<PAGE>   1

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

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

                                   FORM 10-K
                           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

                  For the fiscal year ended December 31, 1997
                                       OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

          For the transition period from             to             .

                         Commission file number 0-21512

                           MARINER HEALTH GROUP, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S>                                                   <C>
                DELAWARE                                  06-1251310
      (STATE OR OTHER JURISDICTION                    (I.R.S. EMPLOYER
    OF INCORPORATION OR ORGANIZATION)                 IDENTIFICATION NO.)

          1881 WORCESTER ROAD
            FRAMINGHAM, MA                                  01701
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                  (ZIP CODE)
</TABLE>

       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 March 23, 1998
(computed based on the closing price of such stock on The Nasdaq National Market
on March 23, 1998) was $465,846,287.

     The number of shares of the registrant's Common Stock, $.01 par value,
outstanding as of March 23, 1998 was 29,577,542 shares.

                      DOCUMENTS INCORPORATED BY REFERENCE

     The following documents, or indicated portions thereof, have been
incorporated herein by reference:

     1. Specifically identified information in the Registrant's definitive proxy
        statement for its annual meeting of stockholders which is currently
        expected to be filed with the Securities and Exchange Commission within
        120 days of December 31, 1997 and is incorporated by reference into Part
        III hereof.
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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, hospital unit
management and rehabilitation staffing. 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 or manages 94 inpatient
facilities and 39 hospital skilled nursing facilities or units with an aggregate
of approximately 13,304 beds, 42 outpatient rehabilitation clinics and, as of
February 28, provides contract rehabilitation services within 471 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.

MARINER'S STRATEGY

     Mariner's goal is to be a low 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 has also
designed 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

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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 spent approximately $6,100,000
in 1997 and currently plans to spend approximately $9,000,000 in 1998 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, Northeast, Central, 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 establishing relationships 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
provide care for patients who would benefit from Mariner's clinical programs and
to contract with payors on a case rate or capitated basis.

     Commitment to Employee Training:  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 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 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. Acquisition candidates include individual
inpatient facilities, businesses that operate multiple inpatient facilities and
other health care services businesses. The Company continuously identifies and
evaluates acquisition candidates and in many cases engages in discussions and
negotiations regarding potential acquisitions or dispositions. There can be no
assurance that any of the Company's discussions or negotiations will result in
an acquisition or dispositions. 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(R) 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(R) 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.

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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(R) programs typically involve
inpatient treatment periods of 20 to 45 days. At its inpatient facilities, the
Company offers a mix of MarinerCare(R) 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(R) programs or other clinical programs.

     The Company currently offers the following MarinerCare(R) 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.

     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(R)
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. 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 provides rehabilitation programs for 471 skilled
nursing facilities.

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     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 therapists 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
42 outpatient rehabilitation clinics located primarily in metropolitan areas.
These clinics provide routine physical and occupational therapy to patients who
suffer from occupational, athletic or other injuries and are capable of being
treated on an outpatient basis. The Company also manages several pediatric
programs, provides temporary staffing to schools, and provides therapists to
clinics.

  Other Inpatient Services

     In Mariner's inpatient facilities, all patients receive basic medical
services including nursing care, special diets, nutrition 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
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, as appropriate,
admission into the Company's MarinerCare(R) 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.

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  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.

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,
                                        -----------------------------------------------------
                                             1995               1996               1997
                                        ---------------    ---------------    ---------------
                                           $         %        $         %        $         %
                                        --------    ---    --------    ---    --------    ---
                                                       (DOLLARS IN THOUSANDS)
<S>                                     <C>         <C>    <C>         <C>    <C>         <C>
Private Payors(1).....................  $177,479     50%   $221,446     37%   $248,471     34%
Medicare..............................   102,713     29     217,271     37     260,296     35
Medicaid..............................    74,614     21     152,092     26     224,709     31
                                        --------    ---    --------    ---    --------    ---
          Total.......................  $354,806    100%   $590,809    100%   $733,476    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 payors, 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 payor source.

     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,
in January, 1998, the Health Care Finance Administration ("HCFA") published new
salary equivalency guidelines. These guidelines, which are effective April 1,
1998, will be used by Medicare fiscal intermediaries to determine the maximum
allowable costs for rehabilitation services. Mariner is currently evaluating the
effects of these new guidelines. There can be no assurance that the impact of
these guidelines will not have a material adverse effect on the Company's
business and result of operations.

     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,

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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 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). 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 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.

     The Balanced Budget Act of 1997 (the "Balanced Budget Act") provides for a
significant change in Medicare reimbursement to many types of providers
including the Company. Skilled nursing facilities will receive a fixed payment
based on their historic costs and a federally calculated rate adjusted for
regional usage variations. The federal rates have not yet been established or
published. This payment will not be cost settled and will commence July 1, 1998
and later to coincide with the facilities' Medicare fiscal year. See "Government
Regulation."

     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. HCFA has published salary equivalency guidelines for all
therapies furnished under these types of arrangements. The guidelines are
applicable for services furnished after April 1, 1998. In addition, Mariner
provides certain services between subsidiary companies, some of which are
charged at cost and others of which 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, this may result in a reduction in
reimbursements in the future periods, and may have a material adverse effect on
the Company's business and results of operations.

     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

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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 and continuing in 1997, 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 reserves in 1996 for potential lower
levels of Medicare reimbursement. While the Company believes the amount of its
current reserves to be sufficient, there can be no assurance that this amount
will be adequate in the future if there is an additional change in the practices
of Mariner's fiscal intermediaries. Accordingly, Mariner may increase the amount
of its reserve based on the practices of its fiscal intermediaries in the
future. Any such increase would adversely effect Mariner's results of
operations.

     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
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(R) programs, the Company pursues a two-tiered
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(R)
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

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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.

QUALITY ASSURANCE

     Mariner has developed a comprehensive quality assurance program at all of
its facilities and units. This program seeks to ensure 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.

     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 as measured by regulatory surveys and its patient and family
satisfaction questionnaires.

                                        9
<PAGE>   10

FACILITIES

     The following table provides information by state about each of the
facilities owned, leased and managed by the Company as of March 23, 1998:

<TABLE>
<CAPTION>
                                                                               MANAGED
                                 OWNED FACILITIES   LEASED FACILITIES   FACILITIES AND UNITS          TOTAL
                                ------------------  ------------------  ---------------------  -------------------
                                FACILITIES   BEDS   FACILITIES   BEDS   FACILITIES      BEDS   FACILITIES    BEDS
                                ----------   -----  ----------   -----  -----------    ------  ----------   ------
<S>                             <C>          <C>    <C>          <C>    <C>            <C>     <C>          <C>
Florida Region
  Florida.....................      16       1,933       9       1,128       8           739       33        3,800
Southwest Region:
  California..................      --          --      --          --       1            11        1           11
  Colorado....................      --          --       2         237       1            12        3          249
  Kansas(2)...................       1         101      --          --      --            --        1          101
  Oklahoma....................      --          --       1         161       2            21        3          182
  Texas(1)....................       6         952       5         685      11           289       22        1,926
Northeast Region:
  Connecticut.................       2         250       1          90      --            --        3          340
  Massachusetts...............       6         748      --          --      11         1,168       17        1,916
Mid-Atlantic Region:
  District of Columbia........      --          --      --          --       1            19        1           19
  Delaware....................      --          --      --          --       1            99        1           99
  Maryland(1).................      10       1,635       3         576       6           264       19        2,475
  New Jersey..................      --          --      --          --       6           280        6          280
  Pennsylvania................       2         205      --          --       1            32        3          237
  Virginia....................      --          --      --          --       1            60        1           60
  West Virginia...............       1         186      --          --      --            --        1          186
Central Region:
  Georgia.....................       1         165      --          --      --            --        1          165
  Illinois....................       1         120      --          --      --            --        1          120
  Indiana.....................      --          --      --          --       1            24        1           24
  Louisiana...................      --          --      --          --       2            25        2           25
  Nevada......................      --          --      --          --       3            63        3           63
  North Carolina..............       1         150      --          --      --            --        1          150
  Ohio........................       1          93      --          --       1            12        2          105
  South Carolina..............       3         308      --          --      --            --        3          308
  Tennessee...................       2         210       2         253      --            --        4          463
                                    --       -----      --       -----      --         -----      ---       ------
     Totals...................      53       7,056      23       3,130      57         3,118      133       13,304
                                    ==       =====      ==       =====      ==         =====      ===       ======
</TABLE>

---------------
(1) Three facilities in Maryland, one in North Carolina and one in Texas are
    owned under joint venture arrangements.

(2) This facility is under contract for sale.

     The Company owns an 80,000 square foot building located in New London,
Connecticut. The Company also leases approximately 31,000 square feet in
Framingham, Massachusetts that serve as its executive offices. The Company's
other 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.

                                       10
<PAGE>   11

SIGNIFICANT DEVELOPMENTS

1997

     1997 Facility Acquisition.  During 1997, the Company acquired four skilled
nursing facilities with a total of 587 beds in the Baltimore metropolitan area
for a total purchase price of approximately $37,000,000 (the "1997 Facility
Acquisitions"). The Company borrowed approximately $37,000,000 under its Credit
Facility to finance these acquisitions. Goodwill of $22,000,000 was recorded in
connection with these acquisitions.

     Prism and Related Rehabilitation Transaction.  In October 1997, the Company
completed its merger with Prism Health Group, Inc. (the "Prism Merger"). All of
the issued and outstanding shares of Prism capital stock were converted into the
right to receive an aggregate of approximately $84,300,000 in cash. In
connection with the Prism Merger the Company also repaid approximately
$9,500,000 in assumed debt and paid expenses of approximately $700,000 prior to
the closing. Goodwill of approximately $91,000,000 was recorded in connection
with this transaction. The Company borrowed approximately $94,500,000 under its
Credit Facility to finance the Prism Merger.

     In June, 1997, the Company also acquired another rehabilitation company for
a total purchase price of approximately $15,403,000. The Company made an initial
payment of $2,000,000 and in 1998 paid an additional $3,135,000. These amounts
were funded under the Company's Credit Facility. In addition, the Company
entered into a three year, 7% interest bearing Note for $5,134,000. The Company
also agreed to pay the remaining $5,134,000 in contingent consideration over the
next three years provided certain financial targets were met. Goodwill of
$2,552,000 was recorded in connection with this transaction.

     Joint Ventures.  The Company entered into three joint venture arrangements
in connection with three of its facilities located in Maryland and North
Carolina. The Company retained a 50% interest in two of the facilities and 60%
in the third facility. The Company received a total of $5,349,000 of capital
contributions from its joint venture partners and recognized a gain of
approximately $1,659,000 from these transactions.

     Dispositions.  During 1997, the Company sold two nursing facilities which
were located in non-strategic locations. The Company received approximately
$4,890,000 from the sale of these facilities and recognized a pretax loss of
$4,579,000. In 1997, the two facilities generated an aggregate of $6,854,000 and
$550,000 of revenue and income from operations, respectively.

     Additionally, during the course of 1997, Mariner commenced operation of
several new home health agencies in Florida and other states.

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, with and into CSI and
the acquisition of certain related assets. 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. The
Company acquired 25 skilled nursing facilities, one rehabilitation hospital and
one continuing care retirement community, with an aggregate of 3,801 beds in
connection with this transaction. On January 2, 1996 the CSI Merger was
consummated.

     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 and 1997. The Company recorded a charge of
approximately

                                       11
<PAGE>   12

$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 US Department of Housing and
Urban Development ("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.

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

General

     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, rehabilitation companies and other health care services businesses.
In addition, the Company continuously identifies and evaluates potential
acquisition candidates, evaluates strategic divestitures and in many cases
engages in discussions and negotiations regarding potential acquisitions and
dispositions. There can be no assurance that any of the Company's discussions or
negotiations will result in an acquisition or a disposition. 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, assisted living 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

                                       12
<PAGE>   13

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.

     Mariner's medical services business and home health business face broad
based competition from both large institutional providers as well as regional
and local providers. In addition, several states do not require a certificate of
need to operate home health agencies, thereby causing certain of Mariner's home
health markets to be intensely competitive.

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. 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 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.

