<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

[X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001

                                       or

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

                           COMMISSION FILE NO. 1-10968

                        MARINER POST-ACUTE NETWORK, INC.
             (Exact Name of Registrant as Specified in its Charter)

               DELAWARE                                           74-2012902
    (State or Other Jurisdiction of                           (I.R.S. Employer
     Incorporation or Organization)                          Identification No.)

     ONE RAVINIA DRIVE, SUITE 1500                                   30346
           ATLANTA, GEORGIA                                        (Zip Code)
(Address of Principal Executive Offices)

                                 (678) 443-7000
              (Registrant's Telephone Number, Including Area Code)

        Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]   No [ ]

        There were 73,688,379 shares of Common Stock of the registrant issued
and outstanding as of May 11, 2001.

        Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ]  No [ ]  N/A [X]  (The registrant and its
subsidiaries have made filings under chapter 11 of the Bankruptcy Code and are
currently in the process of preparing a plan of reorganization. No plan of
reorganization has been filed with or confirmed by a bankruptcy court at this
time.)



<PAGE>   2


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES

                                    FORM 10-Q

                                 MARCH 31, 2001


                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>                                                                                     <C>
PART I - FINANCIAL INFORMATION

    Item 1. Condensed Consolidated Financial Statements                                   1

    Item 2. Management's Discussion and Analysis of Financial
            Condition and Results of Operations                                          21

    Item 3. Quantitative and Qualitative Disclosure About Market Risk                    38

PART II - OTHER  INFORMATION

    Item 1. Legal Proceedings                                                            39

    Item 2. Changes in Securities and Use of Proceeds                                    40

    Item 3. Defaults Upon Certain Securities                                             40

    Item 4. Submission of Matters to a Vote of Security Holders                          40

    Item 5. Other Information                                                            41

    Item 6. Exhibits and Reports on Form 8-K                                             41

    SIGNATURE PAGE
</TABLE>




<PAGE>   3


PART 1  FINANCIAL INFORMATION

  ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000)
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                (dollars in thousands, except per share amounts)
                                   (unaudited)


<TABLE>
<CAPTION>
                                                            THREE MONTHS                   SIX MONTHS
                                                           ENDED MARCH 31,               ENDED MARCH 31,
                                                      -----------------------     ---------------------------
                                                         2001         2000           2001            2000
                                                      ---------     ---------     -----------     -----------
<S>                                                   <C>           <C>           <C>             <C>
Net revenues                                          $ 520,783     $ 541,514     $ 1,044,925     $ 1,078,720

Costs and expenses:
      Salaries, wages and benefits                      298,265       312,894         597,523         626,841
      Nursing, dietary and other supplies                31,009        31,427          61,290          64,848
      Ancillary services                                 59,947        65,941         114,875         130,587
      General and administrative                         50,599        56,736         101,486         117,347
      Insurance                                          27,734        23,681          56,495          43,145
      Rent                                               18,378        23,586          37,461          46,275
      Depreciation and amortization                      13,182        14,807          25,988          25,637
      Provision for bad debts                             9,192         6,695          17,164          15,095
      Other expenses                                         33           416              86           8,411
      Loss (gain) on disposal of assets                      --          (793)             --             130
                                                      ---------     ---------     -----------     -----------
           Total costs and expenses                     508,339       535,390       1,012,368       1,078,316
                                                      ---------     ---------     -----------     -----------
Operating income                                         12,444         6,124          32,557             404

Other income (expenses):
      Interest expense (contractual interest for
        the three and six months ended
        March 31, 2001 was $49,629 and $112,040,
        respectively and for the three and six
        months ended March 31, 2000 was $62,093
        and $119,336, respectively)                         (18)       (9,973)         (3,259)        (67,216)
      Interest and dividend income                          407         3,070           2,873           7,202
      Reorganization items                                 (587)      (12,437)         (8,689)        (12,437)
      Other                                                 930        (1,013)           (396)           (223)
                                                      ---------     ---------     -----------     -----------
Net income (loss)                                     $  13,176     $ (14,229)    $    23,086     $   (72,270)
                                                      =========     =========     ===========     ===========

Net income (loss) per share - basic and diluted       $    0.18     $   (0.19)    $      0.31     $     (0.98)
                                                      =========     =========     ===========     ===========
</TABLE>


   The accompanying notes are an integral part of these financial statements.


                                       1


<PAGE>   4


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000)
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                  (dollars in thousands, except share amounts)

<TABLE>
<CAPTION>
                                                                                         MARCH 31,          SEPTEMBER 30,
                                                                                           2001                2000
                                                                                        -----------         ------------
                                                                                        (unaudited)
                                     ASSETS
<S>                                                                                     <C>                 <C>
Current assets:
  Cash and cash equivalents                                                             $   203,686         $   170,468
  Receivables, net of allowances of $72,220 and $68,691                                     301,878             282,200
  Inventories                                                                                19,592              20,670
  Prepaid and other current assets                                                           30,801              52,635
                                                                                        -----------         -----------
     Total current assets                                                                   555,957             525,973

Property and equipment, net of accumulated depreciation of $372,695 and $360,055            439,054             452,413
Goodwill, net of accumulated amortization of $29,337 and $24,035                            211,374             217,381
Restricted investments                                                                       33,197              35,671
Other assets, net                                                                            38,100              19,363
                                                                                        -----------         -----------
                                                                                        $ 1,277,682         $ 1,250,801
                                                                                        ===========         ===========
                 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
  Accounts payable                                                                      $    55,952         $    67,810
  Accrued compensation and benefits                                                          83,468              88,340
  Accrued insurance obligations                                                              10,063              12,905
  Other current liabilities                                                                  42,062              47,440
                                                                                        -----------         -----------
    Total current liabilities                                                               191,545             216,495

