equal the
market price of the Company's stock on the date of grant and their maximum terms
are generally ten years.  Options vest generally over a five-year period or upon
achievement of certain earnings targets. As of December 31, 1996, 122,080 shares
were authorized for grants of options under the Company's plans.


<TABLE>
<CAPTION>
                                                   STOCK OPTION        WEIGHTED AVERAGE
                                                     AMOUNTS           EXERCISE PRICES
                                                   -----------         ---------------
<S>                                                 <C>                <C>
Outstanding at December 31, 1993                     1,107,671             $ 5.27  
  Granted                                            1,083,808             $ 5.85
  Exercised                                           (180,418)            $ 5.92
  Canceled                                            (525,354)            $10.45
                                                    ------------         
Outstanding at December 31, 1994                     1,485,707             $10.90
  Granted                                            2,266,046             $13.78
  Exercised                                           (140,111)            $ 7.20
  Canceled                                            (191,694)            $15.04
                                                    ------------         
Outstanding at December 31, 1995                     3,419,948             $11.37
  Granted                                            1,214,073             $11.12
  Exercised                                           (491,702)            $ 7.91
  Canceled                                            (472,745)            $12.68
                                                    ============         
Outstanding at December 31, 1996                     3,669,574             $11.55
                                                    ============         
</TABLE>                                                             
       
         At December 31, 1996, the Company had  approximately  3,669,574 options
outstanding  of which  approximately  1,290,285  were  exercisable at a weighted
average exercise price of $10.64.  

<TABLE>
<CAPTION>

                                       Options Outstanding                         Options Exercisable
                     ---------------------------------------------------    --------------------------------
                                 Weighted-Average
                                     Remaining
   Range of            Number       Contractual         Weighted-Average       Number         Weighted-Average
Exercise Prices     Outstanding        Life              Exercise Price      Exercisable       Exercise Price
---------------     -----------        ----              --------------      -----------       --------------
<C>                <C>              <C>                     <C>               <C>                 <C>   
$ 2.00-$10.00       1,535,132        9.0  Years              $ 8.01            508,632             $ 6.94
$11.00-$20.00       2,130,873        8.3  Years              $14.00            778,084             $12.90
Over $20.00             3,569        2.83 Years              $44.49              3,569             $44.49
                    ---------                                                ---------
                    3,669,574                                                1,290,285   
                    =========                                                =========
</TABLE>

         During 1994,  the Company  recorded a charge of $1,375,000  relating to
the  accelerated  vesting of certain stock  options.  The charge for the options
relates to a change in vesting  criteria for 100,000 options granted in 1992. As
a result of these changes,  these options became  exercisable  during the second
quarter of 1994, thereby requiring the charge in the second quarter.

         During the third quarter of 1995, the exercise price of certain options
was reduced to reflect the decreased market value of the Company's stock. All of
the options  repriced  had been issued  originally  at prices  significantly  in
excess of $12.63,  the market value on the day of the adjustment.  No charge was
required for this transaction.


12.  PREFERRED STOCK

         In conjunction with the Company's  initial public offering in 1993, the
Company authorized  1,000,000 shares of Preferred Stock with a par value of $.01
per share. No shares of this Preferred Stock have been issued.


                                       56




         Effective December 9, 1993, 5,800,000 shares of MedRehab 8% convertible
preferred stock and accrued dividends thereon were converted into  approximately
799,000 shares of common stock.

         On May 10,  1994 in  connection  with the  merger  with  Pinnacle  Care
Corporation, the then outstanding Convertible Preferred Stock was converted into
2,136,332 shares of Mariner Common Stock.







13.  WARRANTS

         During 1996, the Company issued warrants to purchase  210,000 shares of
its Common  Stock at $11.38 in  exchange  for an  appointment  as the  preferred
subacute  care  provider  for a national  hospital  alliance  with 1,700  member
hospitals.  The Company may receive  management  fees under the  agreement.  The
Company recorded a charge of  approximately  $850,000 related to the issuance of
the warrants. Under this arrangement, the Company



                                       57



will issue up to 1,890,000  additional  warrants if the relationship  results in
specified  gains to the  Company.  No  additional  warrants  were  earned by the
hospital alliance in 1996.


14.  EMPLOYEE BENEFIT PLANS

         The  Company  has a  defined  contribution  401(k)  plan  which  covers
substantially all eligible nonunion employees.  Employees who participate in the
plan may  contribute  up to $9,500 of their  salaries  or wages and the  Company
contributes 5% of the employees' contributions. Defined contribution expense for
the Company for the years ended December 31, 1994,  1995, and 1996 was $108,000,
$76,000, and $ 54,000 respectively.

         The  MedRehab,   Inc.  Tax-Deferred   Retirement  Savings  Plan  covers
substantially  all former  employees  of MedRehab  who meet the  term-of-service
requirements. Employees are eligible to make contributions to the plan under the
guidelines of Section 401(k) of the Internal Revenue Code. Company contributions
to the plan are at the  discretion of the board of directors.  All assets of the
plan are held by a trustee.

         The  Company  also has a defined  benefit  pension  plan  which  covers
certain full-time employees. Assets held by the plan include money market funds,
government bonds, convertible bonds, common and preferred stock, and real estate
related investments The Company incurred a pension curtailment effective July 1,
1991 as a result of freezing pension benefits.  There was no service cost charge
in 1994,  1995 or 1996 as a result of this  curtailment.  Pension  benefits  are
based  primarily on years of service and age. The Company's  funding  policy for
the defined benefit plan is to fund the minimum annual contribution  required by
applicable  regulations.  The  following  table sets forth the  defined  benefit
plan's  funded  status and  amounts  recognized  in the  Company's  consolidated
balance sheets and statements of operations at December 31, 1994, 1995 and 1996:

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                                   ------------
                                                         1994          1995         1996
                                                         ----          ----         ----
                                                                  (IN THOUSANDS)
                                                                  --------------
<S>                                                   <C>          <C>           <C>        
Actuarial present value of benefit obligations:
  Vested                                              $     393    $     438     $       495
  Nonvested                                                 102          116              64
                                                      ---------    ----------    -----------
Accumulated benefit obligation                              495          554             559
                                                      ---------    ----------    -----------

Projected benefit obligation                                495          554             559
Less: plan assets at fair value                             318          439             630
                                                      ---------    ----------    -----------
Projected benefit obligation in excess of (less
than) plan assets                                           177          115             (71)
Adjustment required to recognize minimum liability          214          208             ---
Unrecognized transition asset                                12           10               9
Unrecognized net loss                                      (226)        (218)           (146)
                                                      ---------    ----------    -----------
Accrued (prepaid) pension cost                        $     177    $     115     $      (208)
                                                      =========    ==========    ===========

</TABLE>

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                                          -----------------------
                                                    1994            1995          1996
                                                    ----            ----          ----
                                                               (IN THOUSANDS)
                                                               --------------

<S>                                               <C>            <C>           <C>      
Interest cost on projected benefit obligation     $     36       $      36     $      36
Actual return on plan assets                             3             (73)         (103)
Net amortization                                       (10)             59            78
                                                  --------       ---------     ---------
                                                  $     29       $      22     $      11
                                                  ========       =========     =========

Key Assumptions:
  Weighted average discount rate of                    7.5%            7.5%          7.0%
obligations
  Long-term rate of return on assets                   7.5%            7.5%          7.5%

</TABLE>

         Subsequent to the curtailment  date, no increases in compensation  were
assumed.




                                       58



15.  COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

         The Company leases a facility  under a  sale-leaseback  agreement.  The
term of the lease is 10 years. The Company has the option to renew the lease for
additional terms of up to 18 years.

         The Company  also  leases  certain  office  space and  equipment  under
cancelable and  non-cancelable  operating leases most of which may be renewed by
the Company. At December 31, 1996,  long-term operating lease commitments are as
follows:

                          OPERATING LEASES
                           (IN THOUSANDS)

1997....................................$    11,353
1998.....................................    10,234
1999.....................................     8,599
2000.....................................     5,716
2001.....................................     4,297
Thereafter...............................     8,302
                                        --------------------
                                        $    48,501
                                        ====================

         Total rental expense under operating leases for 1994, 1995 and 1996 was
$5,841,000, $5,516,000, and $ 10,071,000 respectively.

SELF INSURANCE

   
         Approximately  20% of employees  enrolled in Company  sponsored  health
plans are covered under a self-insured plan. The Company's  liability for losses
under  this plan is capped at  $200,000  per  claim and  $1,000,000  per  person
through a contract with an insurance  company.  The Company is also self-insured
for  Workers'  Compensation.  The  Company's  liability  for losses is capped at
$500,000 per claim through a contract with an insurance company. The Company has
an outstanding  letter of credit of  $3,831,000,  which is held as collateral by
this insurance company.
    

LITIGATION

         The Company is a party to various claims,  legal actions and complaints
arising in the ordinary  course of business.  In the opinion of management,  all
such matters are adequately  reserved,  covered by insurance or  indemnification
or, if not so covered,  are without  merit or are of such kind,  or involve such
amounts,  that unfavorable  disposition  would not have a material effect on the
financial position of the Company.

REGULATORY ENVIRONMENT

         The health care industry is subject to numerous laws and regulations of
federal,   state,  and  local  governments.   Compliance  with  these  laws  and
regulations can be subject to future  government  review and  interpretation  as
well as  regulatory  actions  unknown  or  unasserted  at this  time.  Recently,
government   activity  has  increased   with  respect  to   investigations   and
allegations  concerning  possible  violations  by health care  providers  which
creates a possibility of significant  repayments  for  reimbursement  of patient
services previously billed.


16.  DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

         The methods  and  assumptions  used to estimate  the fair value of each
class  of  financial  instruments,   for  those  instruments  for  which  it  is
practicable  to  estimate  that  value,  and the  estimated  fair  values of the
financial instruments are as follows:

CASH AND CASH EQUIVALENTS

         The  carrying  amount  approximates  fair  value  because  of the short
effective maturity of these instruments.



                                       59


LONG-TERM DEBT

         The fair value of the Company's  long-term  debt is estimated  based on
the current rates offered to the Company for similar debt. The carrying value of
the Company's long-term debt approximates its fair value as of December 31, 1995
and 1996.

17. RELATED PARTY TRANSACTIONS

         The Company  leases 14 facilities  under  operating and capital  leases
from affiliates of the former CSI, in which entity a board member of the Company
has a significant  interst.  During 1996, the Company made cash payments on such
lease obligations of $7,593,000.  Capital lease obligations  include $68,798,000
of minimum lease payments due over the remaining lease terms.  In addition,  the
Company manages three  facilities for affiliates of the former CSI. In 1996, the
Company  recognized  $1,135,000  of  management  fee  reveune  related  to  this
arrangement.  In addition , the Company made interest-free loans to partnerships
that owned two  facilities  purchased by the Company.  The loans have  principal
balances of $955,521  and $663,256  respectively  and mature on May 24, 1999 and
2000,  respectively.  These loans are  guaranteed by a Director and  significant
shareholder of the Company.

18.  PRO FORMA INFORMATION (UNAUDITED)

         The following  unaudited pro forma  condensed  statements of operations
for the  years  ended  December  31,  1995  and  1996  give  effect  to  certain
acquisitions  as if they had occurred at the beginning of these years.  The 1995
pro forma amounts give effect to a 1995 acquisition  (Heritage) and acquisitions
consummated in 1996 (CSI, the 1996 Florida  Acquisition  and Allegis).  The 1996
pro  forma  amounts  give  effect  only to the  1996  transactions  as the  1995
acquisitions  are  included  in the  results of the  Company  for the year ended
December 31, 1996. The condensed  information  presented  includes the impact of
certain adjustments related to the acquisitions such as additional  depreciation
and  amortization  on the purchase of property,  plant and  equipment,  interest
expense based on additional debt and rental expense reductions.

         The pro forma  condensed  statements of operations do not purport to be
indicative  of the  results  that  actually  would  have  been  achieved  if the
Acquisitions  and the  merger  with CSI had  occurred  at the  beginning  of the
period.