     Medicare utilizes a cost-based reimbursement system for nursing facilities,
long-term acute care hospitals and home health agencies for reasonable direct
and indirect allowable costs incurred in providing "routine service" (as defined
by the program and subject to certain limits) as well as capital costs and
ancillary costs. The Company is filing Routine Cost Limit Exception requests for
the facilities which exceed the limits and fit the criteria as exception
candidates. The Company may benefit from exceptions to the routine cost limits.
Allowable costs include nursing, administrative and general, dietary,
housekeeping, laundry, social services, activities, central supply, maintenance
and plant operations as well as ancillary and capital costs. There can be no
assurance that any such requests for the Routine Cost Limit Exception will be
granted.

     Congress passed a fiscal year 1995 budget reconciliation bill that
contained a provision that would have required Medicare to pay skilled nursing
facilities on a prospective payment basis beginning in October 1997. Although
this bill was ultimately vetoed by the President, the Clinton Administration had
proposed adopting prospective payment for skilled nursing facilities in 1999.
See the discussion of the Balanced Budget Act below for additional discussion
regarding the prospective payment system. Other legislative proposals, including
one adopted by the U.S. Senate, have called for developing a prospective payment
system for specialty medical care programs within acute care hospitals.
Proposals to reduce the growth in Medicare and Medicaid expenditures are under
active consideration in the current session of Congress. The Company cannot
predict at this time whether any of these proposals will be adopted or, if
adopted and implemented, what effect such proposals would have on the Company.
There can be no assurance that payments under state or federal governmental
programs will remain at levels comparable to present levels or will be
sufficient to cover the costs allocable to patients eligible for reimbursement
pursuant to such programs, particularly with respect to the Medicaid programs,
which generally provide lower reimbursement rates than the Medicare program.

                                       13
<PAGE>   14

     Balance Budget Act.  The Balanced Budget Act, signed into law on August 5,
1997, makes numerous changes to the Medicare and Medicaid programs which could
potentially affect the Company. With respect to the Medicare program, the new
law required the establishment of a prospective payment system for Medicare
skilled nursing facility services, under which facilities will be paid a federal
per diem rate for virtually all covered services. The prospective payment system
will be phased in over three cost reporting periods, starting with cost
reporting periods beginning on or after July 1, 1998. The Balanced Budget Act
also institutes consolidated billing for skilled nursing facility services,
under which payments for non-physician Part B services for beneficiaries no
longer eligible for Part A skilled nursing facility care will be made to the
facility, regardless of whether the item or service was furnished by the
facility, by others under arrangement or under any other contracting or
consulting arrangement, effective for items or services furnished on or after
July 1, 1998. Likewise, the Balanced Budget Act requires the Secretary of the
United States Health and Human Services ("HHS") to establish a prospective
payment system for home health services, to be implemented beginning October 1,
1999. The legislation also requires home health agencies to submit claims for
all services, and all payments will be made to the home health agencies
regardless of whether the item or service was furnished by the agency, by others
under arrangement or under any other contracting or consulting arrangement. The
law also contains provisions affecting outpatient rehabilitation agencies and
providers, including a 10 percent reduction in operating and capital costs for
1998, a fee schedule for therapy services beginning in 1999, and the application
of per beneficiary therapy caps currently applicable to independent therapists
to all outpatient rehabilitation services beginning in 1999. Other provisions
limit Medicare payments for certain drugs and biologicals, durable medical
equipment and parenteral and enteral nutrients and supplies.

     The Balanced Budget Act also contains a number of changes affecting the
Medicaid program. Significantly, the law repeals the so-called Boren Amendment,
which required state Medicaid programs to reimburse nursing facilities for the
costs that are incurred by efficiently and economically operated providers in
order to meet quality and safety standards. Effective for Medicaid services
provided on or after October 1, 1997, states will have considerable flexibility
in establishing payment rates. The Company is not able to predict whether any
states will adopt changes in their Medicaid reimbursement systems, or, if
adopted and implemented, what effect such initiatives would have on the Company.
Nevertheless, there can be no assurance that such changes in Medicaid
reimbursement to nursing facilities will not have an adverse effect on the
Company. Further, the Balanced Budget Act allows states to mandate enrollment in
managed care systems without seeking approval from the Secretary of HHS for
waivers from certain Medicaid requirements as long as certain standards are met.
These managed care programs have historically exempted institutional care.
However, no assurance can be given that these waiver provisions ultimately will
not change the reimbursement system for long-term care facilities from
fee-for-service to managed care negotiated or capitated rates or otherwise
affect the level of payments to the Company.

     Prospective Payment System.  In August 1997, the Balanced Budget Act was
passed mandating that traditional cost-based Medicare reimbursement for
long-term care transition into a per-diem prospective payment system ("PPS").
This legislation essentially requires providers to prospectively manage the care
of the patient and the resources that are consumed. Under PPS, each patient's
clinical status is evaluated and placed into a payment category. The patient's
payment category dictates the amount that the provider will receive to care for
the patient on a daily basis.

     PPS is required to be phased in over four years beginning on July 1, 1998.
The new federal rates that are utilized for Medicare reimbursement will be all
inclusive of routine, capital and ancillary costs. The facility specific rate
will be based upon 1995 allowable costs and will take exceptions into account if
approved for that year. Exemptions will be included, but capped at 150% of the
routine cost limit, and must be accounted for in a closed cost report prior to
October 1, 1995. PPS will be phased in as follows:

          Year 1: 25% of the federal rate and 75% of the facility specific rate.
          Year 2: 50% of the federal rate and 50% of the facility specific rate.
          Year 3: 75% of the federal rate and 25% of the facility specific rate.
          Year 4: 100% of the federal specific rate.

                                       14
<PAGE>   15

     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, the commencement of
activities and services for new home health agencies 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,
managed units and home health agencies. 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, home health agencies 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 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. 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 and other applicable requirements.

     Medicare Related Party Rule.  Subject to certain exceptions, Medicare's
related party rule generally requires that services between related entities be
charged 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 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 which event Mariner's revenues, profitability and financial
condition may be significantly and adversely affected.

     Inspections.  Federal, 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 submission of false claims, the payment,
receipt, solicitation or offering of any direct or indirect remuneration
                                       15
<PAGE>   16

intended to induce the referral of Medicare or Medicaid patients or for the
ordering or providing of Medicare or Medicaid covered services, items, equipment
or other prohibited activities including, fee splitting between healthcare
providers. These laws include the "anti-kickback" provisions of the federal
Medicare and Medicaid programs, which prohibit, among other things, knowingly
and willfully soliciting, receiving, offering or paying any remuneration
(including any kickback, bribe or rebate) directly or indirectly in return for
or to induce the referral of an individual to a person for the furnishing or
arranging for the furnishing of any item or service for which payment may be
made in whole or in part under Medicare or Medicaid. These laws also include the
"Stark legislations" which prohibit, with limited exceptions, the referral of
patients by physicians for certain services, including home health services,
physical therapy and occupational therapy, to an entity in which the physician
has an ownership interest. In addition, some states restrict certain business
relationships between physicians and other providers of healthcare services.
Where referrals to related organizations do occur, disclosures of the
relationship is required, and patient and families are presented patient care
alternatives other than the related organizations. 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 and civil and criminal 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. Although the Company has contractual arrangements with some
healthcare providers to which the Company pays fees for services rendered or
products provided, the Company believes that its practices are not in violation
of these laws. The Company cannot accurately predict whether enforcement
activities will increase or the effect of any such increase on its business.
There have also been a number of recent federal and state legislative and
regulatory initiatives concerning reimbursement under the Medicare and Medicaid
programs and compliance with applicable laws, rules and regulations, as well as
numerous civil and criminal investigations regarding the operations and business
practices of various healthcare providers. Accordingly, it is anticipated that
these areas will come under closer scrutiny by the government. The Company
cannot accurately predict the impact of any such initiatives. See "Risk
Factors -- Health Care Reform and Prospective Payment System."

     Additionally, the Health Insurance Fortability and Accountability Act of
1996 (the "Accountability Act") granted expanded enforcement authority to HHS
and the U.S. Department of Justice ("DOJ"), and provided enhanced resources to
support the activities and responsibilities of the Office of Inspector General
("OIG") and DOJ by authorizing large increases in funding for investigating
fraud and abuse violations relating to healthcare delivery and payment. The
Balanced Budget Act also includes numerous health fraud provisions, including
new civil money penalties for contracting with an excluded provider; new surety
bond and information disclosure requirements for certain providers and
suppliers; and an expansion of the mandatory and permissive exclusions added by
the Health Insurance Fortability and Accountability Act of 1996 to any federal
healthcare program (other than the Federal Employees Health Benefits Program).

     Management expects that business practices of providers and financial
relationships between providers will be subject to increased scrutiny as
healthcare reform efforts continue at federal and state levels. Although the
Company has contractual arrangements with some healthcare providers, it believes
that its practices are not in violation of these federal and state prohibitions.
Management cannot reasonably predict whether enforcement activities will
increase at the federal or state level or the effect of any such increase on the
business of the Company.

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. However, in certain states where the Company does business,
insurance regulations do not allow insurance coverage for punitive damages. Such
damages would be borne by the Company and could have a material adverse impact
on its business and results of operations. The award and amount of punitive
damages is difficult to predict and while the Company endeavors to provide
appropriate

                                       16
<PAGE>   17

reserves, there can be no assurance that such reserves are, in fact, adequate.
See Note 16 of the Consolidated Financial Statements appearing in Item 8 of this
Report.

EMPLOYEES

     As of December 31, 1997, Mariner employed approximately 17,000 full and
part-time employees. The employees at nine of Mariner's skilled nursing
facilities, representing approximately 5% of Mariner's work force, are
represented by labor unions. Two contracts are currently under negotiation, one
expires in December of 1998, two expire in January of 1999, one expires in March
of 1999 and the remainder after the first quarter of 1999. In addition, the
Company has experienced organizational activities at certain of its facilities.
Management cannot predict the impact of continued or increased union
representation or organizational activities on its future operations. Management
of Mariner considers the relationship between Mariner and its employees to be
good, but cannot predict whether it will face additional union activity.

     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 and other health care personnel. 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 1881 Worcester Road,
Framingham, Massachusetts, 01701. Information regarding other Mariner properties
and facilities appears under the heading "Facilities" in Item 1 of this Report.

ITEM 3.  LEGAL PROCEEDINGS

     Mariner is subject to claims, investigations and legal actions from time to
time. The Company's Massachusetts pharmacy operations were reviewed for certain
matters with respect to technical requirements. This review, paid and settled in
1997, did not have a material adverse effect on Mariner. Mariner has also
assumed claims and legal actions brought against certain of the companies and/or
assets which it has acquired, some of which 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. Many states, however, do not permit providers to insure against
punitive awards with respect to liability matters. In the event that a
significant punitive claim is awarded against Mariner, a material adverse impact
on Mariner's cash flow, resources, profitability and financial condition could
result. See "Risk Factors -- Uncertainty of Regulation."

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

     At the Company's annual meeting of stockholders held on December 17, 1997,
the Company's stockholders elected two Class I Directors to the Company's Board
of Directors and ratified the selection of Coopers & Lybrand, LLP as the
Company's auditors for fiscal year ended December 31, 1997. Mr. Christopher
Grant Jr. and Mr. John F. Robenault were reelected to the Board of Directors and
Messrs. David C. Fries, David N. Hansen, Samuel B. Kellett, Stiles A. Kellett,
Jr. and Dr. Arthur W. Stratton, Jr.'s terms were continued. With respect to the
election of directors, the votes cast as follows, for Mr. Grant, 26,381,682
voted for reelection, 0 voted against and 199,320 abstained. With respect to Mr.
Robenault, 26,382,732 voted for reelection, 0 voted against and 198,271
abstained. With respect to the

                                       17
<PAGE>   18

ratification of the auditors for the fiscal year 1997, the votes cast as
follows: 21,800,413 voted for the proposal, 3,976,588 voted against the proposal
and 804,002 abstained from voting on the proposal.

EXECUTIVE OFFICERS OF THE REGISTRANT

     The executive officers of the Company as of March 23, 1998, 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. ......  52    Chairman of the Board, President, Chief    1988-Present
                                            Executive Officer & Director
David N. Hansen.....................  45    Executive Vice President, Chief Financial  1996-Present
                                            Officer and Treasurer
Paul Diaz...........................  36    Executive Vice President and Chief         1997-Present
                                            Operating Officer
</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.