Liabilities subject to compromise                                                         2,361,376           2,371,213
Long-term debt, net                                                                              --                  --
Long-term insurance reserves                                                                 99,789              68,987
Other liabilities                                                                            41,850              34,283
                                                                                        -----------         -----------
      Total liabilities                                                                   2,694,560           2,690,978

Commitments and contingencies

Stockholders' equity (deficit):
   Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued                     --                  --
   Common stock, $.01 par value; 500,000,000 shares authorized;
     73,688,379 shares issued                                                                   737                 737
   Capital surplus                                                                          980,952             980,952
   Accumulated deficit                                                                   (2,397,292)         (2,420,378)
   Accumulated other comprehensive loss                                                      (1,275)             (1,488)
                                                                                        -----------         -----------
    Total stockholders' equity (deficit)                                                 (1,416,878)         (1,440,177)
                                                                                        -----------         -----------
                                                                                        $ 1,277,682         $ 1,250,801
                                                                                        ===========         ===========
</TABLE>


The accompanying notes are an integral part of these financial statements.

                                       2


<PAGE>   5


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR-IN-POSSESSION AS OF JANUARY 18, 2000)
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (dollars in thousands)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                             SIX MONTHS ENDED
                                                                                 MARCH 31,
                                                                         -------------------------
                                                                            2001           2000
                                                                         ----------     ----------
<S>                                                                      <C>            <C>
Cash flows from operating activities:
  Net income (loss)                                                      $   23,086     $  (72,270)
  Adjustments to reconcile net income (loss) to net cash provided by
    operating activities:
       Depreciation and amortization                                         25,988         25,637
       Interest accretion on discounted debt                                     --         11,282
       Equity earnings/minority interest                                        396            223
       Reorganization items                                                   8,689             --
       Provision for bad debts                                               17,164         15,095
       Loss on disposal of assets                                                --            130
  Changes in operating assets and liabilities:
       Receivables                                                          (36,832)       (31,944)
       Inventories                                                              788          2,259
       Prepaid expenses and other assets                                     11,941         (3,218)
       Accounts payable                                                      (2,107)        17,422
       Accrued liabilities and other current liabilities                    (13,856)        94,553
  Changes in long-term insurance reserves                                    30,802         (7,615)
  Other                                                                       7,171            140
                                                                         ----------     ----------
Net cash provided by operating activities before reorganization items        73,230         51,694
  Payment of reorganization items, net                                      (18,715)            --
                                                                         ----------     ----------
Net cash provided by operating activities                                    54,515         51,694

Cash flows from investing activities:
  Purchases of property and equipment                                       (15,499)       (19,605)
  Proceeds from sale of property, equipment and other assets                  6,025          4,945
  Restricted investments                                                      1,385         17,779
  Other                                                                         584           (228)
                                                                         ----------     ----------
Net cash (used in) provided by investing activities                          (7,505)         2,891

Cash flows from financing activities:
  Repayment of prepetition long-term debt                                   (13,778)            --
  Other                                                                         (14)         1,622
                                                                         ----------     ----------
Net cash (used in) provided by financing activities                         (13,792)         1,622

                                                                         ----------     ----------
Increase in cash and cash equivalents                                        33,218         56,207

Cash and cash equivalents, beginning of period                              170,468         71,817

                                                                         ----------     ----------
Cash and cash equivalents, end of period                                 $  203,686     $  128,024
                                                                         ==========     ==========
</TABLE>


The accompanying notes are an integral part of these financial statements.


                                       3
<PAGE>   6


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


NOTE 1 - NATURE OF BUSINESS

       REPORTING ENTITY

         Mariner Post-Acute Network, Inc. through its subsidiaries
(collectively, the "Company") provides post-acute health care services,
primarily through the operation of skilled-nursing facilities. At March 31,
2001, the Company's significant operations consisted of (i) approximately 350
nursing home and assisted living facilities containing approximately 42,000
beds; (ii) approximately 33 institutional pharmacies servicing more than 1,500
long-term care centers; and (iii) 13 long-term acute care hospitals with
approximately 620 licensed beds. The Company operates in 25 states with
significant concentrations of facilities and beds in five states and several
metropolitan markets.

       PETITIONS FOR REORGANIZATION UNDER CHAPTER 11

         On January 18, 2000 (the "Petition Date"), the Company and
substantially all of its subsidiaries ("the Company Debtors"), including Mariner
Health Group, Inc. ("Mariner Health") and its subsidiaries (the "Mariner Health
Subsidiaries" and collectively with Mariner Health, the "Mariner Health
Debtors"), filed voluntary petitions (collectively, the "Chapter 11 Filings") in
the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court") under chapter 11 title 11 of the United States Code (the "Bankruptcy
Code"). The Company is presently operating its business as a
debtor-in-possession and is subject to the jurisdiction of the Bankruptcy Court
while a plan of reorganization is formulated (see Note 3). The Company's need to
seek relief afforded by the Bankruptcy Code is due, in part, to the significant
financial pressure created by the implementation of the Balanced Budget Act of
1997.

NOTE 2 - BASIS OF PRESENTATION

         The accompanying unaudited condensed consolidated financial statements
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and disclosures normally included in
the financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the financial information included
herein reflects all adjustments considered necessary for a fair presentation of
interim results, and, except for the costs described in Note 3, all such
adjustments are of a normal and recurring nature. Operating results for interim
periods are not necessarily indicative of the results that may be expected for
the entire year.

         The accompanying unaudited condensed consolidated financial statements
have been prepared on a going concern basis which assumes continuity of
operations and realization of assets and settlement of liabilities and
commitments in the ordinary course of business. The financial statements do not
include any adjustments reflecting the possible future effects on the
recoverability and classification of assets or the amount and classification of
liabilities that may result from the outcome of uncertainties discussed herein.
The accompanying unaudited condensed consolidated financial statements have also
been presented in conformity with the American Institute of Certified Public
Accountants Statement of Position 90-7, "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code" ("SOP 90-7"). The statement requires a
segregation of liabilities subject to compromise by the Bankruptcy Court as of
the Petition Date and identification of all transactions and events that are
directly associated with the reorganization of the Company. Pursuant to SOP
90-7, prepetition liabilities are reported on the basis of the expected amounts
of such allowed claims, as opposed to the amounts for which those claims may be
settled. Under a confirmed final plan of reorganization, those claims may be
settled at amounts substantially less than their allowed amounts.