<TABLE>
<CAPTION>
                                                UNAUDITED (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

                                              PRO FORMA COMBINED             PRO FORMA COMBINED
                                              MARINER, HERITAGE,            MARINER, 1996 FLORIDA
                                               CSI,1996 FLORIDA             ACQUISITION, ALLEGIS
                                             ACQUISITION, ALLEGIS
                                                    1995                             1996
                                                    ----                             ----
<S>                                               <C>                              <C>     
Total operating revenue                           $591,788                         $652,732
Net income before extraordinary items             $ 12,324                         $ 16,127
Net income per share before                       $    .43                         $    .55
extraordinary items
Net income                                        $ 11,186                         $ 16,127
Net income per share                              $    .39                         $    .55

</TABLE>



                                       60


19.  QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

         The following table represents summarized results:



<TABLE>
<CAPTION>
                                                 1995                                                 1996
                                FIRST       SECOND       THIRD      FOURTH         FIRST       SECOND       THIRD        FOURTH
                               QUARTER      QUARTER     QUARTER     QUARTER       QUARTER      QUARTER      QUARTER      QUARTER
                                                                 (IN THOUSANDS EXCEPT PER SHARE DATA)
<S>                           <C>          <C>          <C>         <C>           <C>          <C>          <C>          <C>     
Net patient service revenue   $ 79,339     $ 81,753     $83,325     $ 93,218      $132,629     $143,061     $134,699     $168,366
Other revenue                      820        1,812       6,484       8, 055        2,550         2,543        3,052        3,909
                              ---------    ---------    --------    ---------     --------     ---------    ---------    ---------
Total operating revenue         80,159       83,565      89,809      101,273      135,179       145,604      137,751      172,275
Operating expenses:
  Facility operating costs      62,822       64,451      71,672       77,688      104,591       109,323      112,863      132,350
  Corporate general and          6,548       16,015       8,690        8,577       17,227        11,294       11,025       12,954
other
  Interest expense, net            279          452         896        1,971        4,392         6,578        6,763        8,523
  Facility rent expense, net       355          563         528          384          474           738        1,106        1,409
  Depreciation and               2,660        2,631       2,612        3,494        5,196         5,132        5,349        5,699
amortization
                              ---------    ---------    --------    ---------     --------     ---------    ---------    ---------
Total operating expenses        72,664       84,112      84,398       92,114      131,880       133,065      137,106      160,935
Operating income (loss)          7,495        (547)       5,411        9,159        3,299        12,539          645       11,340
Gain (loss) on sale of             ---         (11)           3            2          ---           ---          ---        (826)
facilities
                              ---------    ---------    --------    ---------     --------     ---------    ---------    ---------

Income (loss) before
income  taxes and                
extraordinary items              7,495        (558)       5,414        9,161        3,299        12,539          645       10,514
Provision for income tax         2,876        (355)       1,928        3,443        1,254         5,015          324        4,206
                              ---------    ---------    --------    ---------     --------     ---------    ---------    ---------
Income (loss) before
extraordinary                    
  items                          4,619        (203)       3,486        5,718        2,045         7,524          321        6,308
Extraordinary items                ---      (1,138)         ---          ---          ---           ---          ---          ---
                              ---------    ---------    --------    ---------     --------     ---------    ---------    ---------
Net income (loss)             $  4,619     $(1,341)     $ 3,486     $  5,718      $ 2,045      $  7,524     $    321     $  6,308
                              =========    =========    ========    =========     ========     =========    =========    =========

Net income (loss) per common
  and common equivalent
share                         $    .20     $  (.06)     $  0.15     $    .25      $   .07      $    .26     $    .01     $     .22
                              =========    =========    ========    =========     ========     =========    =========    =========

</TABLE>


ITEM  9.  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
          FINANCIAL DISCLOSURE

None.


                                       61



   
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS

     The Company's  Board is divided into three  classes:  the Class I, Class II
and Class III  directors.  Each  director  is elected for a  three-year  term of
office,  with one class of  directors  being  elected at each annual  meeting of
stockholders.  Each  director  holds office  until his  successor is elected and
qualified or until his earlier death, resignation or removal.

     The  information  below  sets  forth  for each  member of the  Board,  such
person's age, principal occupations during the past five years and certain other
information:

Class I Directors


     Christopher  Grant,  Jr.,  age 42, has served as a director  of the Company
since 1991.  Mr. Grant has been the President of CGJR Capital  Management,  Inc.
("CGJR Capital"),  a venture capital firm, since May 1995. From May 1994 through
May 1995,  he was  involved in  organizing  CGJR Health  Care  Services  Private
Equities,  L.P., a limited  partnership,  for which CGJR  Capital  serves as the
general  partner.  From January  1994 through May 1994,  Mr. Grant served as the
Senior  Vice  President  and  Chief   Operating   Officer  of  Surgical   Health
Corporation,  an operator of outpatient surgical centers, and now a wholly-owned
subsidiary of HealthSouth Corporation. From March 1993 through January 1994, Mr.
Grant was Executive Vice President,  Chief  Operating  Officer and a director of
Heritage Surgical  Corporation,  an operator of outpatient  surgical centers and
now a wholly-owned subsidiary of Surgical Health Corporation.  From 1990 through
March  1993,  Mr.  Grant  served as Senior Vice  President  and,  through  1992,
Treasurer  of Medical  Care  International,  Inc.,  an  operator  of  outpatient
surgical  centers.  From 1989  through  1990,  Mr.  Grant served as President of
MediVision,  Inc., an operator of eye surgery and ophthalmic  clinics,  and from
1986 through 1989, served as its Chief Financial Officer.

     John F.  Robenalt,  age 44, has served as a director of the  Company  since
1991.  Mr.  Robenalt  has been the  President of Panama City Health Care Center,
Inc. since 1985 and of Sarasota  Health Care Center,  Inc.  since 1990,  both of
which are nursing  facilities  located in Florida.  Since 1992, Mr. Robenalt has
been  President  of Morgan  Hill Health Care  Investors,  Inc.  (an owner of two
nursing facilities in California),  Oak Health Care Investors of Durham, Inc. (a
lessee  of a  nursing  facility  in North  Carolina)  and  Century  Health  Care
Investors,  Inc. (a company  investing  primarily  in nursing  facilities).  Mr.
Robenalt has also been an attorney  practicing  with  Robenalt & Robenalt  since
1984,  and has been the managing  partner of that firm since 1986.  From 1988 to
1991,  Mr.  Robenalt  served as Vice President of Health Care REIT,  Inc.,  with
responsibility for underwriting investments in health care facilities. Since May
1995, Mr.  Robenalt has been a director of Stacey's  Buffet,  Inc., a restaurant
chain based in Florida.

Class II Directors

     David C.  Fries,  Ph.D.,  age 52, has served as a director  of the  Company
since 1992. Since December 1994, Dr. Fries has been the Chief Executive  Officer
and a director of Productivity Solutions, Inc., a software company servicing the
retail  industry.  From 1987  through  December  1994,  Dr.  Fries was 




                                      -62-


a general partner of Canaan Ventures, a venture capital firm. Prior to 1987, Dr.
Fries was an operating  executive  with  General  Electric Co. in several of its
business units.


Class III Directors

     Arthur W.  Stratton,  Jr.,  M.D., age 51, has been Chairman of the Board of
Directors and Chief Executive  Officer of the Company since founding the Company
in 1988.  He also served as President of the Company since  inception  until May
1994 and from February 1995 to the present.  Prior to founding the Company,  Dr.
Stratton was a  practicing  physician  and served in a number of  administrative
capacities in acute care hospitals.

     Stiles A.  Kellett,  Jr.,  age 53, has served as a director  of the Company
since July 1995.  He became a director  of the  Company in  connection  with the
Company's  transactions  with  Convalescent  Services,   Inc.  ("CSI")  and  its
affiliates  and has  been  designated  by the  Stockholders  Agent to serve as a
director of the Company  pursuant to the  Stockholders  Agreement.  See "Certain
Transactions with Convalescent Services, Inc. -- Stockholders Agreement." He was
Chairman  of the  Board of  Directors  of CSI from  1980 to  January  1996.  See
"Certain Transactions--Transactions with Convalescent Services, Inc." Mr. Stiles
A. Kellett,  Jr. is Chairman of Kellett  Investment Corp., a private  investment
company.  Mr. Stiles A. Kellett,  Jr. has served as a director of  LDDS/Worldcom
Inc., a telecommunications company, since 1981.
    


Executive Officers  

EXECUTIVE OFFICERS OF THE REGISTRANT

         The  executive  officers of the Company as of April 28,  1997,  who are
elected  on an  annual  basis  and  serve  at the  discretion  of the  Board  of
Directors, are as follows:


<TABLE>
<CAPTION>
        Name                       Age            Position and Offices            Served
        ----                       ---            --------------------            ------
<S>                                 <C>   <C>                                   <C>
Arthur W. Stratton, Jr., M.D.       51    Chairman of the Board, President,     1988-Present
                                          Chief Executive Officer & Director

David N. Hansen                     44    Executive Vice President, Chief       1996-Present
                                          Financial Officer and Treasurer

</TABLE>

         Dr.  Stratton  has been  Chairman of the Board of  Directors  and Chief
Executive  Officer of the Company  since  founding the Company in 1988.  He also
served as  President  of the  Company  since  inception  until May 1994 and from
February 1995 to the present.  Prior to founding the Company, Dr. Stratton was a
practicing  physician  and served in a number of  administrative  capacities  in
acute care hospitals.

         Mr. Hansen has served as Executive Vice President,  Treasurer and Chief
Financial Officer of the Company since October,  1996. Prior to joining Mariner,
Mr. Hansen was a partner at Coopers & Lybrand L.L.P from 1988 to 1996.


SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers  and  directors,  and  persons  who own  more  than  ten  percent  of a
registered  class  of the  Company's  equity  securities,  to  file  reports  of
ownership  and changes in ownership  with the  Securities  Exchange  Commission.
Officers,  directors and  greater-than-ten  percent stockholders are required by
SEC regulation to furnish the Company with all Section 16(a) forms they file.

     Based solely on its review of the copies of such forms  received by it, the
Company   believes  that  during  1996  all  of  its  officers,   directors  and
greater-than-ten-percent  stockholders  complied  with all Section  16(a) filing
requirements,  except that Mr. Robenalt  reported a stock option exercise on his
Form 5 which should have been reported on an earlier Form 4.




                                      -63-


ITEM 11. EXECUTIVE COMPENSATION

     The  following  table sets forth  certain  information  with respect to the
annual and  long-term  compensation  paid or accrued by the Company for services
rendered to the Company, in all capacities, for the year ended December 31, 1996
by its Chief  Executive  Officer (the "CEO"),  each of the  Company's  executive
officers  other  than the CEO whose  total  salary and bonus  exceeded  $100,000
during the year ended  December  31, 1996,  and  one  additional  individual for
whom  disclosure  would have been required but for the fact that the  individual
was not serving as an  executive  officer at the end of the year  (collectively,
the "Named Executive Officers").




<TABLE>
<CAPTION>

                                                Summary Compensation Table
                                                                                         Long-Term
                                                         Annual Compensation            Compensation
                                                        ---------------------          --------------                              
                                                                            Other        Securities
             Name and                                                      Annual        Underlying/   
        Principal Position             Year      Salary      Bonus     Compensation(a)  Options(#)(b)  
        ------------------             ----      ------      -----     ---------------  -------------  
<S>                                     <C>       <C>         <C>           <C>             <C>        
Arthur W. Stratton, Jr., M.D.......    1996   $700,000    $456,250        $68,219            __        
Chief Executive Officer and            1995    425,000     450,000            __         1,060,000(c)  
President                              1994    350,000     500,000            __           460,000     


Lawrence R. Deering(e).............    1996    275,000     268,750            __             __        
Executive Vice President and Chief     1995    225,000     200,000            __           498,000(d)  
   Operating Officer                   1994     71,683      50,000         20,982(f)       163,000     

David N. Hansen (g) ...............    1996     87,500     100,000            __           500,000     
Executive Vice President, Chief        1995      __          __               __              __       
   Financial Officer and Treasurer     1994      __          __               __              __       

Jeffrey W. Kinell (i)..............    1996    247,680     268,750            __              __       
Executive Vice President, Chief        1995    214,950     200,000            __           453,000(h)  
   Financial Officer and Treasurer     1994    177,000     100,000            __            65,000     

----------------------
</TABLE>


(a) Does not include  perquisites  and other  personal  benefits,  securities or
    property if the aggregate  amount of such  compensation  does not exceed the
    lesser of $50,000 or 10% of the total annual  salary and bonus  reported for
    the Named Executive Officer.