     Mr. Diaz joined Mariner in October, 1996 and has served as Chief Operating
Officer of the Company since November, 1997. Prior to that, he was President of
the Inpatient Division. Mr. Diaz served as Chief Executive Officer of Allegis
Health Services from January, 1995 until the company was purchased by Mariner in
October of 1996. He served as Chief Financial Officer and General Counsel of
Allegis Health Services from January, 1991 through December, 1994.

                                    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:

<TABLE>
<CAPTION>
                                                            HIGH        LOW
                          1997                              ----        ---
<S>                                                        <C>        <C>
4th Quarter..............................................  $17.125    $13.875
3rd Quarter..............................................   16.000     12.125
2nd Quarter..............................................   15.625      7.750
1st Quarter..............................................   10.250      8.125
</TABLE>

<TABLE>
<CAPTION>
                                                            HIGH        LOW
                          1996                              ----        ---
<S>                                                        <C>        <C>
4th Quarter..............................................  $15.250    $ 6.750
3rd Quarter..............................................   19.750     13.625
2nd Quarter..............................................   20.125     15.000
1st Quarter..............................................   20.125     14.875
</TABLE>

     On March 23, 1998 the closing sale price of the Common Stock was $15.75 per
share. As of March 23, 1998, there were approximately 965 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

                                       18
<PAGE>   19

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, 1997 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 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>
                                                      YEARS ENDED DECEMBER 31,
                                     ----------------------------------------------------------
                                       1993        1994        1995        1996         1997
                                     --------    --------    --------    --------    ----------
                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                  <C>         <C>         <C>         <C>         <C>
STATEMENT OF OPERATIONS DATA:
Net patient service revenue(1).....  $209,238    $260,357    $337,635    $578,755    $  714,623
Other income.......................     1,568       3,787      17,171      12,054        18,853
                                     --------    --------    --------    --------    ----------
Total operating revenue............   210,806     264,144     354,806     590,809       733,476
Operating expenses:
  Facility operating costs(2)......   167,785     208,691     276,633     465,226       563,646
  Corporate general and
     administrative expense(3).....    34,902      30,935      39,830      46,401        62,052
  Depreciation and amortization
     expense.......................     6,843       8,091      11,397      21,376        27,499
  Interest expense, net............     7,379       1,819       3,598      26,256        39,952
  Facility rent expense, net.......     1,079       1,739       1,830       3,727         4,421
  Asset Impairment loss............        --          --          --          --        10,486
                                     --------    --------    --------    --------    ----------
     Total operating expenses......   217,988     251,275     333,288     562,986       708,056
Operating income (loss)............    (7,182)     12,869      21,518      27,823        25,420
Net gain (loss) on sale of
  assets...........................       364         932          (6)       (826)       (2,920)
                                     --------    --------    --------    --------    ----------
Income (loss) before income taxes
  and extraordinary items..........    (6,818)     13,801      21,512      26,997        22,500
Net provision for income taxes.....    (3,220)     (5,848)     (7,892)    (10,799)      (10,913)
                                     --------    --------    --------    --------    ----------
Income (loss) from continuing
  operations before extraordinary
  items............................   (10,038)      7,953      13,620      16,198        11,587
  Extraordinary items..............    (5,882)        (86)     (1,138)         --            --
                                     --------    --------    --------    --------    ----------
     Net income (loss).............  $(15,920)   $  7,867    $ 12,482    $ 16,198    $   11,587
                                     ========    ========    ========    ========    ==========
Income (loss) per common and common
  equivalent shares:
Income (loss) from operations
  before extraordinary items.......  $  (0.92)   $   0.41    $   0.60    $   0.55    $     0.39
  Extraordinary items..............      (.51)         --        (.05)         --            --
                                     --------    --------    --------    --------    ----------
  Net Income (loss)................  $  (1.43)   $    .41    $    .55    $    .55    $      .39
                                     ========    ========    ========    ========    ==========
</TABLE>

                                       19
<PAGE>   20

<TABLE>
<CAPTION>
                                                      YEARS ENDED DECEMBER 31,
                                     ----------------------------------------------------------
                                       1993        1994        1995        1996         1997
                                     --------    --------    --------    --------    ----------
                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                  <C>         <C>         <C>         <C>         <C>
Income (loss) per share:
  diluted..........................  $  (1.43)   $   0.41    $   0.55    $   0.55    $     0.39
  basic............................  $  (1.43)   $   0.42    $   0.55    $   0.56    $     0.40
Weighted average number of shares
  outstanding:
  diluted..........................    11,106      19,251      22,755      29,210        29,885
  basic............................    11,106      18,911      22,502      28,721        29,226
</TABLE>

<TABLE>
<CAPTION>
                                                      YEAR ENDED DECEMBER 31,
                                     ----------------------------------------------------------
                                       1993        1994        1995        1996         1997
                                     --------    --------    --------    --------    ----------
                                                           (IN THOUSANDS)
<S>                                  <C>         <C>         <C>         <C>         <C>
BALANCE SHEET DATA:
Working capital....................  $ 55,348    $ 71,217    $ 74,148    $ 68,154    $  102,253
Total assets.......................   208,467     296,933     411,526     881,233     1,075,769
Long-term debt and capital lease
  obligations, less current
  portion..........................    36,874      24,506     107,910     265,545       420,759
Subordinated debt..................     2,611       1,694       1,356     149,691       149,724
Convertible redeemable preferred
  stock(4).........................       790         891       1,030          --            --
Total stockholders' equity.........   127,229     228,148     242,392     324,788       340,818
</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. Includes approximately $7,180,000 in
    1997 for office closings, abandonment of certain furniture and equipment and
    other expenses related to the consolidation of the Company's rehabilitation
    business. 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 MedRehab Merger which was accounted for as a pooling of
    interests and $850,000 was a charge for the warrants granted to the Premier
    affiliate.

    In 1997, corporate, general and administrative expense includes
    approximately $5,713,000 for severance, payroll and relocation, $2,077,000
    for office closings and related expenses and $1,534,000 related to bank fees
    incurred for a certain transaction.

(4) Converted into shares of Common Stock upon the closing of the Company's
    initial public offering in 1993 and the 1996 MedRehab Merger.

                                       20
<PAGE>   21

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 current 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,
rehabilitation and medically demanding subacute 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 1997 the Company added four facilities with a total of 587 beds.
Since these acquisitions, the Company has been focusing 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. 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 23 days in 1996 to 25
days in 1997. The bed turnover rate for the inpatient facilities owned or leased
by the Company during the applicable period has decreased from 2.1 times in 1996
to 2.0 times in 1997. The increase in median length of stay and decrease in bed
turnover rate from 1996 to 1997 resulted principally from the acquisition of
four facilities in 1997 as well as inclusion for a full year of the facilities
acquired in connection with the Allegis Transaction, which facilities had a
significantly higher level of Medicaid patients. 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.

                                       21
<PAGE>   22

     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 74% in 1996
to 69% in 1997. The decrease in payor mix from 1996 to 1997 resulted principally
from the result of a full year of revenue generated from the facilities acquired
in 1996 which are more heavily dependent on Medicaid reimbursement.

     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
increased from $34,046 per bed in 1996 to $38,231 per bed in 1997. This increase
was primarily due to the increase in the percentage of revenues derived from
states in the Mid-Atlantic region, which have higher Medicaid rates than the
Florida and Texas 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 has increased from 429 as of December 31, 1996 to 480 as of
December 31, 1997. This increase was principally the result of the Prism and
other rehabilitation acquisitions in 1997.

     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.

     As a result of these trends, Mariner's average revenue per occupied bed per
year increased from $58,795 in 1996 to $59,396 in 1997. Revenue per
rehabilitation program increased from $412,265 in 1996 to $478,473 in 1997.
These trends are illustrated in the following table:

<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                             --------------------------------
                                                               1995        1996        1997
                                                             --------    --------    --------
<S>                                                          <C>         <C>         <C>
Inpatient Operations
  Licensed beds(1).........................................     4,397       9,962      10,140
  Average occupancy rates..................................       88%         88%         90%
  Median length of stay(2).................................   20 days     23 days     25 days
  Bed turnover rate(3).....................................      2.7x        2.1x        2.0x
  Revenue per occupied bed per year(4):
     Private payors and Medicare(5)........................  $101,863    $ 93,189    $ 95,913
     Medicaid..............................................  $ 36,685    $ 34,046    $ 38,231
     Company as a whole....................................  $ 61,495    $ 58,795    $ 59,396
  Percentage of average daily census:
     Private payors and Medicare(5)........................       38%         42%         37%
     Medicaid..............................................       62%         58%         63%
Rehabilitation Operations:
  Revenue per rehabilitation program per year(6)...........  $318,088    $412,265    $478,473
Payor Mix (Company revenue as a whole):
  Private payors and Medicare(5)...........................       79%         74%         69%
  Medicaid.................................................       21%         26%         31%
</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.

                                       22
<PAGE>   23

(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 income."

(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.

     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:

<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              ------------------------
                                                              1995      1996      1997
                                                              ----      ----      ----
<S>                                                           <C>       <C>       <C>
Sites of Service:
Owned and leased freestanding inpatient facilities..........    33        75(1)    76
Managed freestanding inpatient facilities and hospital-based
  units.....................................................    29(1)      8       57
Rehabilitation programs with skilled nursing facilities.....   440       429      480
Outpatient rehabilitation clinics...........................    57        48       42
</TABLE>

---------------
(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 seeks to acquire established skilled nursing facilities and convert
them into facilities focusing increasingly on treating medically demanding and
rehabilitation 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 a length 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 seeks to develop 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.

                                       23
<PAGE>   24

     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.

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,
1995, 1996 and 1997, and the percentage changes in the dollar amounts of revenue
and expenses for 1996 as compared to 1995, and 1997 as compared to 1996.

<TABLE>
<CAPTION>
                                                                                  PERCENTAGE
                                                                                   INCREASE
                                                       PERCENT OF REVENUE         (DECREASE)
                                                     -----------------------    --------------
                                                     YEAR ENDED DECEMBER 31,    1996     1997
                                                     -----------------------    OVER     OVER
                                                     1995     1996     1997     1995     1996
                                                     -----    -----    -----    -----    -----
<S>                                                  <C>      <C>      <C>      <C>      <C>
Revenues:
Net patient service revenue(1).....................   95.2%    98.0%    97.4%    71.4%    23.5%
Other revenue......................................    4.8      2.0      2.6    (29.8)    56.4
                                                     -----    -----    -----
Total operating revenue............................  100.0%   100.0%   100.0%    66.5%    24.1%
                                                     =====    =====    =====
Operating and administrative expenses:
Facility operating costs(2)........................   78.0     78.7     76.8     68.2     21.2
Corporate general & administrative(3)..............   11.2      7.9      8.5     16.5     33.7
Interest expense, net..............................    1.0      4.4      5.4    629.7     52.2
Facility rent expense, net.........................    0.5      0.6      0.6    103.7     18.6
Depreciation and amortization......................    3.2      3.6      3.7     87.6     28.6
Asset impairment charge............................     --       --      1.4       --    100.0
                                                     -----    -----    -----
Total operating expenses...........................   93.9%    95.2%    96.4%    68.9%    25.8%
                                                     =====    =====    =====
</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.
    Includes approximately $7,180,000 in 1997 for office closings, abandonment
    of certain furniture and equipment and other expenses related to certain
    transactions.

(3) 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 MedRehab Merger with and issuance of warrants amounting to 1.2% of
    revenue for the year ended December 31, 1996. In 1997, Corporate general and
    administrative expense includes $5,713,000 for severance, payroll and
    relocation, $2,077,000 for office closings and related expenses and
    $1,534,000 related to bank fees incurred for a certain transaction.

YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

     Revenue.  Total operating revenue increased 67% from $354,806,000 in 1995
to $590,809,000 in 1996 and 24% to $733,476,000 in 1997.

     Net patient service revenue increased by $241,120,000, or 71%, from 1995 to
1996 and by $135,868,000, or 24%, from 1996 to 1997. The increase in 1996 was
due primarily to the inclusion of revenue generated 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 increase in revenue in 1997 was primarily due to the
inclusion of revenue generated from additional rehab contracts and inpatient
revenues from four additional

                                       24
<PAGE>   25

facilities added during the year and a full year of revenue from the Allegis
acquisition. The Company also experienced increases in the use of ancillary
medical services at its inpatient facilities. The revenue increases in 1996 and
1997 were partially offset by reductions due to the cancellation or non-renewal
of contracts for certain rehabilitation programs.