                                       4

<PAGE>   7


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


         The Company's cumulative operating losses, liquidity issues and the
reorganization proceedings raise substantial doubt about the Company's ability
to continue as a going concern. The ability of the Company to continue as a
going concern and the appropriateness of using the going concern basis of
accounting is dependent upon, among other things, the ability to comply with the
terms of the DIP Financings (as defined herein), confirmation of a plan of
reorganization, success of future operations after such confirmation and the
ability to generate sufficient cash from operations and financing sources to
meet obligations.

         These financial statements should be read in conjunction with the
audited consolidated financial statements and notes thereto for the year ended
September 30, 2000 included in the Company's Annual Report filed with the
Securities and Exchange Commission on Form 10-K.

       NET REVENUES

           Net revenues are recorded based upon estimated amounts due from
patients and third party payors for healthcare services provided, including
anticipated settlements under reimbursement agreements with Medicare, Medicaid
and other third party payors. A summary of approximate net revenues by payor
type is as follows (in thousands):

<TABLE>
<CAPTION>
                       THREE MONTHS ENDED          SIX MONTHS ENDED
                            MARCH 31,                  MARCH 31,
                     ----------------------    ------------------------
                       2001         2000         2001           2000
                     --------    ----------    ----------    ----------
<S>                  <C>         <C>           <C>           <C>
Medicaid             $251,977    $  266,425    $  514,593    $  536,124
Medicare              146,571       134,837       279,320       265,365
Private and other     122,235       140,252       251,012       277,231
                     --------    ----------    ----------    ----------
                     $520,783    $  541,514    $1,044,925    $1,078,720
                     ========    ==========    ==========    ==========
</TABLE>

       RECENT ACCOUNTING PRONOUNCEMENTS

         In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. Gains or losses from changes in fair value would be recognized in
earnings in the period of change unless the derivative is designated as a
hedging instrument. In June 1999, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 137, which amended SFAS
133, delaying its effective date to fiscal years beginning after June 15, 2000.
The Company does not currently hold any derivative instruments nor does it
engage in hedging activities. The Company adopted this accounting standard as
required effective October 1, 2000 and it did not have a material impact on its
consolidated financial position or results of operations.

       RECLASSIFICATIONS

         Certain prior period amounts have been reclassified to conform with the
current period presentation.


                                       5

<PAGE>   8


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


NOTE 3 - PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

        EVENTS LEADING TO BANKRUPTCY

         During fiscal year 1999, the Company and Mariner Health experienced
significant losses, resulting in certain financial covenant violations under the
Company's various loan agreements. In addition, the Company and Mariner Health
did not make any scheduled interest and principal payments due subsequent to
September 30, 1999 which resulted in an event of default under their respective
loan agreements. The inability of the Company and Mariner Health to service or
restructure their respective debt and other obligations culminated in the
Chapter 11 Filings on January 18, 2000. Except as may be otherwise determined by
the Bankruptcy Court overseeing the Chapter 11 Filings, the automatic stay
protection afforded by the Chapter 11 Filings prevents any action from being
taken by creditors with regard to any defaults under the prepetition obligations
of the Company and those of its subsidiaries which are debtors in the Chapter 11
Filings.

       REORGANIZATION

         As noted previously, on January 18, 2000, the Company, Mariner Health
and substantially all of their respective subsidiaries filed voluntary petitions
for relief under the Bankruptcy Code. The Company is presently operating its
business as a debtor-in-possession and is subject to the jurisdiction of the
Bankruptcy Court while a plan of reorganization is formulated. As a
debtor-in-possession, the Company is authorized to operate its business but may
not engage in transactions outside its ordinary course of business without the
approval of the Bankruptcy Court (the "Chapter 11 Proceedings").

         While the Chapter 11 Filings constituted a default under the Company's,
Mariner Health's and their respective subsidiaries' various financing
arrangements, section 362 of the Bankruptcy Code imposes an automatic stay that
generally precludes any creditors and other interested parties under such
arrangements from taking any remedial action in response to any such default
outside of the Chapter 11 Proceedings without obtaining relief from the
automatic stay from the Bankruptcy Court. In addition, under the Bankruptcy Code
the Company may assume or reject executory contracts and unexpired leases.
Parties affected by these rejections may file claims with the Bankruptcy Court
in accordance with the reorganization process. The Company is actively engaged
in the process of reviewing its executory contracts and unexpired leases and
final decisions with respect to assuming or rejecting the contracts and the
approval of the Bankruptcy Court are still pending.

         In connection with the Chapter 11 Filings, the Company obtained a
commitment for $100.0 million in debtor-in-possession ("DIP") financing (the
"Company DIP Financing") from a group of banks led by The Chase Manhattan Bank
("Chase"). Mariner Health also obtained a commitment for $50.0 million in DIP
financing (the "Mariner Health DIP Financing"; together with the Company DIP
Financing, the "DIP Financings") from a group of banks led by PNC Bank, National
Association ("PNC"). The commitment under the Company DIP Financing has been
reduced to $50.0 million. The commitment under the Mariner Health DIP Financing
has been reduced to $25.0 million. (See Note 5).

         On January 19, 2000, the Company received approval from the Bankruptcy
Court to pay prepetition and postpetition employee wages, salaries, benefits and
other employee obligations. The Bankruptcy Court also approved orders granting
authority, among other things, to pay prepetition claims of certain critical
vendors, utilities and patient obligations. All other prepetition liabilities at
March 31, 2001 and September 30, 2000 are classified in the condensed
consolidated balance sheets as liabilities subject to compromise. The Company
has been and intends to continue to pay bona fide postpetition claims of all
vendors and providers in the ordinary course of business.