(b) The Company did not grant any restricted stock awards or stock  appreciation
    rights or make any long-term  incentive  plan payouts  during the year ended
    December 31, 1996.

(c) Pursuant to the rules of the Securities and Exchange Commission, this number
    consists of (i) options to purchase 460,000 shares which had been previously
    granted to Dr. Stratton in 1994, but were repriced by July 14, 1995 and (ii)
    options to purchase 600,000 shares granted to Dr. Stratton in 1995, of which
    options to purchase 300,000 shares were repriced on July 14, 1995.

(d) Pursuant to the rules of the Securities and Exchange Commission, this number
    includes options to acquire 163,000 shares which had been previously granted
    to Mr. Deering in 1994, but were repriced on July 14, 1995.

   
(e) Mr.  Deering  joined the Company in  September  1994.  Mr.  Deering left the
    Company in March 1997.
    

(f) Represents  the  reimbursement  by the Company of Mr.  Deering's  relocation
    expenses.

   
(g) Mr. Hansen joined the Company in October 1996.
    

(h) Pursuant to the rules of the Securities and Exchange Commission, this number
    includes options to acquire 65,000 shares which had been previously  granted
    to Mr. Kinell in 1994, but were repriced on July 14, 1995.

(i)  Mr. Kinell left the Company in September 1996.






                                      -64-


Options and Stock Plans

     Option Grant Table.  The  following  table sets forth  certain  information
regarding options granted during the year ended December 31, 1996 by the Company
to the Named Executive Officers.


<TABLE>
<CAPTION>

                                                                                                   Potential
                                                                                               Realizable Value
                                              Percent of                                       at Assumed Annual
                                             Total Options                                       Rate of Stock
                                              Granted to                                      Price Appreciation
                                Options      Employees in    Exercise or   Expiration        For Option Term (b)($)
           Name               Granted (#)  Fiscal Year(a)(%) Base Price($)    Date             5%             10%
           ----               -----------   --------------   ----------   -------------      ------         ------
<S>                               <C>            <C>            <C>           <C>             <C>            <C>
Arthur W. Stratton, Jr.,           
M.D........................        --             --             --            --             --              --
Lawrence R. Deering........        --             --             --            --             --              --
David N. Hansen............   300,000(c)          41%           8.06        10/21/06       1,520,667      3,853,669
                              200,000(d)                        8.06        10/21/06       1,013,778      2,569,113
Jeffrey W. Kinell..........        --             --             --            --             --              --
------------------
</TABLE>

(a)  Based on 1,214,073 options granted in 1996.  

(b)  Amounts  represent  hypothetical  gains  that  could  be  achieved  for the
     respective  options if exercised at the end of the option term. These gains
     are  based  on  assumed  rates of stock  price  appreciation  of 5% and 10%
     compounded  annually from the date the  respective  options were granted to
     their  expiration  dates.  These  numbers  are  calculated  based  on rules
     promulgated by the Securities and Exchange  Commission and do not represent
     an estimate by the Company of its future stock price growth.  Actual gains,
     if any, on stock option  exercises and Common Stock  holdings are dependent
     on the timing of such exercise and the future  performance of Common Stock.
     There can be no assurances that the rates of  appreciation  assumed in this
     table can be achieved or that the amounts reflected will be received by the
     individuals.

(c)  These options vest in five equal  installments  on December 31 of each your
     from 1996 to 2000.

(d)  These options vest on the earlier of (i) the fifth  anniversary of the date
     of grant or (ii)  ratably in 1996,  1997 and 1998 if the  Company  achieves
     certain targeted earnings per shares for 1996, 1997 and 1998.


     Year-End Option Table.  The following table sets forth certain  information
concerning stock option exercises in fiscal 1996 by the Named Executive Officers
and the value of the  unexercised  stock options as of December 31, 1996 held by
the Named Executive Officers.

<TABLE>
<CAPTION>

                                                                                          Value of Unexercised,
                                                            Number of Unexercised              In-the-Money
                                                              Options at Fiscal             Options at Fiscal
                                Shares                            Year-End (#)               Year-End ($)(b)
                               Acquired        Value      --------------------------   ----------------------------    
           Name                   on         Realized                              
                             Exercise (#)      ($)(a)     Exercisable  Unexercisable   Exercisable    Unexercisable
                             ------------    --------     -----------  -------------   -----------    -------------               
<S>                              <C>           <C>            <C>          <C>              <C>            <C>
Arthur W. Stratton, Jr.,          
M.D........................       --            --          481,000      644,000          401,375           --
Lawrence R. Deering........     44,167       353,336        125,799      328,034             --             --
David N. Hansen............       --            --           60,000      440,000           18,900        138,600
Jeffrey W. Kinell..........    127,367       688,125           --           --               --             --
-------------------------
</TABLE>

(a)  Amounts  disclosed in this column do not reflect amounts actually  received
     by the Named Executive  Officers but are calculated based on the difference
     between the fair market  value of Common  Stock on the date of exercise and
     exercise price of the options.  Named Executive  Officers will receive cash
     only if and when they sell the Common  Stock  issued  upon  exercise of the
     options and the amount of cash,  if any,  received by such  individuals  is
     dependent  on the price of the  Company's  Common Stock at the time of such
     sale.

(b)  Value is based on the difference  between the option exercise price and the
     fair market value at December 31, 1996 ($8.375 per share) multiplied by the
     number of shares underlying the option.






                                      -65-



   
     Stock Plans.  The Company  currently  maintains three employee stock plans:
the 1992 Stock Option Plan,  the 1993 Employee  Stock Purchase Plan and the 1994
Stock Plan.  Each plan is  administered  by the  Compensation  Committee  of the
Board. The 1994 Stock Plan, as amended,  at 1996 year-end provided for the grant
of incentive stock options, non-qualified options, awards, and authorizations to
purchase up to  3,265,494  shares of Common  Stock,  plus,  on January 1 of each
year, an  additional  number of shares of Common Stock equal to two percent (2%)
of the total number of shares of Common Stock  outstanding on December 31 of the
preceding year. The maximum number of shares of Common Stock which may be issued
on the  exercise of  incentive  stock  options (as defined in Section 422 of the
Internal  Revenue  Code of  1986,  as  amended  (the  "Code"))  may  not  exceed
5,000,000.  The terms of such  options,  including  number of  shares,  exercise
price,  duration and  vesting,  are  generally  determined  by the  Compensation
Committee.

     The 1992  Stock  Option  Plan  provides  for the grant of  incentive  stock
options and  non-qualified  options to purchase  up to an  aggregate  of 750,000
shares of Common  Stock to the  Company's  employees,  officers,  directors  and
consultants.  The terms of such options,  including  number of shares,  exercise
price,  duration and  vesting,  are  generally  determined  by the  Compensation
Committee.


     Under the 1993 Employee Stock Purchase Plan,  which commenced on January 1,
1994,  eligible  employees of the Company may  participate in  semi-annual  plan
offerings in which payroll  deductions may be used to purchase  shares of Common
Stock.  The purchase price of such shares is the lower of 85% of the fair market
value of the Common Stock on the day the  offering  commences or 85% of the fair
market value of the Common Stock on the day the offering terminates. The Company
may issue up to an aggregate of 500,000  shares of Common Stock  pursuant to the
1993 Employee  Stock Purchase Plan.

     In addition to the three employee stock plans maintained by the Company, in
connection   with  the  Company's   merger  with   Pinnacle   Care   Corporation
("Pinnacle"),  the  Company  assumed  stock  options  that had been  granted  by
Pinnacle to certain of its employees.  Further, in connection with the Company's
merger with MedRehab, Inc. ("MedRehab"),  the Company assumed stock options that
had been granted by MedRehab to certain of its employees.
    

DIRECTORS' COMPENSATION

     During the year ended  December 31, 1996,  members of the Board received an
annual fee of $10,000,  plus $2,000 for each  meeting of the Board  attended and
$1,500 for each meeting of any of the committees of the Board attended,  if held
separately.  Directors are also  reimbursed for their  reasonable  out-of-pocket
expenses  incurred  in  attending  meetings.  Executive  officers  serve  at the
discretion  of the  Board.  There are no family  relationships  among any of the
executive officers or directors of the 





                                      -66-



Company.  Nancy L. Stratton,  Secretary and a  former  Regional President of the
Company, is the spouse of Dr. Stratton.

   
      The Company's 1995 Non-Employee Director Stock Option Plan (the "Directors
Plan") is administered by the Compensation Committee of the Company.  Subject to
availability   of  shares  under  the   Directors   Plan,  a  director  will  be
automatically granted on January 1 of each year during the term of the Directors
Plan an option to purchase  2,500 shares of Common Stock at fair market value as
of the date of grant.  Each  person who becomes a director of the Company in the
future  will  receive a grant of 2,500  shares on the date such  person is first
elected to the Board. 
    



EMPLOYMENT AGREEMENTS

     The  Company  has  entered  into an  employment  agreement  with  Arthur W.
Stratton,  Jr., M.D., the Company's President and Chief Executive Officer. Under
this  employment  agreement,  Dr.  Stratton  will serve as the  Company's  Chief
Executive Officer for a term from January 1, 1995 through December 31, 1997. The
term of the employment agreement automatically extends thereafter for additional
one-year  periods,  unless  terminated by either party at least 90 days prior to
the  expiration of the then current term.  The Company is also  obligated to use
all reasonable  efforts to have Dr. Stratton  reelected to the Board for as long
as he is an employee of the Company.  Pursuant to the employment agreement,  Dr.
Stratton  will  receive a base salary (the "Base  Salary")  and a bonus of up to
100% of the Base  Salary if the Company  meets  certain  performance  objectives
established by the Committee.  Dr.  Stratton's Base Salary was $700,000 for 1996
and  is  $750,000 for 1997. The Company has agreed to maintain life insurance on
the life of Dr.  Stratton  with total  death  benefits of  $5,000,000,  of which
$3,000,000  is payable to the Company in the event of Dr.  Stratton's  death and
$2,000,000 is payable in accordance with Dr.  Stratton's  written  instructions,
and  disability  benefits  in  the  amount  of 70%  of  Dr.  Stratton's  average
compensation  for the three  years prior to his  disability.  In  addition,  Dr.
Stratton  received  stock options to purchase an aggregate of 600,000  shares of
which  one-half  were  granted in each of March 1995 and  December  1995.  These
options (as amended) vest on the fifth  anniversary  of the date of grant unless
the Company meets certain performance criteria established by the Committee,  in
which  case  the  options  will  vest at the time the  criteria  are  satisfied.
Finally,  Dr.  Stratton will be eligible to  participate  in the benefits  plans
maintained by the Company.