     Other revenue increased $6,799,000 or 56% from 1996 to 1997. This increase
was due primarily from the Company's management activities related to subacute
care units and facilities and consulting fees generated from services provided
to certain rehabilitation clients. In 1995, this 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.

     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. 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 68% from $276,633,000 in 1995 to
$465,226,000 in 1996 and 21% to $563,646,000 in 1997. 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 acquired in 1997. In 1997, Facility operating costs included
approximately $7,180,000 in office closings, abandonment of certain furniture
and equipment and other expenses related to consolidation of the Company's
rehabilitation operations. In addition, these costs included $4,333,000 related
to a significant change in business focus at the Company's Baltimore facilities
in 1995. As a percentage of total operating revenue, these costs increased from
78.0% in 1995 to 78.7% in 1996 and decreased to 76.8% in 1997.

     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 17% from
$39,830,000 in 1995 to $46,401,000 in 1996 and 34% to $62,052,000 in 1997. The
increases were, in part, a result of additional personnel required to support
the facilities acquired during 1995, 1996 and 1997.

     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.

     In 1997, corporate general and administrative expense includes
approximately $5,713,000 for severance, payroll and relocation, $2,077,000 for
office closings and related expenses and $1,534,000 related to bank fees
incurred related to the Prism Merger.

     As a percentage of total operating revenue, corporate general and
administrative expenses were 11% in 1995, 8% in 1996 and 9% in 1997.

                                       25
<PAGE>   26

     Interest Expense, Net.  Net interest expense increased 630% from $3,598,000
in 1995 to $26,256,000 in 1996 and 52% to $39,952,000 in 1997. The increases
were the result of the Notes issued in April 1996, debt assumed in businesses
acquired during these periods, increased interest rates on borrowings and
additional borrowings which were primarily used to fund acquisitions.

     Facility Rent Expense, Net.  Net rent expense increased 104% from
$1,830,000 in 1995 to $3,727,000 in 1996, and 19% to $4,421,000 in 1997. This
expense is related to a facility leased under a sale/leaseback arrangement and
facilities leased in connection with the CSI, 1996 Florida Acquisition and
Allegis transactions. The increases resulted from the lease costs associated
with new leases in connection with acquisitions during 1996 and a full year of
rent expense in 1997 related to the Allegis and 1996 Florida Acquisition
transactions in 1996.

     Depreciation and Amortization.  Depreciation and amortization expense
increased 88% from $11,397,000 in 1995 to $21,376,000 in 1996, and 29% to
$27,499,000, 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, the completion of facility renovations and increased goodwill
amortization.

     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 reflected this in its tax rate in 1996. In 1997 the Company's
effective tax rate was 48.5%, significantly above the statutory rate primarily
due to non-deductible amortization of goodwill from certain transactions.

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

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, sales of debt securities and borrowings under its Credit Facility. As
of December 31, 1997, working capital and cash and cash equivalents were
$102,253,000 and $3,627,000, respectively.

     Mariner has a $460,000,000 senior secured revolving credit facility with a
syndicate of banks (the "Credit Facility"). On October 3, 1997, the Company
entered into an amendment to the Credit Facility to increase borrowing capacity
to $325,000,000 from $250,000,000. As of January 2, 1998 the terms were amended
to increase the size of the Credit Facility to $460,000,000, 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 December 31, 1996 and 1997, principal balances outstanding under its
Credit Facility were approximately $132,000,000 and $301,000,000, respectively,
and letters of credit outstanding under this facility were approximately
$5,499,000 and $6,715,000, respectively. As of December 31, 1997 the Letters of
Credit under the Credit Facility included $5,624,000 that related to workers'
compensation insurance and $1,091,000 associated with debt and other agreements.
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
collateralized by mortgages on certain inpatient facilities of the Company's,
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 January 2, 2003 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;

                                       26
<PAGE>   27

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 $126,938,000 and $154,162,000
at December 31, 1996 and 1997, respectively. Estimated settlements due from
third-party payors aggregated $18,912,000 and $34,335,000 at December 31, 1996
and 1997, respectively. The number of days sales in accounts receivable and
estimated settlements due from third-party payors was approximately 78 days at
December 31, 1996 and 82 days at December 31, 1997. The increase was primarily
due to the change in fiscal intermediary during the second quarter of 1997 which
resulted in processing delays related to its estimated settlements and an
increase in accounts receivable at certain facilities acquired during 1997.

     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 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 $1,500,000 in cash which was
financed under the Credit Facility. This investment was subsequently written off
in 1997.

                                       27
<PAGE>   28

     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 its 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.

1997

     1997 Facility Acquisitions.  During 1997, the Company acquired four skilled
nursing facilities with a total of 587 beds in the Baltimore metropolitan area
for a total purchase price of approximately $37,000,000 (the "1997 Facility
Acquisitions"). The Company borrowed approximately $37,000,000 under its Credit
Facility to finance these acquisitions. Goodwill of $22,000,000 was recorded in
connection with these acquisitions.

     Prism and Related Rehabilitation Transaction.  In October 1997, the Company
completed its merger with Prism Health Group, Inc. (the "Prism Merger"). All of
the issued and outstanding shares of Prism capital stock were converted into the
right to receive an aggregate of approximately $84,300,000 in cash. In
connection with the Prism Merger the Company also repaid approximately
$9,500,000 in assumed debt and paid expenses of approximately $700,000 prior to
the closing. Goodwill of approximately $91,000,000 was recorded in connection
with this transaction. The Company borrowed approximately $94,500,000 under its
Credit Facility to finance the Prism Merger.

     In June, 1997, the Company also acquired another rehabilitation company for
a total purchase price of approximately $15,403,000. The Company made an initial
payment of $2,000,000 and in 1998 paid an additional $3,135,000. These amounts
were funded under the Company's Credit Facility. In addition, the Company
entered into a 3 year, 7% interest bearing note for $5,134,000. The Company also
agreed to pay the remaining $5,134,000 in contingent consideration over the next
three years provided certain financial targets were met. Goodwill of $2,552,000
was recorded in connection with this acquisition.

     The assets acquired and liabilities assumed in connection with the
aforementioned mergers and acquisitions have been included in the financial
statements based on preliminary estimates of fair values and may be revised as
additional information becomes available. As a result, the financial information
included in the financial statements is subject to adjustment from subsequent
revisions and estimates of fair value if any are necessary.

     Joint Ventures.  The Company entered into three joint venture arrangements
in connection with three of its facilities located in Maryland and North
Carolina. The Company retained a 50% interest in two of the facilities and 60%
in the third facility. The Company received a total of $5,349,000 of capital
contributions from its joint venture partners and recognized a gain of
approximately $1,659,000 from these transactions.

                                       28
<PAGE>   29

     Dispositions.  The Company executed agreements to sell two nursing
facilities in non-strategic locations. Total sales proceeds were $4,890,000 and
a net pretax loss of $4,579,000 was recorded. For 1997, these facilities
generated aggregate net revenues of $6,849,000 and income from continuing
operations of $550,000.

     From January 1, 1998 through March 25, 1998, the Company also borrowed
approximately $10,500,000 under the Credit Facility primarily to fund capital
expenditures.

     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, 1996
and 1997 were approximately $22,502,000 and $37,173,000, respectively. The
Company's capital expenditures in 1997 included approximately $6,000,000 for
improvements to the Company's information systems. The Company has currently
budgeted approximately $45,000,000 for capital expenditures during 1998. The
Company's currently planned capital expenditures include approximately
$9,000,000 for upgrading the Company's information systems, approximately
$21,000,000 for expansion of existing facilities, as well as the costs of
maintaining the Company's inpatient facilities and offices, and approximately
$12,000,000 for the completion of three new inpatient sites begun in 1997.

     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, 1998.

RECENTLY ISSUED PRONOUNCEMENTS

     Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," was issued in June 1997. This statement establishes
standards for reporting and displaying comprehensive income and its components
in the financial statements.

     SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was also issued in June 1997. This statement requires that public
business enterprises report certain information about operating segments and
related disclosures about products and services, geographic areas and major
customers.

     SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" was issued in February 1998. This statement
standardizes disclosure requirements for pension and other postretirement
benefits, requires additional information on changes in benefit obligations and
fair values of plan assets, and eliminates certain existing disclosure
requirements.

     SFAS Nos. 130, 131 and 132 become effective in the Company's fiscal year
ending December 31, 1998. The adoption of these statements are expected to have
no impact on the Company's results of operations, financial position or cash
flows and to produce no major changes in current disclosures.

     The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants issued Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," in March 1998. This statement provides guidance as to whether
certain internal-use software costs should be capitalized as a long-lived asset
or expensed when incurred. SOP 98-1

                                       29
<PAGE>   30

becomes effective in the Company's fiscal year ending December 31, 1998, but may
be adopted earlier. The Company is in the process of evaluating the requirements
of SOP 98-1, but does not expect that it will materially affect its results of
operations, financial position or cash flows. The Company has not yet decided
whether it will adopt this standard in 1998.

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.

                                       30
<PAGE>   31

                                  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, 1995, 1996 and 1997, the
Company derived 21%, 26%, and 31% respectively, of its revenue from Medicaid
programs and 29%, 37%, and 35%, 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 which 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" See
"Government Regulation -- Medicare Related Party Rule" as defined in Item 1 of
this Report. 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.

     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 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

                                       31
<PAGE>   32

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 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. Due to
the foregoing factors, among others, it is possible that the Company's results
of operations could fail to meet the expectations of securities analysts or
investors. In such event, or in the event that adverse conditions prevail or are
perceived to prevail, the price of the Company's Common Stock would likely be
materially adversely affected.

HEALTH CARE REFORM

     The recently enacted Balanced Budget Act is intended to reduce Medicare
payments by $115 billion over the next five years and makes extensive changes in
the Medicare and Medicaid programs. In addition, private payors, including
managed care payors, increasingly are demanding discounted fee structures and
the assumption by healthcare providers of all or a portion of the financial risk
of caring for patients. Efforts to impose greater discounts and more stringent
cost controls by private payors are expected to continue. There can be no
assurances that adequate reimbursement levels will continue to be available for
services provided by the Company which are currently being reimbursed by
Medicare, Medicaid or private payors. Significant limits on the scope of
services reimbursed and on reimbursement rates and fees could have a material
adverse effect on the Company's liquidity, financial condition and results of
operations. In January, 1998, the Health Care Finance Administration ("HCFA")
published new salary equivalency guidelines. These guidelines, which are
effective April 1, 1998, will be used by Medicare fiscal intermediaries to
determine the maximum allowable costs for rehabilitation services. Mariner is
currently evaluating the effects of these new guidelines.

     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. The final provisions of the Balanced Budget Act
have yet to be published and may be in force before public comment. The details
of the final implementation of regulations may contain provisions which have an
adverse effect on operations and payment. Additionally, provisions of the
Balanced Budget Act may temporarily disrupt cash flow if the government's fiscal
intermediaries fail to react in a timely fashion to the final regulations. 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 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. See "Business -- Government
Regulation" in Item 1 of this Report.

                                       32
<PAGE>   33

PROSPECTIVE PAYMENT SYSTEM

     In August 1997, the Balanced Budget Act was passed mandating that
traditional cost-based Medicare reimbursement for long-term care transition into
a per-diem Prospective Payment System ("PPS"). This legislation essentially
requires providers to prospectively manage the care of the patient and the
resources that are consumed. Under PPS, each patient's clinical status is
evaluated and placed into a payment category. The patient's payment category
dictates the amount that the provider will receive to care for the patient on a
daily basis.

     PPS is required to be phased in over four years beginning on July 1, 1998.
The new federal rates that are utilized for Medicare reimbursement will be all
inclusive of routine, capital and ancillary costs. The facility specific rate
will be based upon 1995 allowable costs and will take exceptions into account if
approved for that year. Exemptions will be included, but capped at 150% of the
routine cost limit, and must be accounted for in a closed cost report prior to
October 1, 1995. PPS will be phased in as follows:

          Year 1:  25% of the federal rate and 75% of the facility specific
rate.
          Year 2:  50% of the federal rate and 50% of the facility specific
rate.
          Year 3:  75% of the federal rate and 25% of the facility specific
rate.
          Year 4:  100% of the federal specific rate.