                                       6

<PAGE>   9


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


         The Company and Mariner Health intend to develop a plan or separate
plans of reorganization through negotiations with their respective key creditor
constituencies including their respective senior bank lenders and official
unsecured creditors committees (as used herein, a plan for the company is the
"Company Plan of Reorganization," a plan for Mariner Health is the "Mariner Plan
of Reorganization," and collectively, any such plans are the "Plans of
Reorganization"). A substantial portion of prepetition liabilities are subject
to settlement under each of the Plans of Reorganization to be submitted
respectively by the Company and Mariner Health. Each of the Plans of
Reorganization must be: (i) voted upon by impaired classes of creditors and
equity holders of the Company and Mariner Health, respectively, that are
entitled to vote; and (ii) approved by the Bankruptcy Court. No assurance can be
given regarding the timing of such Plans of Reorganization, the likelihood that
such plans will be developed, or the terms on which such plans may be
conditioned. In addition, there can be no assurances that the Plans of
Reorganization will be approved by requisite holders of claims and equity
holders and confirmed by the Bankruptcy Court, or that either or both Plans of
Reorganization will be consummated. If the Company Plan of Reorganization is not
accepted by the required number of impaired creditors and equity holders and the
Company's exclusive right to file and solicit acceptance of a plan of
reorganization ends (see Note 5), any party in interest may subsequently file
its own plan of reorganization for the Company; the same is true for Mariner
Health if the Mariner Plan of Reorganization is not accepted by the required
number of impaired creditors and equity holders and Mariner Health's exclusive
right to file and solicit acceptance of a plan of reorganization ends (see Note
5). The Bankruptcy Court may confirm a plan of reorganization notwithstanding
the non-acceptance of the plan by an impaired class of creditors or equity
holders if certain requirements of the Bankruptcy Code are met.

       LIABILITIES SUBJECT TO COMPROMISE

         "Liabilities subject to compromise" refers to liabilities incurred
prior to the Chapter 11 Filings. These liabilities, consisting primarily of
long-term debt and certain accounts payable and accrued liabilities, represent
the Company's estimate of known or potential prepetition claims to be resolved
in connection with the Chapter 11 Filings. Such claims remain subject to future
adjustments based on negotiations, actions of the Bankruptcy Court, further
developments with respect to disputed claims, future rejection of executory
contracts or unexpired leases, determination as to the value of any collateral
securing claims, treatment under the Plans of Reorganization and other events.
Payment terms for these amounts will be established in connection with the Plans
of Reorganization. A summary of the principal categories of claims classified as
liabilities subject to compromise at March 31, 2001 and September 30, 2000 are
as follows (in thousands):

<TABLE>
<CAPTION>
                                MARCH 31,      SEPTEMBER 30,
                                 2001              2000
                             -----------------------------
                              (unaudited)
<S>                          <C>              <C>
Long-term debt               $  2,134,326     $  2,149,420

Accounts payable                   92,021           82,318

Accrued interest                   81,064           85,564

Other accrued liabilities          86,885           86,885

Deferred loan costs               (32,920)         (32,974)

                             ------------     ------------
                             $  2,361,376     $  2,371,213
                             ============     ============
</TABLE>

         Approximately $2.3 billion of liabilities subject to compromise would
have been classified as current liabilities at March 31, 2001 if the Chapter 11
Filings had not been filed.


                                       7

<PAGE>   10


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


         In accordance with SOP 90-7, the Company has discontinued accruing
interest relating to its debt facilities currently classified as liabilities
subject to compromise effective January 18, 2000. Contractual interest for the
three months and six months ended March 31, 2001 was $49.6 million and $112.0
million, respectively, which is $49.6 million and $108.8 million in excess of
interest expense included in the accompanying unaudited condensed consolidated
financial statements for the three and six months ended March 31, 2001.
Contractual interest for the three and six months ended March 31, 2000 was $62.1
million and $119.3 million, respectively, which is $49.9 million in excess of
interest expense included in the accompanying unaudited condensed consolidated
financial statements for the three and six months ended March 31, 2000. Interest
expense for the three and six months ended March 31, 2001 represents interest
paid on certain capital equipment leases and other miscellaneous indebtedness.

       REORGANIZATION ITEMS

         Reorganization items consist of income, expenses and other costs
directly related to the reorganization of the Company since the Chapter 11
Filings. Reorganization items included in the accompanying unaudited condensed
consolidated statements of operations for the three and six months ended March
31, 2001 consist of the following (in thousands):


<TABLE>
<CAPTION>
                                                         THREE MONTHS ENDED             SIX MONTHS ENDED
                                                              MARCH 31,                     MARCH 31,
                                                      -------------------------     -------------------------
                                                         2001           2000           2001           2000
                                                      ----------     ----------     ----------     ----------
<S>                                                   <C>            <C>            <C>            <C>
Professional fees                                     $   12,352     $   11,294     $   16,999     $   11,294
Other reorganization costs                                 3,220          1,425          5,257          1,425
Gain on settlement of prepetition accounts payable           (19)          (189)           (39)          (189)
Net gain on divestitures                                 (12,777)            --        (10,026)            --
Interest earned on accumulated cash resulting from
   Chapter 11 Filings                                     (2,189)           (93)        (3,502)           (93)
                                                      ----------     ----------     ----------     ----------
                                                      $      587     $   12,437     $    8,689     $   12,437
                                                      ==========     ==========     ==========     ==========
</TABLE>

NOTE 4 - DIVESTITURES

           During the three and six months ended March 31, 2001, the Company
completed the sale of certain facilities and other assets which resulted in a
net gain on sale of assets of approximately $12.8 million and $10.0 million,
respectively, which is included in reorganization items.