     If the Company terminates the employment agreement without cause ("Cause"),
if Dr.  Stratton  terminates  his  employment  due to a  material  breach by the
Company ("Material  Breach") of the terms of the employment  agreement or if Dr.
Stratton terminates his employment within one year following a Change in Control
(as defined in the  employment  agreement)  of the Company  for  specified  Good
Reason (as defined in the  employment  agreement),  Dr.  Stratton will receive a
severance  benefit until the third  anniversary of such termination equal to the
base  salary  paid  to him  immediately  prior  to his  termination  and a bonus
equivalent to the bonus paid to him with respect to the most recently  completed
fiscal year. If Dr. Stratton's  employment is terminated for any other reason he
will be  entitled  to receive  compensation  and  benefits  through  the date of
termination  and payment of his normal  post-termination  benefits in accordance
with  the   Company's   retirement,   insurance  and  other  benefit  plans  and
arrangements.  In addition,  if Dr.  Stratton's  employment is terminated by the
Company  without Cause or is terminated by him due to a Material  Breach or with
Good Reason,  any options which have not yet 



                                      -67-


vested will vest. Dr.  Stratton will have 60 days after  termination to elect to
receive the  present  value of the entire cash  severance  benefit (as  provided
above).  If such election is made by Dr.  Stratton,  the Company is obligated to
pay such  present  value  amounts  within 30 days  after  notice is given by Dr.
Stratton.  If it is determined that any payment or  distribution  paid or deemed
paid to Dr.  Stratton would be subject to the excise tax imposed by Section 4999
of the Code, or any interest or penalties  with respect to such excise tax (such
excise tax,  together  with any such  interest and  penalties,  are  hereinafter
collectively  referred to as the "Excise Tax"), Dr. Stratton will be entitled to
receive an  additional  payment (a  "Gross-Up  Payment")  in an amount such that
after payment by Dr. Stratton of all taxes  (including any interest or penalties
imposed with respect to such taxes),  including  any Excise Tax imposed upon the
Gross-Up  Payment,  Dr. Stratton retains an amount of the Gross-Up Payment equal
to the Excise Tax imposed upon the payments.

     Dr.  Stratton  has agreed  not to compete  with the  Company,  solicit  its
employees or become  associated  with any competitor of the Company (unless such
association  is limited to  ownership  of less than one  percent of any class of
securities of any corporation traded in a national securities exchange or in The
Nasdaq National Market) for the later of (i) three years from the termination of
his  employment or (ii) the end of the  period  during  which  Dr.  Stratton  is
entitled to receive any severance benefits.

   
     The  Company has  entered  into an  employment  with David N.  Hansen,  the
Company's Executive Vice President, Chief Financial Officer and Treasurer. Under
this agreement,  Mr. Hansen served as the Company's Executive Vice President and
Chief  Financial  Officer for an initial  term from  September  15, 1996 through
December 31, 1996. The term of such employment agreement  automatically extended
through December 31, 1997 and  automatically  extends  thereafter for additional
one-year  periods,  unless  terminated by either party at least 90 days prior to
the expiration of the then current term.  Pursuant to the  employment  agreement
Mr.  Hansen will receive a Base Salary and a bonus if the Company  meets certain
performance  objectives  established by the Committee.  Mr. Hansen's Base Salary
was $87,500 for 1996 and is $350,000 for 1997. In addition,  Mr. Hansen received
stock  options to purchase an  aggregate  of 500,000  shares,  of which  200,000
options  vest on the fifth  anniversary  of the date of grant unless the Company
meets certain performance criteria  established by the Committee,  in which case
the options will vest at the time the criteria are  satisfied.  The remainder of
the options  vest in five equal  annual  installments  beginning on December 31,
1996.  Mr. Hansen also  received a $100,000  signing bonus for entering into the
employment  agreement.  Mr. Hansen will also be eligible to  participate  in the
benefits plans maintained by the Company.

         If the Company  terminates Mr. Hansen's  employment  agreement  without
Cause (as defined in the employment  agreement) or if Mr. Hansen  terminates his
employment  because  of a  Material  Breach of the  Company  (as  defined in the
employment  agreement),  Mr.  Hansen will receive a severance  benefit until the
second  anniversary  of the  termination  equal to the Base  Salary  paid to him
immediately prior to his termination and a bonus equivalent to the bonus paid to
him with respect to the most  recently  completed  fiscal  year.  If the Company
terminates the employment  agreement without Cause at any period within one year
following a Change in Control or if Mr. Hansen  terminates his employment during
this same time  period  because of a Material  Breach of the Company or for Good
Reason (as defined in the  employment  agreement),  Mr.  Hansen  will  receive a
severance  benefit until the third  anniversary of the termination  equal to the
Base  Salary  paid  to him  immediately  prior  to his  termination and a  bonus
equivalent to the bonus paid to him with respect to the most recently  completed
fiscal year. If Mr.  Hansen's  employment is terminated  for any other reason he
will be  entitled  to receive  compensation  and  benefits  through  the date of
termination  and payment of his normal  post-termination  benefits in 





                                      -68-


accordance with the Company's retirement,  insurance and other benefit plans and
arrangements.  In addition,  if Mr.  Hansen's  employment  is  terminated by the
Company  without Cause or is terminated by him due to a Material  Breach or with
Good Reason,  fifty  percent of options  which have not yet vested will vest. If
Mr. Hansen's employment is terminated by the Company without Cause at any period
within one year  following a Change of Control or if Mr. Hansen  terminates  his
employment  during  this same time  period  because of a Material  Breach of the
Company or for Good Reason,  all options which have not yet vested will vest and
may  be  exercised  by  Mr.  Hansen  within  60  days.  Furthermore,  in  such a
termination  situation  Mr. Hansen will have 30 days after such  termination  to
elect to receive an amount equal to the present value of the Extended  Severance
Benefit (as defined in the employment  agreement).  If it is determined that any
payment or  distribution  paid or deemed paid to Mr.  Hansen would be subject to
the excise tax imposed by Section 4999 of the Code, or any interest or penalties
with  respect  to such  excise  tax (such  excise  tax,  together  with any such
interest and penalties,  are hereinafter collectively referred to as the "Excise
Tax"), Mr. Hansen will be entitled to receive an additional payment (a "Gross-Up
Payment")  in an  amount  such that  after  payment  by Mr.  Hansen of all taxes
(including  any  interest or  penalties  imposed  with  respect to such  taxes),
including any Excise Tax imposed upon the Gross-Up  Payment,  Mr. Hansen retains
an amount of the  Gross-Up  Payment  equal to the  Excise Tax  imposed  upon the
payments.
    

         Mr.  Hansen has agreed not to compete  with the  Company,  solicit  its
employees,  become  associated  with any competitor of the Company  (unless such
association  is limited to  ownership  of less than one  percent of any class of
securities of any corporation traded in a national securities exchange or in The
Nasdaq  National  Market) or disclose any material  information  concerning  the
Company for the later of (i) three years from the  termination of his employment
or (ii) the end of the period during which Mr. Hansen is entitled to receive any
severance benefits.




                                      -69-



COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The members of the Committee  are Messrs.  Grant,  Fries and  Robenalt.  No
member of the  Committee  was at any time  during  the past year an  officer  or
employee of the Company or any of its  subsidiaries,  was formerly an officer of
the Company or any of its subsidiaries, or had any relationship with the Company
requiring disclosure herein.

     During the last year,  no  executive  officer  of the  Company  served as a
member of the  compensation  committee  (or  other  Board  committee  performing
equivalent functions or, in the absence of any such committee, the entire Board)
of another  entity,  one of whose  executive  officers served as a member of the
Committee or as a director of the Company. In addition, during the last year, no
executive  officer of the Company served on the Board of another entity,  one of
whose executive officers served as a member of the Committee.




                                      -70-


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following  table sets forth certain  information  regarding  beneficial
ownership of the Company's  Common Stock as of April 21, 1997 (i) by each person
who is known by the Company to own beneficially  more than 5% of the outstanding
shares of Common  Stock,  (ii) by each  director of the  Company,  (iii) by each
Named  Executive  Officer of the Company and (iv) by all directors and executive
officers of the Company as a group.  Unless  otherwise  indicated  below, to the
knowledge  of the  Company,  all  persons  listed  below  have sole  voting  and
investment  power with  respect to their shares of Common  Stock,  except to the
extent authority is shared by spouses under applicable law.

<TABLE>
<CAPTION>
                                                          Shares Beneficially             Percentage of Shares
             Name of Beneficial Owner                          Owned(1)                   Beneficially Owned(1)

<S>                                                              <C>                               <C>                             
Kellett Stockholder Group(2) ...............                  6,016,156                          20.73%
   c/o Samuel B. Kellett,
   as Stockholders Agent
   1935 Garraux Rd., N.W.
   Atlanta, GA  30327
Stiles A. Kellett, Jr.(3)...................                  2,250,196                           7.75
   200 Galleria Parkway
   Suite 1800
   Atlanta, GA  30339
Samuel B. Kellett(4)........................                  2,072,696                           7.14
   1935 Garraux Rd., N.W.
   Atlanta, GA  30327
William R. Bassett, as Trustee(5)...........                  1,708,264                           5.88
   200 Galleria Parkway
   Suite 1800
   Atlanta, GA 30339

Arthur W. Stratton, Jr., M.D.(6)............                    251,944                             *
David N. Hansen (7) .......................                      60,000                             *
Jeffrey W. Kinell ..........................                      1,000                             *
Lawrence R. Deering(8)......................                    128,650                             *
John F. Robenalt, Esq.(9)...................                     20,233                             *
Christopher Grant, Jr.(10)..................                     12,500                             *
David C. Fries, Ph.D.(11)...................                     13,277                             *
All executive officers and directors
      as a group (12).......................                  2,737,800                            9.33%
--------------------------
* Represents less than 1% of the outstanding Common Stock.
</TABLE>


(1)      As of April 21, 1997,  there were  29,031,676  shares of the  Company's
         Common Stock  outstanding.  Pursuant to the rules of the Securities and
         Exchange  Commission,  the  number of shares  of  Common  Stock






                                      -71-


         deemed outstanding includes shares issuable pursuant to options held by
         the  respective  person or group which may be exercised  within 60 days
         after the date of this Proxy Statement  ("presently  exercisable  stock
         options").

(2)      With respect to information  relating to the Kellett Stockholder Group,
         the  Company  has relied on  information  set forth in a  Schedule  13D
         filing  dated  January  2,  1996 (as  amended)  filed on  behalf of the
         Kellett Stockholder Group. The members of the Kellett Stockholder Group
         are Stiles A. Kellett,  Jr., Samuel B. Kellett,  William R. Bassett, as
         Trustee of Samuel B.  Kellett,  Jr.  Irrevocable  Trust Dated  11/1/91,
         William R. Bassett,  as Trustee of Charlotte  Rich Kellett  Irrevocable
         Trust  Dated  11/1/91,  William  R.  Bassett,  as  Trustee of Stiles A.
         Kellett III Irrevocable Trust Dated 11/1/91 and William R. Bassett,  as
         Trustee of Barbara Katherine  Kellett  Irrevocable Trust Dated 11/1/91.
         See footnotes (3), (4) and (5).

(3)      Includes  7,500 shares of Common Stock  issuable  pursuant to presently
         exercisable  stock  options and 10,000  shares of Common Stock owned by
         Mr. Stiles A. Kellett,  Jr.'s spouse.  Does not include an aggregate of
         5,000 shares owned directly by Mr. Stiles A. Kellett, Jr.'s children or
         854,132  shares  held in trust for the  benefit  of his  children.  Mr.
         Stiles A. Kellett,  Jr.  disclaims  beneficial  ownership of the shares
         owned by his children or held in trust for the benefit of his children.
         See footnote (2).

(4)      With respect to  information  relating to Mr.  Samuel B.  Kellett,  the
         Company has relied on  information  set forth in a Schedule  13D filing
         dated  January 2, 1996 (as  amended)  filed on behalf of Mr.  Samuel B.
         Kellett.  Does not include an aggregate of 854,132 shares held in trust
         for the  benefit  of his  children.  Mr.  Samuel B.  Kellett  disclaims
         beneficial ownership of the shares held in trust for the benefit of his
         children. See footnote (2).

(5)      Mr. Bassett is a trustee of the following  trusts:  William R. Bassett,
         as Trustee of Samuel B. Kellett,  Jr.  Irrevocable Trust Dated 11/1/91,
         William R. Bassett,  as Trustee of Charlotte  Rich Kellett  Irrevocable
         Trust  Dated  11/1/91,  William  R.  Bassett,  as  Trustee of Stiles A.
         Kellett III Irrevocable Trust Dated 11/1/91 and William R. Bassett,  as
         Trustee of Barbara Katherine  Kellett  Irrevocable Trust Dated 11/1/91.
         Each of these trusts owns 427,066 shares of Common Stock.  See footnote
         (2).