     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 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.

                                       33
<PAGE>   34

     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. During 1997 both federal and various state governments and the
federal government initiated numerous probes and investigations regarding the
health care industry's operations and practices with a particular emphasis on
billing practices and cost reporting practices. The federal government has and
continues to marshall significant resources in pursuing and investigating fraud
and abuse and false claim allegations. In addition, the government is actively
soliciting cooperation from knowledgeable current or former employees to report
suspected wrongdoing. State attorneys general and various branches of the
federal government have indicated a desire to continue the aggressive pursuit of
investigations and to impose both criminal and civil penalties and sanctions. In
the event that Mariner becomes a target of such an investigation, it could have
a significant adverse impact on Mariner's operations, profitability, growth
strategy and financial condition. 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 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
                                       34
<PAGE>   35

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.

     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, 1997, the Company had approximately $584 million of
outstanding indebtedness, which represented 63% of its total capitalization. In
addition, the Company had approximately $17 million of
                                       35
<PAGE>   36

availability under the Credit Facility. In 1997, the Company requested that its
lenders increase the size of the Credit Facility to $460 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 on January 2, 1998. 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 debt service
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 collateralized 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 covenants.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" in Item 7 of this Report.

                                       36
<PAGE>   37

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, nurses aides 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. The employees at nine of Mariner's skilled nursing
facilities, representing approximately 5% of Mariner's work force, are
represented by labor unions. Two contracts are currently under negotiation, one
expires in December, 1998, two expire in January of 1999 and the remainder after
the second quarter of 1999. In addition, the Company has experienced
organizational activities at certain of its facilities. Management cannot
predict the impact of continued or increased union representation or
organizational activities on its future operations. Management of Mariner
considers the relationship between Mariner and its employees to be good, but
cannot predict whether it will face additional union activity. 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
increased from 429 as of December 31, 1996 to 480 as of December 31, 1997. In
addition, each year a number of contracts have been canceled or not renewed by
the Company or its clients. In October, 1997 the Company completed the Prism
Merger, which added rehabilitation services contracts for approximately 150
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" in Item 1
of this Report.

                                       37
<PAGE>   38

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.

CONTROL BY SIGNIFICANT STOCKHOLDERS

     As of March 23, 1998 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 two seats 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 subsidiaries. As of March 25, 1998, 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 $449.6
million. In addition, under the Indenture, the Company would have been permitted
to borrow up to an additional $148.5 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
                                       38
<PAGE>   39

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 25, 1998 the
Company's subsidiaries would have had approximately $138.1 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 are not
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 separate and distinct legal entities and have no obligation, contingent or
otherwise, to pay amounts due pursuant to the Notes or to make any funds
available therefore. 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
indebtedness of such subsidiaries, including covenants which restrict in certain
circumstances the payment of dividends and distributions and the transfer of
assets to the Company.

IMPACT OF THE YEAR 2000 ISSUE

     The Company has made an initial review of issues related to the Year 2000
and does not expect that it will have a material impact on the Company's
business, operations or financial condition. However, the Company could be
adversely impacted by the Year 2000 issue if its key suppliers and other third
parties do not address the issue successfully. The Company is addressing these
risks in order to reduce the impact on the Company.

                                       39
<PAGE>   40

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                       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, 1996 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 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 10, 1998

                                       40
<PAGE>   41

                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                (IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                              DECEMBER 31,   DECEMBER 31,
                                                                  1996           1997
                                                              ------------   ------------
<S>                                                           <C>            <C>
                                         ASSETS
Current Assets:
  Cash and cash equivalents.................................    $  4,616      $    3,627
  Accounts receivable, less allowance for doubtful accounts
     of $11,872 and $16,046 respectively....................     126,938         154,162
  Estimated settlements due from third-party payors.........      18,912          34,335
  Prepaid expenses and other current assets.................       8,880          19,268
  Deferred income tax benefit...............................      11,008           8,560
                                                                --------      ----------
     Total current assets...................................     170,354         219,952
Property, plant and equipment, net..........................     386,425         415,948
Goodwill, net of accumulated amortization of $10,561 and
  $18,170, respectively.....................................     280,803         382,459
Intangible and other assets, net of accumulated amortization
  of $5,813 and $7,315, respectively........................      20,991          24,670
Restricted cash and cash equivalents........................       2,885           2,888
Deferred income tax benefit.................................      19,775          29,852
                                                                --------      ----------
          Total assets......................................    $881,233      $1,075,769
                                                                ========      ==========
                          LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Current maturities of long-term debt and capital lease
     obligations............................................    $  8,030      $   13,911
  Accounts payable..........................................      31,024          26,943
  Accrued payroll...........................................       9,944          17,454
  Accrued vacation..........................................       8,235          10,955
  Other accrued expenses....................................      41,141          44,874
  Deferred income taxes.....................................          25              43
  Other liabilities.........................................       3,801           3,519
                                                                --------      ----------
     Total current liabilities..............................     102,200         117,699
Long-term debt and capital lease obligations................     415,236         570,483
Deferred income taxes.......................................      18,073          17,307
Deferred gain...............................................       1,955           1,789
Other long-term liabilities.................................      18,981          27,673
                                                                --------      ----------
     Total liabilities......................................     556,445         734,951
Commitments and contingencies (Note 16)
Stockholders' equity
Common stock, $.01 par value; 50,000,000 shares authorized;
  28,978,225 and 29,447,614 issued and outstanding at
  December 31, 1996 and 1997, respectively..................         290             295
Additional paid-in capital..................................     312,786         317,216
Unearned compensation.......................................          (8)             --
Retained earnings...........................................      11,720          23,307
                                                                --------      ----------
     Total stockholders' equity.............................     324,788         340,818
                                                                --------      ----------
          Total liabilities and stockholders' equity........    $881,233      $1,075,769
                                                                ========      ==========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.
                                       41
<PAGE>   42

                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

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

<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                             --------------------------------
                                                               1995        1996        1997
                                                             --------    --------    --------
<S>                                                          <C>         <C>         <C>
Net patient service revenue................................  $337,635    $578,755    $714,623
Other revenue..............................................    17,171      12,054      18,853
                                                             --------    --------    --------
Total operating revenue....................................   354,806     590,809     733,476
                                                             --------    --------    --------
Operating expenses:
  Facility operating costs.................................   276,633     465,226     563,646
  Corporate general and administrative expense.............    39,830      46,401      62,052
                                                             --------    --------    --------
                                                              316,463     511,627     625,698
  Interest expense.........................................     4,440      26,853      40,327
  Interest income..........................................      (842)       (597)       (375)
  Facility rent expense, net...............................     1,830       3,727       4,421
  Depreciation and amortization expense....................    11,397      21,376      27,499
  Asset impairment loss....................................        --          --      10,486
                                                             --------    --------    --------
     Total operating expenses..............................   333,288     562,986     708,056
Operating income...........................................    21,518      27,823      25,420
Net loss on sale of assets.................................        (6)       (826)     (2,920)
                                                             --------    --------    --------
Income before income taxes and extraordinary items.........    21,512      26,997      22,500
Net provision for income taxes.............................    (7,892)    (10,799)    (10,913)
                                                             --------    --------    --------
Income before extraordinary items..........................    13,620      16,198      11,587
Extraordinary items........................................    (1,138)         --          --
                                                             --------    --------    --------
Net income.................................................  $ 12,482    $ 16,198    $ 11,587
                                                             ========    ========    ========
Net income per diluted share:
  Income from continuing operations before extraordinary
     items.................................................     $0.60       $0.55       $0.39
  Extraordinary items......................................     (0.05)         --          --
                                                             --------    --------    --------
  Net income per diluted share.............................     $0.55       $0.55       $0.39
                                                             ========    ========    ========
Income per share
  diluted..................................................     $0.55       $0.55       $0.39
  basic....................................................     $0.55       $0.56       $0.40
Shares used in per share computation:
  diluted..................................................    22,755      29,210      29,885
  basic....................................................    22,502      28,721      29,226
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.
                                       42
<PAGE>   43

                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                   YEARS ENDED DECEMBER 31,
                                                              ----------------------------------
                                                                1995        1996         1997
                                                              --------    ---------    ---------
<S>                                                           <C>         <C>          <C>
Cash flows provided by (used in) operating activities:
  Net income................................................  $ 12,482    $  16,198    $  11,587
  Adjustments to reconcile net income to cash provided by
    (used in) operating activities:
  Depreciation and amortization.............................    11,418       22,274       28,781
  Amortization of deferred gain.............................    (1,468)        (167)        (156)
  Amortization of stock plan................................        --           --            8
  Loss on facility closure..................................     1,801          826           --
  Extraordinary item-loss due to early retirement of debt...     1,138           --           --
  Non-recurring charges.....................................        --          850           --
  Net loss on disposal of assets............................        20        1,061        4,420
  Asset impairment loss.....................................        --           --       10,486
  Earnings from partnerships................................       (14)          --           --
  Provisions for bad debt...................................     3,698        2,738        4,448
  Deferred income taxes.....................................      (824)       6,313        2,881
  Changes in operating assets and liabilities:
  Increase in accounts receivable...........................   (40,787)     (24,848)     (19,080)
  (Increase) decrease in estimated settlements from third
    party payors............................................    (7,156)         235      (13,621)
  (Increase) decrease in prepaid expenses and other current
    assets..................................................    (3,397)       1,059       (9,741)
  Increase (decrease) in accounts payable...................     3,778       10,968       (4,845)
  Increase (decrease) in accrued liabilities................     6,884       (4,779)      (3,773)
  Decrease in other current liabilities.....................      (166)      (6,921)         298
                                                              --------    ---------    ---------
    Net cash provided by (used in) operating activities.....   (12,593)      25,807       11,693
                                                              --------    ---------    ---------
Cash flows used in investing activities:
  Purchase of property, plant and equipment.................   (11,943)     (22,502)     (37,173)
  Proceeds from sale of plant, property and equipment.......        --        3,080        4,890
  Increase in other assets..................................    (3,210)     (35,500)      (9,732)
  Payments related to prior acquisitions....................     1,055           --       (2,062)
  (Increase) decrease in restricted cash....................       756            4           (3)
  Cash paid for acquisitions, net of cash acquired..........   (52,389)    (168,697)    (138,789)
  Purchase deposits.........................................   (19,500)          --           --
                                                              --------    ---------    ---------
    Net cash used in investing activities...................   (85,231)    (223,615)    (182,869)
                                                              --------    ---------    ---------
Cash flows from financing activities:
  Drawings on line of credit................................    80,775      217,481      319,000
  Proceeds from debt offering, net..........................        --      149,666           --
  Repayments of debt........................................   (17,921)    (173,063)    (158,232)
  Exercise of stock options.................................     1,008        3,887        3,595
  Shares issued under employee stock purchase plan..........       400          310          475
  Investments from joint venture partners...................        --           --        5,349
  Other increases from financing activities.................       439           57           --
                                                              --------    ---------    ---------
    Net cash provided by financing activities...............    64,701      198,338      170,187
                                                              --------    ---------    ---------
Increase (decrease) in cash and cash equivalents............   (33,123)         530         (989)
Cash and cash equivalents at beginning of year..............    37,209        4,086        4,616
                                                              --------    ---------    ---------
Cash and cash equivalents at end of year....................  $  4,086    $   4,616    $   3,627
                                                              ========    =========    =========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.
                                       43
<PAGE>   44

                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
                       (IN THOUSANDS, EXCEPT SHARE DATA)

                                  COMMON STOCK

<TABLE>
<CAPTION>
                                                                                     RETAINED
                                                       ADDITIONAL                    EARNINGS
                                                PAR     PAID-IN       UNEARNED     (ACCUMULATED
                                   SHARES      VALUE    CAPITAL     COMPENSATION     DEFICIT)      TOTAL
                                 -----------   -----   ----------   ------------   ------------   --------
<S>                              <C>           <C>     <C>          <C>            <C>            <C>
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 purchase 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
     options...................                              326                                       326
  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
  Net income...................                                                        11,587       11,587
  Exercise of options..........      402,753      5        3,590                                     3,595
  Shares purchased under
     Employee Stock Purchase
     Plan......................       66,636                 475                                       475
  Issuance of Common Stock Tax
     benefit arising from
     exercise of employee stock
     options...................                              365                                       365
  Amortization of stock plan
     expense...................                                            8                             8
                                 -----------   ----     --------       -----         --------     --------
Balance at December 31, 1997...   29,447,614   $295     $317,216          --         $ 23,307     $340,818
                                 ===========   ====     ========       =====         ========     ========
</TABLE>

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

                                       44
<PAGE>   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
and any investments in which the Company has a controlling financial interest.
All significant intercompany accounts and transactions have been eliminated in
consolidation.