           During the six months ended March 31, 2000, the Company completed the
sale of certain facilities and other assets which resulted in a net gain on sale
of assets of approximately $1.4 million which is included in loss (gain) on
disposal of assets as these transactions occurred prior to the Petition Date.


                                       8


<PAGE>   11


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


NOTE 5 - DEBT

         Long-term debt at March 31, 2001 and September 30, 2000 is summarized
in the following table (in thousands):

<TABLE>
<CAPTION>
                                                      MARCH 31,          SEPTEMBER 30,
                                                        2001                 2000
                                                    ------------         ------------
                                                    (unaudited)
<S>                                                 <C>                  <C>
Senior credit facilities:
    Senior Credit Facility                          $    894,608         $    905,981
    Mariner Health Senior Credit Facility                233,835              233,835
    Mariner Health Term Loan Facility                    192,439              192,439
Subordinated debt:
    Senior Subordinated Notes                            274,121              274,121
    Senior Subordinated Discount Notes                   220,071              220,071
    Mariner Health Senior Subordinated Notes             103,136              103,136
Other, including capital lease obligations               216,116              219,837
                                                    ------------         ------------
                                                       2,134,326            2,149,420
Less amounts subject to compromise                    (2,134,326)          (2,149,420)
                                                    ------------         ------------
      Total long-term debt                          $         --         $         --
                                                    ============         ============
</TABLE>

       PREPETITION DEBT

         Due to the failure to make scheduled payments, comply with certain
financial covenants and the commencement of the Chapter 11 Proceedings, the
Company is in default on substantially all of its prepetition debt obligations.
Except as otherwise may be determined by the Bankruptcy Court, the automatic
stay protection afforded by the Chapter 11 Filings prevents any action from
being taken with regard to any of the defaults under the prepetition debt
obligations. These obligations are classified as liabilities subject to
compromise at March 31, 2001 and September 30, 2000.

         The obligations of the Company under its senior credit facility are
guaranteed by substantially all of the Company's subsidiaries other than Mariner
Health and the Mariner Health Subsidiaries, and are secured by substantially all
of the otherwise unencumbered owned assets of the Company and such subsidiaries.
Mariner Health's obligations under its senior credit facility, which includes a
revolving credit facility and term loan facility, are guaranteed by
substantially all of the Mariner Health Subsidiaries and are secured by
substantially all of the otherwise unencumbered assets of Mariner Health and
such subsidiary guarantors. Mariner Health and the Mariner Health Subsidiaries
are treated as unrestricted subsidiaries under the Company's debt facilities.
Unlike other subsidiaries of the Company (the "Non-Mariner Health
Subsidiaries"), Mariner Health and the Mariner Health Subsidiaries neither
guarantee the Company's obligations under the Company's debt facilities nor
pledge their assets to secure such obligations. Correspondingly, the Company and
the Non-Mariner Health Subsidiaries do not guarantee or assume any obligations
under the Mariner Health debt facilities. Mariner Health and the Mariner Health
Subsidiaries are not subject to the covenants contained in the Company's debt
facilities, and the covenants contained in the Mariner Health debt facilities
are not binding on the Company and the Non-Mariner Health Subsidiaries.

         No principal payments have been made on prepetition indebtedness since
the Petition Date with the exception of repayments made against the Company's
senior credit facility, as adequate protection payments pursuant to the


                                       9


<PAGE>   12


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


Final Company DIP Order (as defined herein), resulting from the application of
net cash proceeds received from the sales of certain facilities and other
assets, and notional amounts related to certain other indebtedness, including
capital equipment leases. Interest paid on prepetition indebtedness during the
six month periods ended March 31, 2001 and 2000 was $7.8 million and $17.3
million, respectively.

       DEBTOR-IN-POSSESSION FINANCING FOR THE COMPANY

         In connection with the Chapter 11 Filings, the Company entered into a
$100.0 million debtor-in-possession financing agreement (as amended from time to
time, the "Company DIP Credit Agreement") with a group of banks (the "Company
DIP Lenders") led by Chase. On March 20, 2000 the Bankruptcy Court granted final
approval (the "Final Company DIP Order,") of the Company DIP Financing.

         The Company DIP Credit Agreement initially established a $100.0 million
secured revolving credit facility to provide funds for working capital and other
lawful corporate purposes for use by the Company and the other Company Debtors.
The Company DIP Credit Agreement currently provides that amounts outstanding
under the Company DIP Financing may not at any time exceed the maximum borrowing
amounts established for the Company under the Final Company DIP Order or the
Company's borrowing base of eligible accounts receivable (the "Company Borrowing
Base"). Up to $10.0 million of the Company DIP Financing may be utilized for the
issuance of letters of credit as needed in the business of the Company Debtors.
Interest accrues on the principal amount outstanding under the Company DIP
Financing at a per annum rate of interest equal to the Alternative Base Rate
("ABR") of Chase plus three percent (3%) and is payable monthly in arrears.
During the existence and continuation of a default in the payment of any amount
due and payable by the Company Debtors under the Company DIP Credit Agreement,
interest will accrue at the default rate of ABR plus five percent (5%) per
annum.

         The terms of the Company DIP Financing require that the Company prepay
principal to the extent that the principal amount outstanding under the Company
DIP Financing at any time exceeds the Company Borrowing Base then in effect. To
the extent proceeds of loans under the Company DIP Financing are used to
complete the construction of certain healthcare facilities (which proceeds are
not permitted to exceed $8.8 million), proceeds from the sale of any such
properties must be used first to repay any portion of the loans made pursuant to
the Company DIP Financing, with 75% of any remaining net cash proceeds to be
applied as an adequate protection payment to the lenders under the Company's
prepetition senior credit facility and the remaining 25% of such excess net cash
proceeds to be retained by the Company or its applicable subsidiary as
additional working capital. Pursuant to the terms of the Final Company DIP
Order, 75% of the net cash proceeds of other asset sales approved by the
Bankruptcy Court and the requisite Company DIP Lenders are to be applied as an
adequate protection payment to the lenders under the Company's prepetition
senior credit facility. The Company has the right to make optional prepayments
in increments of $1.0 million, and to reduce the commitment under the Company
DIP Credit Agreement in increments of $5.0 million.