(6)      Consists  of  158,900  shares  of Common  Stock  owned  jointly  by Dr.
         Stratton  and his  spouse,  497  shares  of Common  Stock  owned by Dr.
         Stratton's  spouse,  65,000 shares of Common Stock issuable pursuant to
         presently  exercisable stock options granted to Dr. Stratton and 27,547
         shares of Common Stock issuable pursuant to presently exercisable stock
         options  granted to Dr.  Stratton's  spouse.  Does not  include  40,000
         shares of Common Stock held in trust for the benefit of Dr.  Stratton's
         children.  Dr. Stratton  disclaims  beneficial  ownership of the shares
         held in trust for the benefit of his children.

(7)      Consists  of  60,000  shares  of  Common  Stock  issuable  pursuant  to
         presently exercisable stock options.

(8)      Includes 125,800 shares of Common Stock issuable  pursuant to presently
         exercisable stock options.

(9)      Includes  1,200  shares owned by Mr.  Robenalt's  spouse and 900 shares
         held by a trust for the benefit of his children. Mr. Robenalt disclaims
         beneficial  ownership of such  shares.  Also  includes  8,500 shares of
         Common Stock issuable pursuant to presently exercisable stock options.

(10)     Includes  7,500 shares of Common Stock  issuable  pursuant to presently
         exercisable stock options.

(11)     Includes  7,500 shares of Common Stock  issuable  pursuant to presently
         exercisable stock options.

(12)     Includes  presently  exercisable stock options to purchase an aggregate
         of 309,347  shares of Common Stock.  See footnotes  (3), (6), (7), (8),
         (9), (10) and (11).




                                      -72-


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

TRANSACTIONS WITH CONVALESCENT SERVICES, INC. AND THE KELLETT PARTNERSHIPS

      On  January  9, 1995,  the  Company,  CSI,  CSI's  stockholders  (the "CSI
Stockholders")  and certain of their affiliates  entered into certain agreements
governing  the  merger  (the  "CSI  Merger")  of  Blue  Corporation,  a  Georgia
corporation and wholly owned subsidiary of the Company ("Merger Sub"),  with and
into CSI and the acquisition of certain related assets (the "Transactions"). CSI
operated  subacute-oriented skilled nursing facilities that provided restorative
nursing care and specialty medical services,  including rehabilitation programs,
respiratory  therapy,  infusion  therapy,  wound care  treatment  and  Alzheimer
disease management. At the time, CSI operated 25 skilled nursing facilities, one
rehabilitation  hospital and one continuing care retirement  community,  with an
aggregate  of  3,801  beds  (the  "CSI  Facilities").  The  CSI  Facilities  are
concentrated primarily in Florida and Texas.

      May 1995 Closing.  By late April 1995,  however, a number of conditions to
the  closing of the CSI  Merger had not been  satisfied.  On May 24,  1995,  the
parties  entered  into  agreements  reflecting  the  changes  to the  terms  and
conditions  of the proposed  Transactions  and  completed  certain  transactions
related to the proposed  Transactions (the "May 1995 Closing").  At the May 1995
Closing,   the  Company  and  CSI  entered  into  a  Management  Agreement  (the
"Management  Agreement") pursuant to which the Company would manage all of CSI's
facilities and  operations.  Under the Management  Agreement,  the Company would
receive a monthly  management fee equal to 6% of the gross operating  revenue of
CSI's facilities. In addition, upon termination of the Management Agreement, the
Company  would  receive a bonus  management  fee equal to the net  income of the
facilities  managed by the Company during the term of the Management  Agreement,
except that only 66% of the net income of The Westbury Place and none of the net
income of the Haltom  Convalescent  Center would be included in determining  the
bonus management fee. The Management  Agreement would terminate on the sooner of
(1) the closing of the Transactions,  (2) if the Company's  stockholders did not
approve the issuance of the 5,853,658  shares of Common Stock in connection with
the CSI Merger,  (3) January 2, 1996 or (4) if the  proposed  Transactions  were
terminated in accordance with the applicable agreements.

      At the May 1995 Closing, the Company acquired substantially all the assets
of Convalescent Supply Services,  Inc. ("CSSI"),  a Georgia corporation owned by
Stiles A. Kellett,  Jr. and Samuel B. Kellett (the "Kelletts").  Immediately
prior to its  acquisition,  CSSI provided  enteral,  urological,  wound care and
ostomy  products  to  CSI's  facilities.  CSSI's  principal  assets  included  a
five-year agreement to supply CSI's facilities, accounts receivable, inventories
and a partnership interest in a joint venture that provides pharmacy services in
Florida.  The purchase  price for CSSI's  assets was  $6,500,000 in cash and the
assumption of CSSI's trade payables.

      In addition, the Kelletts purchased at the May 1995 Closing certain assets
from  CSI,  which  assets  are  used by the  Kelletts  in their  other  business
activities and include an airplane,  two cars, certain leases for real property,
a condominium and all leasehold  improvements  and all  personality  incident to
CSI's office space in Atlanta,  Georgia,  in exchange for the  assumption of the
liabilities  related to such assets.  Finally,  Mr. Stiles A.  Kellett,  Jr. was
appointed as a director of the Company for a term ending at the Company's Annual
Meeting of  Stockholders in 1996. At the Annual Meeting of Stockholders in 1996,
Mr. Kellett was elected as a director of Mariner for a three-year term ending in
1999.

      January 1996 Closing.  On January 2, 1996 the CSI Merger was  consummated.
As a result of the CSI  Merger,  CSI  became a wholly  owned  subsidiary  of the
Company.  The CSI Merger was effected by the filing of a  Certificate  of Merger
with the Secretary of State of Georgia on January 2, 1996.





                                      -73-


      Pursuant to the CSI Merger  Agreement,  all of the issued and  outstanding
shares of  capital  stock of CSI were  converted  into the right to  receive  an
aggregate of 5,853,656  shares of Common  Stock,  and  $7,000,000  in cash. As a
result of the CSI Merger,  the Kelletts each received 2,072,696 shares of Common
Stock.

   
     The shares of Common  Stock  issued in the CSI Merger  were not  registered
under the  Securities  Act of 1933 (the  "Securities  Act")  and,  consequently,
constitute "restricted securities" as that term is defined in Rule 144 under the
Securities  Act.  Because  the  shares of Common  Stock  received  by the former
stockholders  of CSI (the "CSI  Stockholders")  in the CSI Merger are restricted
securities,  they may only be sold under Rule 144.  Under Rule 144, a person (or
persons whose shares are  aggregated)  who has  beneficially  owned  "restricted
securities"  for at  least  one  year,  including  persons  who  may  be  deemed
affiliates  of the  Company,  would be  entitled  to sell within any three month
period, subject to meeting certain manner of sale notices requirements, a number
of shares  that does not exceed the  greater of (i) one percent of the number of
shares of Common Stock then issued and  outstanding  and (ii) the average weekly
trading volume of the Common Stock during the four calender weeks  preceding the
filing of a Form 144 notice of sale with the Securities and Exchange Commission.
The CSI Stockholders  were able to sell under Rule 144 as of April 29, 1997, but
under the  Stockholders  Agreement  entered into between the Company and the CSI
Stockholders  (described  below),  relating to certain voting and stock transfer
matters,  the CSI  Stockholders  have agreed not to sell their  shares of Common
Stock until May 24, 1997. The Company and the CSI Stockholders have also entered
into a  Registration  Rights  Agreement  granting the CSI  Stockholders  certain
registration rights with respect to the Common Stock received by them in the CSI
Merger (described below).
    

      Also on January 2, 1996, the Company acquired substantially all the assets
of Meadow Rehab Corp., a Georgia corporation owned by the Kelletts ("MRC").  The
assets of MRC consisted of a 50% partnership  interest in IHS Rehab Partnership,
Ltd. ("IHS  Rehab"),  which leases the North Dallas  Rehabilitation  Hospital in
Dallas, Texas. CSI owns the remaining 50% partnership interest in IHS Rehab. The
purchase price for MRC's assets was  $1,600,000 in cash and the Company  assumed
MRC's outstanding indebtedness, which amounted to approximately $335,000.

      In addition,  the Company acquired the assets that constituted the skilled
nursing  facilities  known as Arlington  Heights  Nursing  Center in Fort Worth,
Texas, and Randol Mill Manor in Arlington, Texas. Prior to the CSI Merger, these
facilities  were  leased by CSI from  partnerships  owned by the  Kelletts.  The
purchase prices for these facilities  aggregated  approximately $9.7 million. In
addition,  the Company made  interest-free  loans to the partnerships that owned
Arlington  Heights Nursing Center and Randol Mill Manor,  with principal amounts
of $955,521 and $663,256,  respectively,  which mature on May 24, 1999 and 2000,
respectively. The Kelletts have agreed to guaranty the repayment of these loans.

      In connection  with the CSI Merger,  CSI (which as of July 31, 1996 merged
with and into another wholly owned subsidiary of Mariner, Mariner Health Care of
Nashville,   Inc.)  entered  into  leases  on  14  skilled  nursing   facilities
(collectively, the "Leased Facilities") from partnerships owned or controlled by
the Kelletts.  Each of the leases for the Leased Facilities (the "Leases") has a
base  term of eight  years and four  months  from  January  2, 1996 as well as a
number of five-year  renewal  terms at the option of CSI,  except that the Lease
for  Centerville  Care  Center has a term of seven years and four months with no
renewal  terms.  Each Lease  provides for a fixed rent,  which will not increase
over the base or renewal terms of such Lease.  The aggregate annual rent for the
Leased Facilities is approximately  $8,040,000.  In addition to paying scheduled
rent for each Leased Facility,  CSI is required to pay all utilities,  insurance
and property taxes and to maintain the Leased Facility, reasonable wear and tear
excepted.

     If the Company leases a Leased Facility for all optional renewal terms, the
Company may  purchase  such Leased  Facility at the end of the last renewal term
for its fair market value,  as  determined by agreement  between the Company and
the applicable Lessor or, absent such agreement,  by appraisal at such time. For
each Leased  Facility  other than Bethany  Village  Health Care Center and North
Dallas  Restorative  Care  Center,  the  Company  also will have the option (the
"Options")  to purchase the Leased  Facility for a fixed price during  specified
one-year periods for the applicable  Lease.  The Options are exercisable  during
specified






                                      -74-


periods  between 1998 and 2010.  The fixed prices are based on  appraisals  that
estimate the fair market value of each Leased Facility as of the date the Option
for each Leased  Facility is first  exercisable.  The aggregate  estimated  fair
market  value  as of the  earliest  exercise  date of the  Options  of,  and the
aggregate purchase price for, the 12 Leased Facilities subject to the Options is
approximately  $59,585,000.  On May 24,  1995,  the Company made a deposit of an
aggregate  of  $13,155,000  with the  Lessors  for the  Options.  If the Company
exercises  an Option for a Leased  Facility,  the  portion  of such  $13,155,000
deposited  by the  Company  for the  Option  for that  Leased  Facility  will be
credited  toward the purchased price for that Leased  Facility.  If an Option is
not exercised during the applicable  exercise period,  the applicable portion of
such  deposit  will be  forfeited  by the  Company.  If an Option is  exercised,
approvals from health care regulatory  authorities may be required to consummate
the purchase of the Leased Facility.

      Stockholders Agreement.  Pursuant to the terms of a stockholders agreement
(the "Stockholders Agreement") between the Company and the CSI Stockholders, the
CSI  Stockholders  are  prohibited  from  selling  any  shares of  Common  Stock
beneficially  owned by them prior to May 24, 1997.  Between May 24, 1997 and May
24, 1998, the CSI  Stockholders are prohibited from selling more than 50% of the
shares of Common Stock  beneficially  owned by them. After May 24, 1998, the CSI
Stockholders  may sell the  shares of Common  Stock  beneficially  owned by them
without limitation as to volume imposed by the Stockholders Agreement.  Sales of
such shares must  otherwise  be made in  compliance  with the other terms of the
Stockholders Agreement.