  Reclassifications

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

  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 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

                                       45
<PAGE>   46
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 which 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 the Health Care Finance Administration
("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 has promulgated new salary equivalency
guidelines

                                       46
<PAGE>   47
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

which will update current physical therapy and respiratory therapy rates and
establish new guidelines for occupational therapy and speech therapy. Mariner is
in the process of determining whether these new proposals will have a material
effect on its rehabilitation operations. 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, had 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, in the third
quarter of 1996, 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, many of which were subsequently
acquired. 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, 1995, 1996 and 1997 of $50,738,000, $69,950,000 and $132,862,000
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, 1995, 1996 and 1997, were
$225,895,000, $395,276,000 and $430,784,000 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. Interest associated with construction
projects is capitalized and included in the basis of the property.

     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

        Software -- 3-7 years

                                       47
<PAGE>   48
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

  Impairment of Long-Lived Assets

     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 determined in connection with
various refinancings.

     During 1997, the Company recorded losses on long-lived assets where those
events or circumstances indicated that the assets were impaired. The impairment
charge was the difference between the carrying value and the estimated fair
value of the assets. The Company estimated fair values based on sales prices for
comparable assets. The total impairment of long-lived assets was $10,486,000,
$5,400,000 after income taxes, of which $2,886,000 related to various physician
practices and $2,514,000 related to skilled nursing facilities.

  Goodwill, Intangibles and Other Assets

     Goodwill, intangibles and other assets primarily consist of amounts
identified in connection with certain 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, 1995, 1996 and 1997 was $3,112,000,
$6,158,000 and $8,911,000 respectively.

  Income Taxes

     The Company follows the provisions of Statement of Financial Accounting
Standards (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

     During 1997, the Company adopted SFAS 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. See Note 18.

  Recently Issued Pronouncements

     Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," was issued in June 1997. This statement establishes
standards for reporting and displaying comprehensive income and its components
in the financial statements.

                                       48
<PAGE>   49
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was also issued in June 1997. This statement requires that public
business enterprises report certain information about operating segments and
related disclosures about products and services, geographic areas and major
customers.

     SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" was issued in February 1998. This statement
standardizes disclosure requirements for pension and other postretirement
benefits, requires additional information on changes in benefit obligations and
fair values of plan assets, and eliminates certain existing disclosure
requirements.

     SFAS Nos. 130, 131 and 132 become effective in the Company's fiscal year
ending December 31, 1998. The adoption of these statements are expected to have
no impact on the Company's results of operations, financial position or cash
flows and to produce no major changes in current disclosures.

     The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants issued Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," in March 1998. This statement provides guidance as to whether
certain internal-use software costs should be capitalized as a long-lived asset
or expensed when incurred. SOP 98-1 becomes effective in the Company's fiscal
year ending December 31, 1998, but may be adopted earlier. The Company is in the
process of evaluating the requirements of SOP 98-1, but does not expect that it
will materially affect its results of operations, financial position or cash
flows. The Company has not yet decided whether it will adopt this standard in
1998.

3.  MERGERS AND ACQUISITIONS

     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,
with and into CSI and the acquisition of certain related assets. 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. The Company acquired 25 skilled nursing facilities, one
rehabilitation hospital and one continuing care retirement community, with an
aggregate of 3,801 beds in connection with this transaction. On January 2, 1996
the CSI Merger was consummated.

     On March 1, 1996, the Company consummated a merger with MedRehab, a company
whose primary business was 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 and 1997, other accrued expenses includes $2,009,000 and $377,000,

                                       49
<PAGE>   50
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

respectively, 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 senior secured revolving credit facility with a
syndicate of banks ("Credit Facility"). The Company has recorded a total of
$2,400,000 in goodwill related to this transaction. This investment was
subsequently written off in 1997.

     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
in 1997 once certain financial performance conditions for 1996 were confirmed.
Goodwill was adjusted to a total of $73,400,000 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 $4,100,000 million was accounted for as goodwill.

     During 1996, all acquisitions were accounted for as purchases except for
the merger with MedRehab Inc. which was accounted for as a pooling of interests.
In connection with the CSI and 1996 Florida Acquisitions, 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.

     1997 Facility Acquisitions.  During 1997, the Company acquired four skilled
nursing facilities with a total of 587 beds in the Baltimore metropolitan area
for a total purchase price of approximately $37,000,000 (the "1997 Facility
Acquisitions"). The Company borrowed approximately $37,000,000 under its Credit
Facility to finance these acquisitions. Goodwill of $22,000,000 was recorded in
connection with these acquisitions.

     Prism and Related Rehabilitation Transaction.  In October 1997, the Company
completed its merger with Prism Health Group, Inc. (the "Prism Merger"). All of
the issued and outstanding shares of Prism capital stock were converted into the
right to receive an aggregate of approximately $84,300,000 in cash. In
connection with the Prism Merger the Company also repaid approximately
$9,500,000 in assumed debt and paid expenses of approximately $700,000 prior to
the closing. Goodwill of approximately $91,000,000 was recorded in connection
with this transaction. The Company borrowed approximately $94,500,000 under its
Credit Facility to finance the Prism Merger.

                                       50
<PAGE>   51
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     In June, 1997, the Company also acquired another rehabilitation company for
a total purchase price of approximately $15,403,000. The Company made an initial
payment of $2,000,000 and in 1998 paid an additional $3,135,000. These amounts
were funded under the Company's Credit Facility. In addition, the Company
entered into a 3 year, 7% interest bearing note for $5,134,000. The Company also
agreed to pay an additional $5,134,000 in contingent consideration over the next
three years provided certain financial targets were met. Goodwill of $2,552,000
was recorded in connection with this acquisition.

     The assets acquired and liabilities assumed in connection with the
aforementioned mergers and acquisitions have been included in the financial
statements based on preliminary estimates of fair values and may be revised as
additional information becomes available. As a result, the financial information
included in the financial statements is subject to adjustment from subsequent
revisions and estimates of fair value if any are necessary.

     In the fourth quarter of 1997 the Company incurred $7,180,000 of costs
related to office closings, abandonment of certain furniture and equipment and
other expenses related to consolidation of the Company's rehabilitation
operations. Additional expenses of $9,324,000, including $5,713,000 for
severance, payroll, and relocation costs, $2,077,000 for office closings and
related expenses and $1,534,000 related to bank fees were recorded in connection
with the Prism merger.

     Joint Ventures.  The Company entered into three joint venture arrangements
at three of its facilities located in Maryland and North Carolina. The Company
retained a 50% interest in two of the facilities and 60% of the third facility.
The Company received a total of $5,349,000 of capital contributions from its
joint venture partners and recognized a gain of approximately $1,659,000 from
these transactions.

     All 1997 acquisitions were accounted for as Purchases.

4.  DISPOSITION OF FACILITIES

     The Company executed agreements to sell two nursing facilities in
non-strategic locations. Total sales proceeds were $4,890,000 and a net pretax
loss of $4,579,000 was recorded. For 1997, these facilities generated aggregate
net revenues of $6,849,000 and income from continuing operations of $550,000.

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. Of the Company's accounts receivable and estimated settlements due
from third party payors are 24% and 20% from Medicaid and 31% from Medicare at
December 31, 1996 and 1997, 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.
                                       51
<PAGE>   52
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     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 an unrelated
long-term care 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 and $1,078,000 at December 31, 1996 and 1997, respectively.
Additional deferred gains of $711,000 relate to transactions with Pinnacle Care
in 1994.

7.  PROPERTY, PLANT AND EQUIPMENT

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

<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                     ------------------------
                                                       1996            1997
                                                     --------        --------
<S>                                                  <C>             <C>
Land and improvements..............................  $ 32,433        $ 33,822
Building and improvements..........................   329,141         340,273
Furniture and equipment............................    63,361          68,826
Leasehold rights and improvements..................     2,841           8,791
Software...........................................     2,348           8,691
Construction in progress...........................     3,850          17,654
                                                     --------        --------
                                                      433,974         478,057
Less: accumulated depreciation.....................   (47,549)        (62,109)
                                                     --------        --------
                                                     $386,425        $415,948
                                                     ========        ========
</TABLE>

     Depreciation expense related to property, plant and equipment for the years
ended December 31, 1995, 1996 and 1997 was $8,285,000, $15,218,000 and
$18,588,000, respectively.

     Interest costs associated with construction or renovations are capitalized
in the period in which they are incurred. No interest was capitalized during
1995 or 1996. Capitalized interest in 1997 amounted to approximately $878,000.

     Included in property, plant and equipment is equipment, furniture, land and
buildings under capital leases with cost bases totaling $94,582,000 and
$94,763,000 at December 31, 1996 and 1997, respectively. Accumulated
amortization on equipment under capital leases is approximately $2,479,000 and
$4,424,000 at December 31, 1996 and 1997, respectively.

8.  RESTRICTED CASH AND CASH EQUIVALENTS

     Approximately $2,885,000 and $2,888,000 of the Company's cash is restricted
for capital improvements and collateral under the terms of various financing
arrangements at December 31, 1996 and 1997, respectively. This includes amounts
related to debt assumed in connection with certain acquisitions.

                                       52
<PAGE>   53
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9.  ACCRUED EXPENSES

     At December 31, 1997, accrued expenses include approximately $10,890,000
for employee benefits and withholdings, $7,342,000 for interest, $5,497,000 for
income and property related taxes, and $7,050,000 for asset impairments.

10.  LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

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

<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                     ------------------------
                                                       1996            1997
                                                     --------        --------
                                                          (IN THOUSANDS)
<S>                                                  <C>             <C>
Senior Subordinated Notes..........................  $149,691        $149,724
Revolving credit and term loan agreement...........   132,000         301,000
Capital lease obligations..........................    76,502          73,225
Mortgage loans.....................................    51,232          50,704
Tax exempt low floater with annual maturities of
  $395,000 through October 2010....................     5,480           5,085
Term loans and other...............................     8,361           4,656
                                                     --------        --------
                                                      423,266         584,394
Current maturities of long-term debt...............    (4,802)         (6,171)
Current portion of capital lease obligations.......    (3,228)         (7,740)
                                                     --------        --------
                                                     $415,236        $570,483
                                                     ========        ========
</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").

     Mariner has a $460,000,000 senior secured revolving credit facility with a
syndicate of banks (the "Credit Facility"). As of October 3, 1997, the Company
entered into an amendment to the Credit Facility to increase borrowing capacity
to $325,000,000 from $250,000,000, As of January 2, 1998 the terms were amended
to increase the size of the Credit Facility to $460,000,000, 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 December 31, 1996 and 1997, principal balances outstanding under the
Credit Facility were approximately $132,000,000 and $301,000,000 respectively,
and letters of credit outstanding under this facility were approximately
$5,499,000 and $6,715,000. As of December 31, 1997 the letters of credit under
the Credit Facility were $5,624,000 that related to workers compensation
insurance and $1,091,000 associated with debt and other agreements. 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

                                       53
<PAGE>   54
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 collateralized 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 January 2, 2003 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 a minimum fixed charge
coverage ratio, maximum leverage ratio, minimum net worth, senior indebtedness
to cash flow from operations, total indebtedness to consolidated cash flows from
operations and ratio of total indebtedness to consolidated cash flow. Additional
covenants include 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, 1996 and 1997 was
7.13% and 8.00% per annum, respectively.

     Term loans at December 31, 1996 and 1997 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, the
MedRehab merger, an airplane, notes payable in connection with the purchase of
three physicians practices and a non-interest bearing term note in connection
with the Prism acquisition. A total of $1,210,000 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 8% to 12% per annum.