         The obligations of the Company under the Company DIP Credit Agreement
are jointly and severally guaranteed by each of the other Company Debtors,
except for certain Company Debtors owning facilities that are mortgaged to Omega
Healthcare Investors, Inc. (the "Omega Debtors") whose guarantee is limited to
the negative cash flows of the Omega Debtors pursuant to the Company DIP Credit
Agreement. Under the terms of the Final Company DIP Order, the obligations of
the Company Debtors under the Company DIP Credit Agreement (the "Company DIP
Obligations") constitute allowed super priority administrative expense claims
pursuant to section 364(c)(1) of the Bankruptcy Code (subject to a carve out for
certain professional fees and expenses incurred by the Company Debtors). The
Company DIP Obligations are secured by perfected liens on all or substantially
all of the assets of the Company Debtors (excluding bankruptcy causes of
action), the priority of which liens (relative to prepetition creditors having
valid, non avoidable, perfected liens in those assets and to any "adequate
protection" liens granted


                                       10


<PAGE>   13

                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


by the Bankruptcy Court) is established in the Final Company DIP Order and the
related cash collateral order entered by the Bankruptcy Court (the "Final
Company Cash Collateral Order"). The Bankruptcy Court has also granted certain
prepetition creditors of the Company Debtors replacement liens and other rights
as "adequate protection" against any diminution of the value of their existing
collateral that may result from allowing the Company Debtors to use cash
collateral in which such creditors had valid, non-avoidable and perfected liens
as of the Petition Date. The discussion contained in this paragraph is qualified
in its entirety by reference to the Final Company DIP Order, the Final Company
Cash Collateral Order, and related stipulations, and reference should be made to
such orders (which are available from the Bankruptcy Court) and stipulations for
a more complete description of such terms.

         The Company DIP Credit Agreement contains customary representations,
warranties and other affirmative and restrictive covenants of the Company
Debtors, as well as certain financial covenants relating to minimum EBITDA,
maximum capital expenditures, and minimum patient census. The breach of such
representations, warranties or covenants, to the extent not waived or cured
within any applicable grace or cure periods, could result in the Company being
unable to obtain further advances under the Company DIP Financing and possibly
the exercise of remedies by the Company DIP Lenders, either of which events
could materially impair the ability of the Company to successfully reorganize in
chapter 11 and to operate as a going concern. Such a default may also impair the
ability of the Company Debtors to use cash collateral to fund operations. At
March 31, 2001, there were no outstanding borrowings under the Company DIP
Credit Agreement. At March 31, 2001, there were also letters of credit
outstanding under the Company DIP Financing of approximately $5.2 million.

         The outstanding principal of the Company DIP Financing, together with
all accrued and unpaid interest and all other obligations thereunder, was
originally due and payable one year from the Petition Date. With the approval of
the Bankruptcy Court, the Company Debtors, Chase and the requisite Company DIP
Lenders amended the Company DIP Credit Agreement as of January 11, 2001, to
(among other things) extend the maturity date of the Company DIP Financing from
January 19, 2001 to August 31, 2001 and to provide for the modification of
certain financial and other covenants. Effective as of January 19, 2001, the
Company also exercised its right under the Company DIP Credit Agreement to
reduce the $100.0 million Company DIP Financing commitment to $50.0 million.

       DEBTOR-IN-POSSESSION FINANCING FOR MARINER HEALTH

         Among the orders entered by the Bankruptcy Court in the chapter 11
cases of Mariner Health and its subsidiaries, were orders approving (a) the use
of cash collateral by the Mariner Health Debtors, and (b) the funding of up to
$50.0 million in principal amount at any time outstanding under a
debtor-in-possession financing arrangement pursuant to that certain
Debtor-in-Possession Credit Agreement dated as of January 20, 2000 (as amended
from time to time, the "Mariner Health DIP Credit Agreement") by and among
Mariner Health and each of the other Mariner Health Debtors, as co-borrowers
thereunder, the lenders signatory thereto as lenders (the "Mariner Health DIP
Lenders"), First Union National Bank, as Syndication Agent, PNC Capital Markets,
Inc. and First Union Securities, Inc., as co-arrangers, and PNC, as
Administrative Agent and Collateral Agent. After a final hearing on February 16,
2000 the Bankruptcy Court entered an order granting final approval of up to
$50.0 million of the Mariner Health DIP Financing (the "Final Mariner Health DIP
Order").

         The Mariner Health DIP Credit Agreement initially established a $50.0
million secured revolving credit facility comprised of a $40.0 million tranche A
revolving loan commitment and a $10.0 million tranche B revolving loan
commitment. Under the Mariner Health DIP Credit Agreement's current terms,
advances under the Mariner Health DIP Financing may be used by the Mariner
Health Debtors (and to a limited degree, by certain joint venture subsidiaries
of Mariner Health that are not debtors in the Mariner Health chapter 11 cases)
for working capital and


                                       11

<PAGE>   14


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


other lawful corporate purposes. Amounts outstanding under the Mariner Health
DIP Financing may not at any time exceed the maximum borrowing amounts
established for the Mariner Health Debtors under the Final Mariner Health DIP
Order. Up to $5.0 million of the Mariner Health DIP Financing may be utilized
for the issuance of letters of credit as needed in the businesses of the Mariner
Health Debtors.