      The Stockholders  Agreement  prohibits each of Stiles A. Kellett,  Jr. and
the trusts for the benefit of his family members that are CSI  Stockholders as a
group,  and  Samuel B.  Kellett  and the  trusts  for the  benefit of his family
members  that  are  CSI  Stockholders  as a  group,  from  acquiring,  directly,
indirectly  or as part of a group,  more than 12.5% of the total voting power of
the  outstanding  voting  securities  of the Company,  without the prior written
consent of the Company. The CSI Stockholders have also agreed not to (1) solicit
or  initiate  any offer or proposal  for a business  combination  involving  the
Company  or  any  of  its  subsidiaries,  or  involving  the  acquisition  of  a
substantial portion of any of their assets; (2) solicit, or become a participant
in any  solicitation  of,  proxies from any holder of voting  securities  of the
Company in connection  with any vote on any matter;  (3)  participate in a group
with respect to any voting securities of the Company,  other than the group that
currently  exists  among the CSI  Stockholders;  or (4) grant any  proxies  with
respect to any voting securities of the Company to any person, unless such proxy
specifies  that the person  holding the proxy shall vote in compliance  with the
Stockholders  Agreement (other than as recommended by the Board), or deposit any
voting  securities  of the  Company  in a voting  trust or enter  into any other
arrangement or agreement with respect to the voting thereof.

      In addition, the CSI Stockholders have agreed to grant the Company a right
of first refusal on any sale, transfer or other disposition of voting securities
of the Company by a CSI Stockholder or any affiliate of a CSI Stockholder  where
such sale,  transfer or other  disposition  involves  voting  securities  of the
Company  representing more than 1% of the then issued and outstanding  shares of
Common  Stock.  The right of first  refusal does not,  however,  apply to sales,
transfers  or  other  dispositions  of  voting  securities  of  the  Company  in
registered public offerings or in transactions  pursuant to Rule 144 or Rule 145
under the Securities Act, if the transferee in such transfer is not known to the
CSI Stockholder.

      Under  the  Stockholders   Agreement,  an  agent  designated  by  the  CSI
Stockholders (the "Stockholders Agent") has the right to designate one person to
serve on the  Company's  Board  of  Directors.  The  director  designee  must be
reasonably  acceptable  to the  Company.  The  Company is  obligated  to use all
reasonable efforts to cause the designee to be elected as a director.  Effective
as of June 2, 1995,  Mr. Stiles A.  Kellett,  Jr. was appointed as a director of
the Company for a term ending at the





                                      -75-


Company's  Annual Meeting of  Stockholders in 1996, at which time he was elected
for a three year term ending at the Company's  Annual Meeting of Stockholders in
1999. 


      The provisions of the Stockholders  Agreement relating to the Stockholders
Agent's right to designate a director and voting  matters  terminate on the date
on which the CSI  Stockholders own less than 5% of the total voting power of the
outstanding  voting  securities  of the  Company.  All other  provisions  of the
Stockholders  Agreement terminate (1) with respect to Stiles A. Kellett, Jr. and
the trusts for the benefit of his family members that are CSI  Stockholders as a
group, on the date on which they own less than 2.5% of the total voting power of
the outstanding voting securities of the Company, and (2) with respect to Samuel
B.  Kellett  and the trusts for the benefit of his family  members  that are CSI
Stockholders  as a group,  on the date on which  they own less  than 2.5% of the
total voting power of the outstanding voting securities of the Company.

      Registration  Rights Agreement.  The CSI Stockholders are also entitled to
require the Company to register  under the  Securities  Act the shares of Common
Stock  issued  to them in the  CSI  Merger  pursuant  to a  registration  rights
agreement  (the  "Registration  Rights  Agreement").   The  Registration  Rights
Agreement  provides  that if the Company  proposes to register  shares of Common
Stock  under the  Securities  Act at any time  after May 24,  1997,  subject  to
certain exceptions, the CSI Stockholders shall be entitled to include the shares
of Common  Stock  issued to them in the  Merger  in such  registration.  If such
registration  involves an underwritten  public offering,  the CSI  Stockholders'
rights to include  shares is subject  to the  satisfaction  of the rights of the
Company's other stockholders who have contractual registration rights and to the
rights of the  managing  underwriter  of the  offering to exclude for  marketing
reasons some or all of the CSI Stockholders' shares from such registration.

      The CSI  Stockholders  have the  additional  right under the  Registration
Rights Agreement to require the Company to prepare and file on three occasions a
registration  statement under the Securities Act with respect to their shares of
Common Stock.  This right is  exercisable at any time after May 24, 1997 and, if
the person designated by the Stockholders  Agent to be nominated for election as
a director of the  Company  pursuant to the  Stockholders  Agreement  stands for
election  and is not  elected,  once  within 120 days after the meeting at which
such  designee is not  elected.  Except for  registrations  requested  after the
Stockholders  Agent's  designee is not  elected,  the Company is not required to
register  more than 50% of the shares of Common Stock to be issued in the Merger
between  May 24,  1997 and May 24,  1998.  The  Company is  required  to use all
reasonable  efforts to effect such  registration,  subject to certain conditions
and limitations.  The Company is generally  required to bear the expenses of all
registrations under the Registration Rights Agreement,  except for underwriter's
discounts and commissions or any stock transfer taxes attributable to the shares
being  offered  and  sold.   The  CSI   Stockholders'   right  to  request  such
registrations  will terminate when the CSI  Stockholders own less than 5% of the
total voting power of the outstanding voting securities of the Company.

         Other  Agreements  related to the  Kelletts.  During  1996 the  Company
advanced $640,000 to Fort Worth Medical Investor Ltd., L.P. in connection with a
recoupment requirement from a third-party intermediary. Mr. Samuel B. Kellett is
the general  partner  of, and owns a minority  interest  in, Fort Worth  Medical
Investors,  Ltd., L.P., the assets of which are managed by Mariner. Also, during
1996,  Mariner  advanced  $1.5  million to Sun City Center  Associates,  L.P. in
connection with repayments for units being vacated in accordance with membership
agreements.  The Kelletts are the sole general and limited  partners of Sun City
Center  Associates,  L.P.,  the  assets of which are  managed  by  Mariner.  The
Kelletts  have entered into an agreement to repay the $1.5 million to Mariner by
September 30, 1997. 





                                       76


                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1)   List of Financial Statements

The following audited consolidated financial statements of Mariner Health Group,
Inc. and its subsidiaries,  and the accountant's  report relating  thereto,  are
filed as a part of this Report:

         Report of Independent Accountants

         Consolidated Balance Sheets as of December 31, 1995 and 1996

         Consolidated  Statements of Operations for the Years Ended December 31,
         1994, 1995 and 1996

         Consolidated  Statements of Cash Flows for the Years Ended December 31,
         1994, 1995 and 1996

         Consolidated  Statements  of  Stockholders'  Equity for the Years Ended
         December 31, 1994, 1995 and 1996

         Notes to Consolidated Financial Statements

(a)(2)   List of Schedules

         Included at the end of this Report is the following:

         Schedule II.  Valuation and Qualifying Accounts

         All  other  schedules  to the  consolidated  financial  statements  are
         omitted as the required information is either inapplicable or presented
         in the financial statements or related notes.

(a)(3)   List of Exhibits

   
         The Exhibits which are filed with this Report or which are incorporated
by reference  herein are set forth in the Exhibit Index which appears at page 79
hereof.
    

(b)      Reports on Form 8-K:

         October 3,  1996.  Item 2 -  Acquisition  or  Disposition  of Assets to
disclose the acquisition by one of the Company's  subsidiaries of certain assets
of Allegis Health Services, Inc. and certain of its Affiliates ("Allegis"); Item
5 - Other Events,  to disclose a press  release  addressing  uncertainty  in the
Medicare  industry and  describing  the Company's  adoption of a generally  more
conservative  approach to accounting  for Medicare  reimbursement;  and Item 7 -
Financial Statements,  Pro Forma Financial Information and Exhibits, to disclose
certain financial information relating to Allegis.





                                       77


                                   SIGNATURES


   
         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its  behalf by the  undersigned,  thereunto  duly  authorized,  this 30th day of
April, 1997.
    


                                            MARINER HEALTH GROUP, INC.



                                           By:  /s/ David N. Hansen
                                                -------------------------------
                                                David N. Hansen
                                                Executive Vice President, Chief
                                                Financial Officer and Treasurer

       

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this report has been signed by the following  persons in the  capacities  and on
the dates indicated.

   
<TABLE>
<CAPTION>
Signature                              Title(s)                                               Date
<S>                                    <C>                                             <C>
/s/  Arthur W. Stratton, Jr.*          Chairman of the Board of                        April 30, 1997
----------------------------
Arthur W. Stratton, Jr.                Directors, Chief Executive
                                       Officer, President and Director
                                       (principal executive officer)


/s/ David N. Hansen                    Executive Vice President, Chief                 April 30, 1997
-------------------
David N. Hansen                        Financial Officer and Treasurer
                                       (principal financial and
                                       accounting officer)

/s/  David C. Fries *                  Director                                        April 30, 1997
-------------------
David C. Fries


/s/  Christopher Grant, Jr.*           Director                                        April 30, 1997
---------------------------
Christopher Grant, Jr.


/s/ Stiles A. Kellett, Jr.*            Director                                        
---------------------------
Stiles A. Kellett, Jr.


/s/  John F. Robenalt *                Director                                        April 30, 1997
---------------------
John F. Robenalt

*By: /s/ David N. Hansen
    ---------------------
    David N. Hansen, Attorney in Fact.

</TABLE>



                                       78
    



                                   SCHEDULE II

                           MARINER HEALTH GROUP, INC.
                SCHEDULE II --- VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                       Balance at             Provision        Uncollectible                              Balance at
                                       Beginning                for              Accounts                Other              End of
Allowance for Doubtful Accounts        of Period              Bad Debt          Written Off            Changes (1)          Period
-------------------------------        ---------              --------          -----------            -------              ------
<S>                                    <C>                 <C>                <C>                   <C>                 <C>
Year ended December 31, 1996           $ 10,078,000        $ 2,738,000        $ 6,349,000           $ 5,405,000         $11,872,000
Year ended December 31, 1995           $  6,379,000        $ 3,698,000        $   634,000           $   635,000         $10,078,000
Year ended December 31, 1994           $  6,040,000        $ 1,338,000        $ 1,281,000           $   282,000         $ 6,379,000

</TABLE>

(1)  Principally  represents  reserves  acquired in purchases of businesses  and
facilities.





                                  EXHIBIT INDEX

         The following designated exhibits are, as indicated below, either filed
herewith  or have  heretofore  been  filed  with  the  Securities  and  Exchange
Commission and are referred to and incorporated by reference to such filings.



EXHIBIT NO.        DESCRIPTION

2.1, 10.1          Participation  Agreement  dated as of  January 9, 1995 by and
                   among the Company, Blue Corporation, Mariner Supply Services,
                   Inc., MHC Rehab Corp.,  Convalescent Services,  Inc. ("CSI"),
                   Convalescent  Supply Services,  Inc.,  Meadow Rehab Corp. and
                   Stiles A. Kellett, Jr., Samuel B. Kellett, Stiles A. Kellett,
                   Jr., as Trustee of Samuel B. Kellett,  Jr.  Irrevocable Trust
                   Dated  11/1/91,   Stiles  A.  Kellett,  Jr.,  as  Trustee  of
                   Charlotte  Rich  Kellett  Irrevocable  Trust  Dated  11/1/91,
                   Samuel B.  Kellett,  as  Trustee  of Stiles  A.  Kellett  III
                   Irrevocable  Trust Dated  11/1/91 and Samuel B.  Kellett,  as
                   Trustee of Barbara Katherine Kellett  Irrevocable Trust Dated
                   11/1/91  (Incorporated  by reference to Exhibit 2.1,  10.1 to
                   the  Company's  Annual Report on Form 10-K for the year ended
                   December 31, 1994).

2.2, 10.2          Asset Purchase  Agreement  dated as of January 9, 1995 by and
                   among Mariner Supply Services,  Inc. and Convalescent  Supply
                   Services, Inc. ("CSSI") (Incorporated by reference to Exhibit
                   2.2,  10.2. to the  Company's  Annual Report on Form 10-K for
                   the year ended December 31, 1994).