     At December 31, 1997, mortgage loans collateralized by the properties
included $8,494,000 on one facility related to the purchase of a previously
leased facility, $8,419,000 in mortgages guaranteed by HUD, $17,035,000 for
facilities acquired in the 1996 Florida Acquisition, $9,259,000 for former CSI
facilities, and $7,497,000 related to Allegis facilities. These notes bear
interest rates ranging from 8.0% to 11.5% per annum, 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 of
$5,480,000 issued by a bank and guaranteed by the Company. The interest rate is
set weekly by the bank. At December 31, 1997, the rate was 3.75% per annum.

     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, 1997 are as follows:

<TABLE>
<CAPTION>
                                            TOTAL        DEBT      CAPITAL LEASES
                                           --------    --------    --------------
<S>                                        <C>         <C>         <C>
1998.....................................  $ 13,911    $  6,171       $ 7,740
1999.....................................    12,275       9,705         2,570
2000.....................................     9,718       7,027         2,691
2001.....................................    11,239       1,127        10,112
2002.....................................     5,288       3,123         2,165
Thereafter...............................   531,963     484,016        47,947
                                           --------    --------       -------
                                           $584,394    $511,169       $73,225
                                           ========    ========       =======
</TABLE>

                                       54
<PAGE>   55
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     In 1997 interest expense includes $1,282,000 in amortization related to
deferred finance costs. Interest paid for the years ended December 31, 1995,
1996 and 1997 amounted to approximately $3,599,000, $22,939,000 and $35,966,000
respectively.

11.  INCOME TAXES

     The provision for income taxes consists of the following at December 31,
1995, 1996 and 1997:

<TABLE>
<CAPTION>
                                                       DECEMBER 31,
                                              -------------------------------
                                               1995        1996        1997
                                              -------    --------    --------
                                                      (IN THOUSANDS)
<S>                                           <C>        <C>         <C>
Deferred Federal income tax benefit
  (provision)...............................  $   704    $    963    $ (2,459)
Deferred state income tax benefit
  (provision)...............................      120         280        (422)
Current Federal income tax provision........   (6,398)     (9,340)     (6,171)
Current state income tax provision..........   (2,318)     (2,702)     (1,861)
                                              -------    --------    --------
Total provision for income taxes............  $(7,892)   $(10,799)   $(10,913)
                                              =======    ========    ========
</TABLE>

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

<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                       ----------------------
                                                       1995     1996     1997
                                                       ----     ----     ----
<S>                                                    <C>      <C>      <C>
Statutory rate.......................................    35%      35%      35%
State taxes, net of Federal effect...................     7%       7%       6%
Reversal of deferred taxes at higher statutory
  rate...............................................    (2%)     --       --
Amortization of goodwill.............................    --      5.5%     7.3%
Other permanent differences..........................    --      0.5%     0.2%
Net operating loss carryforward utilization..........    (1%)     --       --
Change in valuation allowance........................    --       (5%)     --
Other................................................    (2%)     (3%)     --
                                                       ----     ----     ----
                                                       37.0%    40.0%    48.5%
                                                       ====     ====     ====
</TABLE>

                                       55
<PAGE>   56
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Deferred tax assets and liabilities are comprised of the following at
December 31, 1996 and 1997:

<TABLE>
<CAPTION>
                                                            1996       1997
                                                           -------    -------
<S>                                                        <C>        <C>
Deferred Tax Assets
  Current
     Reserve for receivables.............................  $ 4,439    $ 8,227
     Accrued expenses....................................    6,569         --
     Other...............................................       --        333
                                                           -------    -------
                                                            11,008      8,560
                                                           -------    -------
  Long-Term
     Deferred revenue....................................      500        442
     Merger costs........................................      657        205
     Accrued expenses....................................   16,192     27,574
     Net Operating Loss..................................    1,631      1,631
     Other...............................................      795         --
                                                           -------    -------
                                                            19,775     29,852
                                                           -------    -------
Total Deferred Tax Assets................................   30,783     38,412
                                                           -------    -------
Deferred Tax Liabilities
  Current
     Other...............................................       25         43
                                                           -------    -------
                                                                25         43
                                                           -------    -------
  Long-Term
     Fixed assets........................................   13,539     12,655
     Write off of deferred costs.........................      601         65
     Goodwill............................................    3,128      2,776
     Tax Lease...........................................      805      1,811
                                                           -------    -------
                                                            18,073     17,307
                                                           -------    -------
Total Deferred Tax Liabilities...........................   18,098     17,350
                                                           -------    -------
Net Deferred Tax Asset...................................  $12,685    $21,062
                                                           =======    =======
</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 Prism Merger resulted in the addition of $2,194,000 of additional
deferred tax assets. The establishment of reserves in conjunction with the Prism
Merger and other acquisitions resulted in an increase of $9,064,000 to long term
deferred tax assets.

                                       56
<PAGE>   57
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     During 1995, 1996 and 1997, the Company paid Federal, state and local
income taxes in the amounts of approximately $7,333,000, $10,922,000 and
$21,133,000 respectively. As of December 31, 1997, other accrued expenses
includes approximately $1,800,000 which represents the liability for Federal,
state and local income taxes.

12.  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, 1997, 1996 and 1995 would have been reduced to the
pro forma amounts indicated below.

<TABLE>
<CAPTION>
                                    1997                          1996                           1995
                         ---------------------------   ---------------------------    ---------------------------
                                           EARNINGS                      EARNINGS                       EARNINGS
                           NET INCOME      PER SHARE     NET INCOME      PER SHARE      NET INCOME      PER SHARE
                         --------------    ---------   --------------    ---------    --------------    ---------
                         (IN THOUSANDS)                (IN THOUSANDS)                 (IN THOUSANDS)
<S>                      <C>               <C>         <C>               <C>          <C>               <C>
As Reported..........       $11,587          $.039        $16,198          $0.55         $12,482          $0.55
Pro forma............       $ 8,449          $0.28        $13,337          $0.46         $ 9,707          $0.43
</TABLE>

     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, 1997, 550,094 shares
were authorized for grants of options under the Company's plans.

<TABLE>
<CAPTION>
                                                                  WEIGHTED AVERAGE
                                                  STOCK OPTION    EXERCISE PRICES
                                                    AMOUNTS          PER SHARE
                                                  ------------    ----------------
<S>                                               <C>             <C>
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
  Granted.......................................   1,364,973           $11.72
  Exercised.....................................    (402,753)          $ 8.93
  Canceled......................................    (785,604)          $11.73
                                                   ---------
Outstanding at December 31, 1997................   3,846,190           $ 9.73
                                                   =========
</TABLE>

                                       57
<PAGE>   58
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     At December 31, 1997, the Company had approximately 3,846,190 options
outstanding of which approximately 911,873 were exercisable at a weighted
average exercise price of $8.51 per share.

<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
----------------   -----------   -----------   ----------------   -----------   ----------------
<S>                <C>           <C>           <C>                <C>           <C>
 $ 2.00-$10.00      3,089,292     8.1 Years         $ 8.54           797,069         $ 7.80
 $10.32-$20.00        754,944     9.4 Years         $14.58           112,850         $13.16
   Over $20.00          1,954     3.7 Years         $30.07             1,954         $30.07
                    ---------                                      ---------
                    3,846,190                                        911,873
                    =========                                      =========
</TABLE>

     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 per share, the market value on the day of the adjustment. No charge was
required for this transaction.

     During January 1997, the Company canceled and reissued 1,612,393 of vested
and unvested incentive stock options at an exercise price of $9.12 per share,
the market price on the day of the issuance.

13.  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.

14.  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 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 or 1997.

15.  EMPLOYEE BENEFIT PLANS

     The Company has a defined contribution 401(k) plan which covers
substantially all nonunion employees who have attained 21 years of age and
completed both one year of service and worked 1,000 hours. 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, 1995,
1996, and 1997 was $76,000, $54,000 and $294,964, respectively.

     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 1995, 1996 or 1997 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

                                       58
<PAGE>   59
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the Company's consolidated balance sheets and statements of operations at
December 31, 1995, 1996 and 1997:

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              -----------------------
                                                              1995     1996     1997
                                                              -----    -----    -----
                                                                  (IN THOUSANDS)
<S>                                                           <C>      <C>      <C>
Actuarial present value of benefit obligations:
  Vested....................................................  $ 438    $ 495    $ 559
  Nonvested.................................................    116       64        0
                                                              -----    -----    -----
Accumulated benefit obligation..............................    554      559      559
                                                              -----    -----    -----
Projected benefit obligation................................    554      559      559
Less: plan assets at fair value.............................    439      630      816
                                                              -----    -----    -----
Projected benefit obligation in excess of (less than) plan
  assets....................................................    115      (71)    (257)
Adjustment required to recognize minimum liability..........    208       --       --
Unrecognized transition asset...............................     10        9        8
Unrecognized net gain (loss)................................   (218)    (146)      11
                                                              -----    -----    -----
Accrued (prepaid) pension cost..............................  $ 115    $(208)   $(238)
                                                              =====    =====    =====
Interest cost on projected benefit obligation...............  $  36    $  36    $  37
Actual return on plan assets................................    (73)    (103)    (198)
Net amortization............................................     59       78      153
                                                              -----    -----    -----
                                                              $  22    $  11       (8)
                                                              =====    =====    =====
Key Assumptions:
  Weighted average discount rate of obligations.............    7.5%     7.0%     7.0%
  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.

16.  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, 1997, long-term operating lease commitments are as follows:

<TABLE>
<CAPTION>
                                       PROPERTY     EQUIPMENT     TOTAL
                                       ---------    ---------    -------
<S>                                    <C>          <C>          <C>
1998.................................     9,097       4,033       13,130
1999.................................     7,738       2,484       10,222
2000.................................     6,419         603        7,022
2001.................................     5,222          41        5,263
2002.................................     3,671          --        3,671
Thereafter...........................     5,184          --        5,184
                                        -------      ------      -------
                                        $37,331      $7,161      $44,492
                                        =======      ======      =======
</TABLE>

                                       59
<PAGE>   60
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Total rental expense under operating leases for 1995, 1996 and 1997 was
$5,516,000, $10,071,000 and $8,777,000, respectively.

  Impact of the Year 2000 Issue

     The Company has made an initial review of issues related to the Year 2000
and does not expect that it will have a material impact on the Company's
business, operations or financial condition. However, the Company could be
adversely impacted by the Year 2000 issue if its key suppliers and other third
parties do not address the issue successfully. The Company is addressing these
risks in order to reduce the impact on the Company.

  Insurance

     In 1997 approximately 18% 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 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 $5,624,000, 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.

17.  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.

  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, 1996 and
1997.

                                       60
<PAGE>   61
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

18.  RELATED PARTY TRANSACTIONS

     The Company leases 14 facilities under operating and capital leases from
affiliates of the former CSI, in which entity two board members of the Company
have a significant interest. During 1997, the Company made cash payments on such
lease obligations of approximately $7,546,000. Capital lease obligations include
approximately $43,470,000 of minimum lease payments due over the remaining lease
terms. In addition, the Company manages three facilities for affiliates of the
former CSI. In 1997, the Company recognized $955,772 of management fee revenue
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 Directors of the
Company.

19.  EARNINGS PER SHARE DISCLOSURE

     The following is a reconciliation of the numerators and denominators of the
basic and diluted EPS computation for "income available to common stockholders"
and other related disclosures required by SFAS 128:
<TABLE>
<CAPTION>
                                                FOR THE YEARS ENDED DECEMBER 31,
                           ---------------------------------------------------------------------------
                                           1997                                   1996
                                       (THOUSANDS)                            (THOUSANDS)
                           ------------------------------------   ------------------------------------
                                                          PER-                                   PER-
                             INCOME         SHARES       SHARE      INCOME         SHARES       SHARE
                           (NUMERATOR)   (DENOMINATOR)   AMOUNT   (NUMERATOR)   (DENOMINATOR)   AMOUNT
                           -----------   -------------   ------   -----------   -------------   ------
<S>                        <C>           <C>             <C>      <C>           <C>             <C>
Basic EPS:
 Income available to
   common shareholders...    $11,587        29,226       $0.40      $16,198        28,721       $0.56
                                                         =====                                  =====
Effect of Dilutive
 Securities:
 Common stock
   equivalents...........                      659                                    489
                                            ------                                 ------
Diluted EPS:
 Income available to
   common stockholders
   and assumed
   conversions...........    $11,587        29,885       $0.39      $16,198        29,210       $0.55
                             =======        ======       =====      =======        ======       =====

<CAPTION>
                             FOR THE YEARS ENDED DECEMBER 31,
                           ------------------------------------
                                           1995
                                       (THOUSANDS)
                           ------------------------------------
                                                          PER-
                             INCOME         SHARES       SHARE
                           (NUMERATOR)   (DENOMINATOR)   AMOUNT
                           -----------   -------------   ------
<S>                        <C>           <C>             <C>
Basic EPS:
 Income available to
   common shareholders...    $12,482        22,502       $0.55
                                                         =====
Effect of Dilutive
 Securities:
 Common stock
   equivalents...........                      253
                                            ------
Diluted EPS:
 Income available to
   common stockholders
   and assumed
   conversions...........    $12,482        22,755       $0.55
                             =======        ======       =====
</TABLE>

     Options to purchase 495,054, 2,649,585 and 12,000 shares of common stock at
a weighted average exercise price of $16.33, $13.30, and $15.75 per share were
outstanding during 1997, 1996, and 1995, respectively, but were not included in
the computation of diluted EPS because the options' exercise price was greater
than the average market price of the common shares.