         Interest accrues on the principal amount outstanding under the Mariner
Health DIP Financing at a per annum rate of interest equal to the "base rate" of
PNC (i.e., the higher of the PNC prime rate or a rate equal to the federal funds
rate plus 50 basis points) plus the applicable spread, which is 250 basis
points. Such interest is due and payable monthly in arrears. During the
existence and continuation of any event of default under the Mariner Health DIP
Credit Agreement, the interest rates normally applicable to loans under the
Mariner Health DIP Financing will be increased by another 250 basis points per
annum.

         The outstanding principal of the Mariner Health DIP Financing, together
with all accrued and unpaid interest and all other obligations thereunder, are
due and payable on the Commitment Termination Date, defined as the first to
occur of (i) January 19, 2001, unless extended (such date having since been
extended to July 19, 2001 as discussed below); (ii) the effective date of a
joint plan of reorganization for the Mariner Health Debtors; (iii) the date of
termination of the exclusivity rights of the Mariner Health Debtors to file a
plan of reorganization; (iv) the filing by the Mariner Health Debtors of any
plan of reorganization (or the modification of any such plan previously filed
with the Bankruptcy Court) not previously approved by the holders of at least
66-2/3% of the outstanding loans or commitments under the Mariner Health DIP
Financing; (v) the date of termination of the commitments under the Mariner
Health DIP Credit Agreement during the continuation of an event of default
thereunder; or (vi) the date on which all or substantially all of the assets or
stock of the Mariner Health Debtors is sold or otherwise transferred.

         Under the current terms of the Mariner Health DIP Credit Agreement, the
Mariner Health Debtors must also prepay principal to the extent that the
principal amount outstanding under the Mariner Health DIP Financing at any time
exceeds the Mariner Health borrowing base then in effect. The Mariner Health
borrowing base for any month is an amount equal to $7.5 million in excess of the
"Working Capital Facility" borrowings projected for such month in Mariner
Health's year 2000 DIP budget.

         The Mariner Health DIP Credit Agreement also provides for mandatory
prepayments under the following circumstances: (a) with net cash proceeds from
asset sales, the incurrence of certain debt, the issuance of new equity, the
receipt of tax refunds exceeding $100,000 in the aggregate, and the receipt of
casualty proceeds in excess of $100,000 that are not applied within 60 days
after receipt to the repair, rebuilding, restoration or replacement of the
assets damaged or condemned (or committed within such period of time to be so
applied); and (b) on each business day, the amount of cash held by the Mariner
Health Debtors in excess of the sum of $5.0 million plus the aggregate sum of
the minimum amount required by depositary banks to be kept in deposit accounts,
concentration accounts and other accounts with such banks. Amounts prepaid
pursuant to clause (a) of the immediately preceding sentence will permanently
reduce the amount of the Mariner Health DIP Financing commitments on a dollar
for dollar basis. Amounts prepaid pursuant to clause (b) of the same sentence
will not permanently reduce such commitments. The Mariner Health Debtors have
the right to make optional prepayments in the minimum principal amount of $1.0
million, and in increments of $100,000 in excess thereof, and, on three business
days' notice, to reduce the commitments under the Mariner Health DIP Credit
Agreement in the minimum amount of $5.0 million, or in increments of $1.0
million in excess thereof.

         As provided in the Final Mariner Health DIP Order, the obligations of
the Mariner Health Debtors under the Mariner Health DIP Credit Agreement
(together with certain potential cash management system liabilities secured on a
pari passu basis therewith, the "Mariner Health DIP Obligations") constitute
allowed super priority


                                       12

<PAGE>   15


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


administrative expense claims pursuant to section 364(c)(1) of the Bankruptcy
Code (subject to a carve-out for certain professional fees and expenses incurred
by the Mariner Debtors). The Mariner Health DIP Obligations are secured by
perfected liens on all or substantially all of the assets of the Mariner Health
Debtors (excluding bankruptcy causes of action), the priority of which liens
(relative to prepetition creditors having valid, non-avoidable, perfected liens
in those assets and to any "adequate protection" liens granted by the Bankruptcy
Court) is established in the Final Mariner Health DIP Order and the related cash
collateral orders entered by the Bankruptcy Court (the "Mariner Health Cash
Collateral Orders"). The Bankruptcy Court has also granted certain prepetition
creditors of the Mariner Health Debtors replacement liens and other rights as
"adequate protection" against any diminution of the value of their existing
collateral that may result from allowing the Mariner Health Debtors to use cash
collateral in which such creditors had valid, non-avoidable and perfected liens
as of the Petition Date. The discussion contained in this paragraph is qualified
in its entirety by reference to the Final Mariner Health DIP Order, the related
Mariner Health Cash Collateral Orders, and related stipulations, and reference
should be made to such orders (which are available from the Bankruptcy Court)
and stipulations for a more complete description of such terms.

         The Mariner Health DIP Credit Agreement contains customary
representations, warranties and other affirmative and restrictive covenants of
the Mariner Health Debtors, as well as certain financial covenants relating to
minimum profitability, minimum patient census, minimum eligible accounts
receivable, maximum variations from Mariner Health's year 2000 DIP budget and
maximum capital expenditures. The breach of such representations, warranties or
covenants, to the extent not waived or cured within any applicable grace or cure
periods, could result in the Mariner Health Debtors being unable to obtain
further advances under the Mariner Health DIP Financing and possibly the
exercise of remedies by the Mariner Health DIP Lenders, either of which events
could materially impair the ability of the Mariner Health Debtors to
successfully reorganize in chapter 11 and to operate as a going concern.
Included among the events of default is the termination of the Mariner Health
Debtor's exclusive right to file a plan or plans of reorganization in any of
their chapter 11 cases other than as the result of the filing of a plan or plans
of reorganization acceptable to the lenders. The occurrence of an event of
default under the Mariner Health DIP Credit Agreement may impair the ability of
the Mariner Health Debtors to use cash collateral to fund operations. At March
31, 2001, there were no outstanding borrowings or letters of credit issued under
the Mariner Health DIP Credit Agreement.