2.3, 10.3          Asset Purchase  Agreement  dated as of January 9, 1995 by and
                   among MHC Rehab Corp. and Meadow Rehab Corp. (Incorporated by
                   reference to Exhibit 2.3, 10.3 to the Company's Annual Report
                   on Form 10-K for the year ended December 31, 1994).

2.4, 10.4          Asset Purchase  Agreement  dated as of January 9, 1995 by and
                   among CSI and  Stiles A.  Kellett,  Jr.,  Samuel B.  Kellett,
                   Stiles A. Kellett,  Jr., as Trustee of Samuel B. Kellett, Jr.
                   Irrevocable Trust Dated 11/1/91,  Stiles A. Kellett,  Jr., as
                   Trustee of  Charlotte  Rich Kellett  Irrevocable  Trust Dated
                   11/1/91,  Samuel B. Kellett,  as Trustee of Stiles A. Kellett
                   III Irrevocable Trust Dated 11/1/91 and Samuel B. Kellett, as
                   Trustee of Barbara Katherine Kellett  Irrevocable Trust Dated
                   11/1/91  (Incorporated  by reference to Exhibit 2.4,  10.4 to
                   the  Company's  Annual Report on Form 10-K for the year ended
                   December 31, 1994).

2.5, 10.5          Agreement  and Plan of Merger  dated as of January 9, 1995 by
                   and among the Company, Blue Corporation and CSI (Incorporated
                   by  reference to Exhibit 2.5,  10.5 to the  Company's  Annual
                   Report on Form 10-K for the year ended December 31, 1994).

2.6, 10.6          Amendment Agreement dated as of May 24, 1995 by and among (i)
                   the Company;  (ii) Blue  Corporation;  (iii)  Mariner  Supply
                   Services,   Inc.;  (iv)  MHC  Rehab  Corp.;   (v)  CSI;  (vi)
                   Convalescent Supply Services, Inc.; (vii) Meadow Rehab Corp.;
                   (viii) Stiles A. Kellett,  Jr., Samuel B. Kellett,  Stiles A.
                   Kellett,   Jr.,  as  Trustee  of  Samuel  B.   Kellett,   Jr.
                   Irrevocable Trust Dated 11/1/91,  Stiles A. Kellett,  Jr., as
                   Trustee of  Charlotte  Rich Kellett  Irrevocable  Trust Dated
                   11/1/91,  Samuel B. Kellett,  as Trustee of Stiles A. Kellett
                   III Irrevocable Trust Dated 11/1/91 and Samuel B. Kellett, as
                   Trustee of Barbara Katherine Kellett  Irrevocable Trust Dated
                   11/1/91,  (ix) Villa Medical Investors,  Ltd. (L.P.) ("VMI");
                   (x)  Arlington   Heights  Medical   Investors,   Ltd.  (L.P.)
                   ("AHMI");  and (xi) Ft. Worth Medical  Investors,  Ltd.,  Sun
                   City  Center  Associates,   L.P.,  Houston-Northwest  Medical
                   Investors,   Ltd.  (L.P.),  Dallas  Medical  Investors,  Ltd.
                   (L.P.),  Ft. Bend Medical Investors,  Ltd. (L.P.),  Northwest
                   Healthcare,  L.P.,  Belleair  East  Medical  Investors,  Ltd.
                   (L.P.),  Denver Medical Investors,  Ltd. (L.P.),  Tallahassee
                   Healthcare Associates, Ltd. (L.P.), Port Charlotte Healthcare
                   Associates,  Ltd. (L.P.), South Denver Healthcare Associates,
                   Ltd. (L.P.),  Melbourne Healthcare Associates,  (L.P. ) Ltd.,
                   Pinellas III Healthcare,  Ltd. (L.P.), Polk Healthcare,  Ltd.
                   (L.P.),  Orange  Healthcare,  Ltd. (L.P.),  and Creek Forest,
                   Limited,  (collectively,   the



                                       79


                   "Lessors") (Incorporated by reference to Exhibit 2.1, 10.1 to
                   the Company's  Form 10-Q for the quarter ended June 30, 1995,
                   as amended).

2.7, 10.7          Second  Amendment  Agreement dated as of December 29, 1995 by
                   and  among (i) the  Company;  (ii)  Blue  Corporation;  (iii)
                   Mariner  Supply  Services,  Inc.,  (iv) MHC Rehab  Corp;  (v)
                   Convalescent   Services,   Inc.;  (vi)  Convalescent   Supply
                   Services,  Inc.;  (vii) Meadow Rehab Corp.,  (viii) Samuel B.
                   Kellett,  as agent of  Stiles  A.  Kellett,  Jr.,  Samuel  B.
                   Kellett, William R. Bassett, as Trustee of Samuel B. Kellett,
                   Jr. Irrevocable Trust Dated 11/1/91,  William R. Bassett,  as
                   Trustee of  Charlotte  Rich Kellett  Irrevocable  Trust Dated
                   11/1/91,  William R. Bassett, as Trustee of Stiles A. Kellett
                   III  Irrevocable  Trust Dated 11/1/91 and William R. Bassett,
                   as Trustee of Barbara  Katherine  Kellett  Irrevocable  Trust
                   Dated  11/1/91,  (ix)  VMI;  (x) AHMI;  and (xi) the  Lessors
                   (Incorporated  by  reference  to Exhibit  2.12,  10.12 to the
                   Company's Current Report on Form 8-K dated January 2, 1996).

2.8, 10.8          Management  Agreement  dated as of May 24,  1995 by and among
                   Mariner and CSI  (Incorporated  by  reference to Exhibit 2.2,
                   10.2 to the  Company's  Form 10-Q for the quarter  ended June
                   30, 1995, as amended).

2.9, 10.9          Asset  Purchase  Agreement  dated  as of May 24,  1995 by and
                   among Blue Corporation and AHMI (Incorporated by reference to
                   Exhibit 2.3, 10.3 to the Company's  Form 10-Q for the quarter
                   ended June 30, 1995, as amended).

2.10, 10.10        Asset  Purchase  Agreement  dated  as of May 24,  1995 by and
                   among Blue Corporation and VMI  (Incorporated by reference to
                   Exhibit 2.4, 10.4 to the Company's  Form 10-Q for the quarter
                   ended June 30, 1995, as amended).

2.11, 10.11        Amended and  Restated  Option  Agreement  dated as of May 24,
                   1995 by and among CSI, Mariner and the Lessors  (Incorporated
                   by reference to Exhibit 2.5, 10.5 to the Company's  Form 10-Q
                   for the quarter ended June 30, 1995, as amended).

2.12, 10.12        Amended and Restated  Registration  Rights Agreement dated as
                   of  December  29,  1995 by and among  Mariner  and  Stiles A.
                   Kellett,  Jr.,  Samuel B.  Kellett,  William R.  Bassett,  as
                   Trustee of Samuel B.  Kellett,  Jr.  Irrevocable  Trust Dated
                   11/1/91,  William R.  Bassett,  as Trustee of Charlotte  Rich
                   Kellett Irrevocable Trust Dated 11/1/91,  William R. Bassett,
                   as Trustee of Stiles A. Kellett III  Irrevocable  Trust Dated
                   11/1/91  and  William  R.  Bassett,  as  Trustee  of  Barbara
                   Katherine    Kellett    Irrevocable   Trust   Dated   11/1/91
                   (Incorporated  by  reference  to Exhibit  2.13,  10.13 to the
                   Company's  Current  Report on Form 8-K dated January 2, 1996,
                   as amended).

2.13, 10.13        Amendment and Restated Stockholders Agreement dated as of May
                   24,  1995  by  and  among   Mariner   and  the   Stockholders
                   (Incorporated  by  reference  to  Exhibit  2.6,  10.6  to the
                   Company's  Form 10-Q for the quarter  ended June 30, 1995, as
                   amended).

2.14, 10.14        Asset Purchase  Agreement,  dated as of July 21, 1995, by and
                   among Mariner Health Care of Pinellas Point,  Inc.,  Heritage
                   Health Care Centers of Central Florida, Inc., Heritage Health
                   Care Center of Baker County,  Inc.,  Inverness Health Care, A
                   Limited Partnership d/b/a Heritage Health Care Center, Dowell
                   Enterprises,  Inc.  and  ABCM  Corporation  (Incorporated  by
                   reference to Exhibit 2, 10 to the Company's Current Report on
                   Form 8-K dated October 2, 1995, as amended).

2.15, 10.15        Agreement and Plan of Merger dated as of February 27, 1996 by
                   and among the  Company,  Mariner  Health  of  Florida,  Inc.,
                   Regency Health Care Centers, Inc., MedTx Corporation,  Dennis
                   J. Ferguson, J. Steven Garthe, Joseph V. Lennartz, Deborah B.
                   Wilson and Ronald E. Hayes, as trustee of the Ronald E. Hayes
                   Revocable Trust of 1994 (Incorporated by reference to Exhibit
                   2.15,  10.15 to the Company's  Annual Report on Form 10-K for
                   the year ended December 31, 1995).

2.16, 10.16        Agreement  and Plan of Merger dated as of February 9, 1996 by
                   and among the Company,




                                       80


                   MRI Acquisition  Corp. and MedRehab,  Inc.  (Incorporated  by
                   reference  to Exhibit  2.16,  10.16 to the  Company's  Annual
                   Report on Form 10-K for the year ended December 31, 1995).

2.17, 10.17        Registration Rights Agreement dated as of February 9, 1996 by
                   and among the  Company  and certain  former  stockholders  of
                   MedRehab,  Inc.  (Incorporated  by reference to Exhibit 2.17,
                   10.17 to the  Company's  Annual  Report  on Form 10-K for the
                   year ended December 31, 1995).

2.18, 10.18        Asset  Purchase  Agreement  dated as of July 31,  1996 by and
                   among Mariner Health Group, Inc.; Mariner Health of Maryland,
                   Inc.;  Allegis Health  Services,  Inc.;  Technicare,  L.L.C.;
                   Rehab   Solutions,    L.L.C.;    Bay   Meadow   Nursing   and
                   Rehabilitation  Center,  L.L.C.;  Camden  Yards  Nursing  and
                   Rehabilitation Center, L.L.C.; Kensington Gardens Nursing and
                   Rehabilitation     Center,    L.L.C.;    Global    Healthcare
                   Center-Overlea,  L.L.C.;  Allegis  Health and  Rehabilitation
                   Center - Southern Maryland,  L.L.C.; Global Healthcare Center
                   - Bethesda,  L.L.C.;  Circle Manor Nursing Home, Inc.; Arcola
                   Nursing and Rehabilitation Center, Inc.; Technicare Pharmacy,
                   Inc.; Global Health Investment  Associates,  L.L.C.;  Paul J.
                   Diaz;  Marvin  H.  Rabovsky;  Harvey  W.  Wertlieb;  Roger C.
                   Lipitz;  Gary M. Sudhalter and Jay Mutchnik  (Incorporated by
                   reference to Exhibit 10.1 to the Company's  Current Report on
                   Form 8-K dated October 3, 1996)

2.19, 10.19        Amendment Number 1 to Asset Purchase  Agreement dated October
                   2, 1996 by and among  Mariner  Health  Group,  Inc.;  Mariner
                   Health of Maryland,  Inc.;  Allegis  Health  Services,  Inc.;
                   Technicare,  L.L.C.;  Rehab  Solutions,  L.L.C.;  Bay  Meadow
                   Nursing  and  Rehabilitation  Center,  L.L.C.;  Camden  Yards
                   Nursing and Rehabilitation Center, L.L.C.; Kensington Gardens
                   Nursing and Rehabilitation  Center, L.L.C.; Global Healthcare
                   Center-Overlea,  L.L.C.;  Allegis  Health and  Rehabilitation
                   Center - Southern Maryland,  L.L.C.; Global Healthcare Center
                   - Bethesda,  L.L.C.;  Circle Manor Nursing Home, Inc.; Arcola
                   Nursing and Rehabilitation Center, Inc.; Technicare Pharmacy,
                   Inc.; Global Health Investment  Associates,  L.L.C.;  Paul J.
                   Diaz;  Marvin  H.  Rabovsky;  Harvey  W.  Wertlieb;  Roger C.
                   Lipitz;  Gary M. Sudhalter and Jay Mutchnik  (Incorporated by
                   reference  to  Exhibit  2.2,  10.2 to the  Company's  Current
                   Report on Form 8-K dated October 3, 1996)

3.1, 4.1           Restated   Certificate  of   Incorporation  of  the  Company.
                   (Incorporated  by  reference  to  Exhibit  3.2,  4.2  to  the
                   Company's Registration Statement No. 33-60736  ("Registration
                   Statement No. 33-60736")).