20.  PRO FORMA INFORMATION (UNAUDITED)

     The following unaudited pro forma condensed statements of operations for
the years ended December 31, 1996 and 1997 give effect to certain acquisitions
as if they had occurred at the beginning of these years. The 1996 pro forma
amounts give effect to acquisitions consummated in 1996 (CSI, the 1996 Florida
Acquisition and Allegis) and the Prism Merger. The 1997 pro forma amounts give
effect only to the 1997 transactions as the 1996 acquisitions are included in
the results of the Company for the year ended December 31, 1997. The 1997 pro
forma 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.

                                       61
<PAGE>   62
                  MARINER HEALTH GROUP, INC. AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     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 had occurred at the beginning of the period.

<TABLE>
<CAPTION>
                                                           PRO FORMA COMBINED      PRO FORMA COMBINED
                                                           MARINER, HERITAGE,        MARINER, 1996
                                                           CSI, 1996 FLORIDA            FLORIDA
                                                          ACQUISITION, ALLEGIS    ACQUISITION, ALLEGIS
                                                               1997 PRISM              1997 PRISM
                                                                  1996                    1997
                                                          --------------------    --------------------
                                                                           UNAUDITED
                                                            (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S>                                                       <C>                     <C>
Total operating revenue.................................        $710,949                $795,931
Net income before extraordinary items...................        $ 12,728                $  7,952
Net income per diluted share before extraordinary
  items.................................................        $    .44                $    .27
Net income..............................................        $ 12,728                $  7,952
Net income per diluted share............................        $    .44                $    .27
</TABLE>

21.  QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

     The following table represents summarized results:

<TABLE>
<CAPTION>
                                                     1996                                        1997
                                   -----------------------------------------   -----------------------------------------
                                    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......  $132,629   $143,061   $134,699   $168,366   $170,824   $170,243   $170,199   $203,357
Other revenue....................     2,550      2,543      3,052      3,909      3,589      4,259      3,979      7,026
                                   --------   --------   --------   --------   --------   --------   --------   --------
Total operating revenue..........   135,179    145,604    137,751    172,275    174,413    174,502    174,178    210,383
Operating expenses:
  Facility operating costs.......   106,149    111,359    114,035    133,683    133,698    132,867    129,889    167,192
  Corporate general and other....    15,669      9,258      9,853     11,621     11,808     12,682     13,209     24,353
  Interest expense, net..........     4,392      6,578      6,763      8,523      9,190      8,711      9,684     12,367
  Facility rent expense, net.....       474        738      1,106      1,409      1,112      1,064      1,098      1,147
  Depreciation and
    amortization.................     5,196      5,132      5,349      5,699      6,546      6,561      6,662      7,730
  Asset impairment loss..........        --         --         --         --         --         --         --     10,486
                                   --------   --------   --------   --------   --------   --------   --------   --------
Total operating expenses.........   131,880    133,065    137,106    160,935    162,354    161,885    160,542    223,275
Operating income (loss)..........     3,299     12,539        645     11,340     12,059     12,617     13,636    (12,892)
Loss on sale of facilities.......        --         --         --       (826)        --         --         --     (2,920)
                                   --------   --------   --------   --------   --------   --------   --------   --------
Income (loss) before income taxes
  and extraordinary items........     3,299     12,539        645     10,514     12,059     12,617     13,636    (15,812)
Provision for (benefit) income
  tax............................     1,254      5,015        324      4,206      5,306      5,551      6,001     (5,945)
                                   --------   --------   --------   --------   --------   --------   --------   --------
Net income (loss)................  $  2,045   $  7,524   $    321   $  6,308   $  6,753   $  7,066   $  7,635   $ (9,867)
                                   ========   ========   ========   ========   ========   ========   ========   ========
Net income (loss) per share
  diluted........................     $0.07      $0.26      $0.01      $0.22      $0.23      $0.24      $0.25     $(0.34)
  basic..........................     $0.07      $0.26      $0.01      $0.22      $0.23      $0.24      $0.26     $(0.34)
                                   ========   ========   ========   ========   ========   ========   ========   ========
Weighted average number of shares
  outstanding
  diluted........................    29,235     29,403     29,573     29,084     29,174     29,523     30,214     29,424
  basic..........................    28,397     28,681     28,858     28,975     29,018     29,061     29,357     29,424
</TABLE>

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

     None.

                                       62
<PAGE>   63

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information regarding the Company's directors and compliance by the
Company's directors and executive officers with Section 16(a) of the Securities
Exchange Act of 1934 will be set forth under the captions "Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance,"
respectively, in the Company's definitive proxy statement for its annual meeting
of stockholders which is currently expected to be filed with the Securities and
Exchange Commission within 120 days of December 31, 1997, and is incorporated
herein by reference.

     Information regarding the Company's executive officers is contained in Part
I of this Report.

ITEM 11.  EXECUTIVE COMPENSATION

     Information required by this item will appear under the caption "Executive
Compensation" in the Company's definitive proxy statement for its annual meeting
of stockholders which is currently expected to be filed with the Securities and
Exchange Commission within 120 days of December 31, 1997, and is incorporated
herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Information required by this item will appear under the caption "Principal
Stockholders of Mariner" in the Company's definitive proxy statement for its
annual meeting of stockholders which is currently expected to be filed with the
Securities and Exchange Commission within 120 days of December 31, 1997, and is
incorporated herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this item will appear under the caption
"Certain Transactions" in the Company's definitive proxy statement for its
annual meeting of stockholders which is currently expected to be filed with the
Securities and Exchange Commission within 120 days of December 31, 1997, and is
incorporated herein by reference.

                                    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, 1996 and 1997

       Consolidated Statements of Operations for the Years Ended December 31,
       1995, 1996 and 1997

       Consolidated Statements of Cash Flows for the Years Ended December 31,
       1995, 1996 and 1997

       Consolidated Statements of Stockholders' Equity for the Years Ended
       December 31, 1995, 1996 and 1997

       Notes to Consolidated Financial Statements

                                       63
<PAGE>   64

(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 65 hereof.

(b)     Reports on Form 8-K

       None.

                                       64
<PAGE>   65

                                   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
March, 1998.

                                          MARINER HEALTH GROUP, INC.

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

     We, the undersigned officers and directors of Mariner Health Group, Inc.,
hereby severally constitute and appoint Arthur W. Stratton, Jr. and David N.
Hansen, and each of them singly, our true and lawful attorneys, with full power
to them and each of them singly, to sign for us in our names in the capacities
indicated below, amendments to this Report on Form 10-K and to file same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.

     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
                     ---------                                   --------                    ----
<C>                                                  <S>                                <C>

            /s/ ARTHUR W. STRATTON, JR.              Chairman of the Board of           March 30, 1998
---------------------------------------------------    Directors, Chief Executive
              Arthur W. Stratton, Jr.                  Officer, President and Director
                                                       (principal executive officer)

                /s/ DAVID N. HANSEN                  Executive Vice President, Chief    March 30, 1998
---------------------------------------------------    Financial Officer, Treasurer
                  David N. Hansen                      and Director (principal
                                                       financial and accounting
                                                       officer)

                /s/ DAVID C. FRIES                   Director                           March 30, 1998
---------------------------------------------------
                  David C. Fries

            /s/ CHRISTOPHER GRANT, JR.               Director                           March 30, 1998
---------------------------------------------------
              Christopher Grant, Jr.

            /s/ STILES A. KELLETT, JR.               Director                           March 30, 1998
---------------------------------------------------
              Stiles A. Kellett, Jr.

               /s/ SAMUEL B. KELLETT                 Director                           March 30, 1998
---------------------------------------------------
                 Samuel B. Kellett

               /s/ JOHN F. ROBENALT                  Director                           March 30, 1998
---------------------------------------------------
                 John F. Robenalt
</TABLE>

                                       65
<PAGE>   66

                                  SCHEDULE II

                           MARINER HEALTH GROUP, INC.
                       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, 1997.......  $11,872,000   $4,448,000    $4,666,000     $4,392,000   $16,046,000
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
</TABLE>

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

                                       66
<PAGE>   67

                                 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.

<TABLE>
<CAPTION>
EXHIBIT NO.                           DESCRIPTION
-----------                           -----------
<S>           <C>
2.1, 10.1     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).
2.2, 10.2     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).
2.3, 10.3     Agreement and Plan of Merger dated as of February 9, 1996 by
              and among the Company, 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 1995).
2.4, 10.4     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).
2.5, 10.5     Asset Purchase Agreement dated July 31, 1996 between 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)
2.6, 10.6     Amendment Number 1 to Asset Purchase Agreement dated October
              2, 1996 between 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).
</TABLE>

                                       67
<PAGE>   68

<TABLE>
<CAPTION>
EXHIBIT NO.                           DESCRIPTION
-----------                           -----------
<S>           <C>
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).
4.6, 10.7     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).
10.8          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).
10.9          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).
10.10         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).
10.11         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).
10.12*        1992 Stock Option Plan (Incorporated by reference to Exhibit
              10.1 to the Company's Registration Statement No. 33-60736).
10.13*        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).
10.14*        1994 Stock Plan, as amended (Incorporated by reference to
              Exhibit 4.5 to the Company's Form S-8, filed November 21,
              1995).
10.15*        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).
10.16+        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).
</TABLE>

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<PAGE>   69

<TABLE>
<CAPTION>
EXHIBIT NO.                           DESCRIPTION
-----------                           -----------
<S>           <C>
10.17         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).
10.18         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).
10.19*        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).
10.20*        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).
10.21*        Amended and Restated Employment Agreement dated as of
              October 20, 1997 by and between the Company and Arthur W.
              Strattan, Jr.
10.22*        Employment Agreement dated as of November 17, 1997 by and
              between the Company and Paul Diaz.
10.23         Amendment No. 16 to the Credit Agreement dated as of January
              2, 1998 by and among Mariner Health Group, Inc., PNC Bank,
              National Association and other banks party thereto.
10.24         Amended and Restated Revolving Credit Agreement dated as of
              May 18, 1994, as amended, by and among Mariner Health Group,
              Inc., PNC Bank, National Association and other banks party
              thereto.
10.25         Lease by and between Mariner Health Group, Inc. and
              Framingham-1881 Associates dated as of August 26, 1997.
21            Subsidiaries of the Company.
23            Consent of Coopers & Lybrand L.L.P.
24            Power of Attorney.
27.1          Financial Data Schedule for fiscal year ended 1997.
27.2          Restated Financial Data Schedule for the fiscal quarter
              ended September 30, 1997.
27.3          Restated Financial Data Schedule for the fiscal quarter
              ended June 30, 1997.
27.4          Restated Financial Data Schedule for the fiscal quarter
              ended March 31, 1997.
27.5          Restated Financial Data Schedule for the fiscal year ended
              1996.
27.6          Restated Financial Data Schedule for the fiscal quarter
              ended September 30, 1996.
27.7          Restated Financial Data Schedule for the fiscal quarter
              ended June 30, 1996.
27.8          Restated Financial Data Schedule for the fiscal quarter
              ended March 31, 1996.
27.9          Restated Financial Data Schedule for the fiscal year ended
              1995.
</TABLE>

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

+ Confidential Treatment Requested.

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