3.2, 4.2           Certificate   of   Amendment   to  the   Company's   Restated
                   Certificate of  Incorporation  (Incorporated  by reference to
                   Exhibit 4.2 to the Company's  Form 10-Q for the quarter ended
                   March 31, 1994, as amended).

3.3, 4.3           By-laws,   as   amended   and   restated,   of  the   Company
                   (Incorporated  by  reference  to  Exhibit  3.2,  4.2  of  the
                   Company's  Annual  Report  on Form  10-K for the  year  ended
                   December 31, 1993).

4.4                Specimen   certificate    representing   the   Common   Stock
                   (Incorporated  by reference  to Exhibit 4.3 to the  Company's
                   Registration Statement No. 33-60736).

4.5                Rights  Agreement,  dated as of  October  31,  1995,  between
                   Mariner  Health  Group,  Inc.  and State  Street Bank & Trust
                   Company,  which includes as Exhibit A the Form of Certificate
                   of Designations, as Exhibit B the Form of Rights Certificate,
                   and as Exhibit C the Summary of Rights to Purchase  Preferred
                   Stock   (Incorporated  by  reference  to  Exhibit  4  to  the
                   Company's Current Report on Form 8-K dated October 31, 1995).



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4.6, 10.20         Indenture  dated as of April 4, 1996 between  Mariner  Health
                   Group,  Inc.  and State  Street  Bank and Trust  Company,  as
                   trustee, including (i) the form of 9-1/2% Senior Subordinated
                   Note due 2006,  Series A and (ii) the form of  9-1/2%  Senior
                   Subordinated   Note  due  2006,  Series  B  (Incorporated  by
                   reference  to  Exhibit  4.1,  10.1 to the  Company's  Current
                   Report on Form 8-K dated April 4, 1996).

4.7                Form of 9 1/2% Senior  Subordinated  Note due 2006,  Series B
                   (Incorporated  by reference  to Exhibit 4.2 of the  Company's
                   Form S-4 Registration Statement No. 333-4266).

10.21              Credit  Agreement  dated  as of May  18,  1994  by and  among
                   Mariner Health Group,  Inc., PNC Bank,  National  Association
                   and the other banks party thereto. (Incorporated by reference
                   to Exhibit  10.1 to the  Company's  Quarterly  Report on Form
                   10-Q/A for the quarter ended June 30, 1994, as amended).

10.22              Amendment No. 4 to Credit Agreement dated as of July 18, 1995
                   by and among Mariner Health Group,  Inc., PNC Bank,  National
                   Association  and the other banks party thereto  (Incorporated
                   by reference to Exhibit 10.24 to the Company's  Annual Report
                   on Form 10-K for the year ended December 31, 1995).

10.23              Amendment No. 5 to Credit  Agreement  dated as of November 3,
                   1995 by and  among  Mariner  Health  Group,  Inc.,  PNC Bank,
                   National   Association   and  other   banks   party   thereto
                   (Incorporated  by reference to Exhibit 10.25 to the Company's
                   Annual  Report on Form 10-K for the year ended  December  31,
                   1995).

10.24              Amendment No. 6 to Credit  Agreement dated as of December 29,
                   1995 by and  among  Mariner  Health  Group,  Inc.,  PNC Bank,
                   National   Association   and  other   banks   party   thereto
                   (Incorporated  by reference to Exhibit 10.26 to the Company's
                   Annual  Report on Form 10-K for the year ended  December  31,
                   1995).

10.25              Amendment No. 7 to Credit  Agreement dated as of February 15,
                   1996 by and  among  Mariner  Health  Group,  Inc.,  PNC Bank,
                   National   Association   and  other   banks   party   thereto
                   (Incorporated  by reference to Exhibit 10.27 to the Company's
                   Annual  Report on Form 10-K for the year ended  December  31,
                   1995).

10.26              Modification  Agreement  dated  as of  March  1,  1995  among
                   Seventeenth    Street   Associates    Limited    Partnership,
                   NationsBank of Tennessee, N.A., NationsBank of Georgia, N.A.,
                   TRI-State Health Corp., Inc. and Pinnacle Care Corporation of
                   Huntington (Incorporated by reference to Exhibit 10.28 to the
                   Company's  Annual  Report  on Form  10-K for the  year  ended
                   December 31, 1995).

10.27              Pledge  Agreement  dated as of March 1, 1995  among  Pinnacle
                   Care  Corporation,  Pinnacle Care  Corporation of Huntington,
                   NationsBank of Tennessee,  N.A., and  NationsBank of Georgia,
                   N.A.  (Incorporated  by  reference  to  Exhibit  10.29 to the
                   Company's  Annual  Report  on Form  10-K for the  year  ended
                   December 31, 1995).

10.28              Guaranty  Agreement  dated as of March 1, 1995 among  Mariner
                   Health  Group  Inc.,  NationsBank  of  Tennessee,  N.A.,  and
                   NationsBank of Georgia,  N.A.  (Incorporated  by reference to
                   Exhibit 10.30 to the Company's Annual Report on Form 10-K for
                   the year ended December 31, 1995).

10.29*             1992 Stock Option Plan  (Incorporated by reference to Exhibit
                   10.1 to the Company's Registration Statement No. 33-60736).

10.30*             1993 Employee Stock Purchase Plan, as amended.  (Incorporated
                   by  reference  to  Exhibit  10.2 to the  Company's  Form  S-1
                   Registration Statement No. 33-71710).

10.31*             1994 Stock Plan,  as amended  (Incorporated  by  reference to
                   Exhibit 4.5 to the  Company's  Form S-8,  filed  November 21,
                   1995).


                                       82



10.32*             1995 Non-Employee Director Stock Option Plan (Incorporated by
                   reference  to Exhibit 4.4 to the  Company's  Form S-8,  filed
                   November 21, 1995).

10.33*             Form of Employment  Agreement  dated as of January 1, 1995 by
                   and among the  Company  and  Arthur W.  Stratton,  Jr.,  M.D.
                   (Incorporated  by reference to Exhibit 10.29 to the Company's
                   Annual Report on Form 10-K/A for the year ended  December 31,
                   1994).

10.34+             Defined Care Partner Agreement,  dated as of January 5, 1996,
                   by and  among  AmHS  Purchasing  Partners,  L.P.  ("AmHSPP"),
                   Mariner Health Care, Inc. and the Company, including: Exhibit
                   A, Warrant to Purchase 210,000 Shares of the Company's Common
                   Stock by and among  AmHSPP and the  Company;  and  Exhibit B,
                   Warrant to Purchase  1,890,000 Shares of the Company's Common
                   Stock by and among  AmHSPP and the Company  (Incorporated  by
                   reference to Exhibit 10.36 to the Company's  Annual Report on
                   Form 10-K for the year ended December 31, 1995).

10.35              Form of Lease by and  between  CSI and each of the  following
                   lessors: (i) Houston Northwest Med. Inv., (ii) Fort Bend Med.
                   Inv., (iii) Northwest Healthcare,  (iv) Dallas Med. Inv., (v)
                   Creek Forest Ltd., (vi) Denver Med. Inv.,  (vii) South Denver
                   Healthcare  Assoc.,  (viii)  Belleair  East Med.  Inv.,  (ix)
                   Tallahassee Healthcare, (x) Port Charlotte Healthcare Assoc.,
                   (xi)  Melbourne   Healthcare   Assoc.,   (xii)  Pinellas  III
                   Healthcare Assoc.,  (xiii) Polk Healthcare,  and (xiv) Orange
                   Healthcare (Incorporated by reference to Exhibit 10.37 to the
                   Company's  Annual  Report  on Form  10-K for the  year  ended
                   December 31, 1995).

10.36              Amendment  No. 8 to  Credit  Agreement  dated as of March 28,
                   1996 by and  among  Mariner  Health  Group,  Inc.,  PNC Bank,
                   National   Association   and  other   banks   party   thereto
                   (Incorporated  by reference to Exhibit 10.38 to the Company's
                   Annual  Report on Form 10-K for the year ended  December  31,
                   1995).

10.37              Amendment  No. 9 to the Credit  Agreement and Waiver dated as
                   of April 30, 1996 by and among Mariner  Health  Group,  Inc.,
                   PNC Bank, National  Association and other banks party thereto
                   (Incorporated  by reference to Exhibit 10.2 to the  Company's
                   Current Report on Form 8-K dated April 30, 1996).

10.38              Amendment No. 10 to the Credit  Agreement and Waiver dated as
                   of July 1, 1996 by and among the Company,  PNC Bank, National
                   Association,  and the other banks party thereto (Incorporated
                   by reference to Exhibit 10.1 to the  Company's  Form 10-Q for
                   the fiscal quarter ended June 30, 1996).

10.39              Amendment No. 11 to the Credit Agreement and Consent dated as
                   of July 31, 1996 by and among the Company, PNC Bank, National
                   Association,  and the other banks party thereto (Incorporated
                   by reference to Exhibit 10.2 to the  Company's  Form 10-Q for
                   the fiscal quarter ended June 30, 1996).

   
10.40#             Amendment No. 12 to the Credit  Agreement and Waiver dated as
                   of  October  3,  1996 by and  among  the  Company,  PNC Bank,
                   National Association, and the other banks party thereto.

10.41#             Amendment  No. 13 to the Credit  Agreement  dated as of March
                   11,  1997  by and  among  the  Company,  PNC  Bank,  National
                   Association, and the other banks party thereto.
    

10.42              Purchase  Agreement dated March 29, 1996 among Mariner Health
                   Group,  Inc.  and  Merrill  Lynch,  Pierce,  Fenner  &  Smith
                   Incorporated,  Alex.  Brown  & Sons  Incorporated,  CS  First
                   Boston  Corporation,   Hambrecht  &  Quist  LLC  and  Salomon
                   Brothers Inc   (Incorporated  by reference to Exhibit 10.2 to
                   the  Company's  Current  Report  on Form 8-K  dated  April 4,
                   1996).



                                       83



10.43              Registration Rights Agreement dated as of April 4, 1996 among
                   Mariner Health Group, Inc. and Merrill Lynch, Pierce,  Fenner
                   & Smith  Incorporated,  Alex. Brown & Sons  Incorporated,  CS
                   First Boston  Corporation,  Hambrecht & Quist LLC and Salomon
                   Brothers Inc   (Incorporated  by reference to Exhibit 10.3 to
                   the  Company's  Current  Report  on Form 8-K  dated  April 4,
                   1996).

10.44*             Form of Employment  Agreement between the Company and each of
                   Jeffrey W. Kinell,  Lawrence R. Deering,  Jennifer Gallagher,
                   Phyllis  Madigan and certain  other  employees of the Company
                   (Incorporated  by  reference  to Exhibit 10 to the  Company's
                   Report on Form 10-Q for the fiscal  quarter  ended  March 31,
                   1996).

10.45*             Employment  Agreement  dated  as of  August  16,  1996 by and
                   between  the Company  and David N.  Hansen  (Incorporated  by
                   reference to Exhibit 10.1 to the Company's  Form 10-Q for the
                   fiscal quarter ended September 30, 1996).

   
11#                Calculation of Shares used in  Determining  Net Income (Loss)
                   Per Share.

21#                Subsidiaries of the Company.

23                 Consent of Coopers & Lybrand L.L.P.

24#                Power of Attorney (included on the Signature Page to this 
                     Report).
    

27                 Financial Data Schedule.

-------------------------

*  Indicates  a  management  contract  or any  compensatory  plan,  contract  or
arrangement.

+  Confidential Treatment Requested.
   
#  Previously filed.