         Among its other restrictive covenants, the Mariner Health DIP Credit
Agreement limits affiliate transactions with the Company Debtors, but does
contemplate weekly overhead payments to the Company equal to 1.25% of projected
net nursing home revenues for such month, subject to a monthly "true-up," such
that the payments for such month equal 5% of actual net nursing home revenues of
the Mariner Health Debtors. Such payments may be suspended by the Mariner Health
Debtors if certain defaults specified in the Mariner Health Credit Agreement
occur and are continuing, though such fees will still accrue and will become due
and payable if and when the subject default has been cured or waived.

         By amendment dated as of January 19, 2001, and with the approval of the
Bankruptcy Court, the Mariner Health DIP Credit Agreement was amended to extend
the stated termination date for the Mariner Health DIP Credit Agreement from
January 19, 2001 to July 19, 2001, and to reduce the maximum amount of the
Mariner Health DIP Credit Financing from $50.0 million to $25.0 million (as a
result of which the tranche B component of that credit facility was eliminated).
Such amendment also, among other things, extended the deadline for filing a plan
of reorganization to February 20, 2001 (which has subsequently been extended by
a series of amendments to July 20, 2001), imposed a 25 basis point utilization
fee on borrowings under the Mariner


                                       13


<PAGE>   16


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


         Health DIP Credit Agreement in excess of $5.0 million and amended
certain reporting requirements. An amendment dated as of March 20, 2001, among
other things, increased the letter of credit sublimit and the borrowing base to
permit the issuance of a $7.85 million letter of credit to facilitate
implementation of a replacement surety bond program by Mariner Health, though
such letter of credit had not been issued as of May 11, 2001. Because such
letter of credit, when issued, is expected to expire well after the Commitment
Termination Date for the Mariner Health DIP Facility, the March 20, 2001
amendment requires such letter of credit to be fully cash collateralized.

         On or about May 14, 2001, Mariner Health and representatives of the
Mariner Health DIP Lenders and the Mariner Health prepetition senior bank group
(the "Mariner Health Principal Secured Lenders") entered into a stipulation (the
"May 14 Stipulation") (i) extending from May 21, 2001 to July 20, 2001, the
Mariner Health Debtors' exclusive right to file a plan of reorganization, and
(ii) if they file a plan within that time, extending the Mariner Health Debtor's
exclusive right to solicit acceptances of such plan to September 20, 2001;
however, such exclusivity rights are modified in that stipulation to permit the
Mariner Health Principal Secured Lenders to file their own plan or plans of
reorganization for the Mariner Health Debtors and to solicit acceptances
thereto, or (at the sole option of the Mariner Health Principal Secured Lenders)
to file a joint plan of reorganization with the Mariner Health Debtors and
solicit acceptances thereto. The May 14 Stipulation remains subject to the
approval of the Bankruptcy Court. If approved by the Bankruptcy Court, the May
14 Stipulation would constitute a waiver by the Mariner Health DIP Lenders of
the covenant in the Mariner Health DIP Credit Agreement that the Mariner Health
Debtors file a plan of reorganization by a certain time and an agreement that
the modification of the Mariner Health Debtors' exclusivity rights pursuant to
that stipulation would not constitute an event of default under the Mariner
Health DIP Credit Agreement. No assurances can be given as to whether or not the
Bankruptcy Court will grant the Mariner Health Debtors' motion to approve the
May 14 Stipulation. Failure of the Bankruptcy Court to grant such approval could
result in the Mariner Health Debtors' losing their exclusive right to file a
plan of reorganization and an event of default occurring under the Mariner
Health DIP Credit Agreement.

NOTE 6 - COMPREHENSIVE INCOME

         Comprehensive income (loss) includes net income (loss), as well as
charges and credits to stockholders' equity (deficit) not included in net income
(loss). The components of comprehensive income (loss), net of income taxes,
consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                        THREE MONTHS ENDED       SIX MONTHS ENDED
                                                             MARCH 31,               MARCH 31,
                                                       ---------------------    ---------------------
                                                         2001         2000        2001        2000
                                                       --------     --------    --------    --------
<S>                                                    <C>         <C>          <C>         <C>
Net income (loss)                                      $ 13,176    $(14,229)    $ 23,086    $(72,270)

Net unrealized gains (losses) on available-for-sale
   securities                                               152          16          213        (180)
                                                       --------     -------     --------    --------
Comprehensive income (loss)                            $ 13,328    $(14,213)    $ 23,299    $ 72,450
                                                       ========     =======     ========    ========
</TABLE>

         Accumulated other comprehensive loss, net of income taxes, is comprised
of net unrealized losses on available-for-sale securities of $1,275 and $1,488
at March 31, 2001 and September 30, 2000, respectively.


                                       14
<PAGE>   17


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


NOTE 7 - EARNINGS PER SHARE

         The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share data) in accordance with
Financial Accounting Standards No. 128, "Earnings per Share":

<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED       SIX MONTHS ENDED
                                                                  MARCH 31,               MARCH 31,
                                                           --------------------     --------------------
                                                             2001        2000         2001        2000
                                                           --------    --------     --------    --------
<S>                                                        <C>         <C>          <C>         <C>
Numerator for basic and diluted loss per share:
  Net income (loss)                                        $ 13,176    $(14,229)    $ 23,086    $(72,270)
                                                           ========    ========     ========    ========

Denominator:
  Denominator for basic income (loss) per share -
    Weighted average shares                                  73,688      73,688       73,688      73,688

  Effect of dilutive securities - stock options                  --          --           --          --
                                                           --------    --------     --------    --------
  Denominator for diluted income (loss) per
    share -  adjusted weighted average shares and
    assumed conversions                                      73,688      73,688       73,688      73,688
                                                           ========    ========     ========    ========

Basic and diluted income (loss) per share:
  Net income (loss) per share                              $   0.18    $  (0.19)    $   0.31    $  (0.98)
                                                           ========    ========     ========    ========
</TABLE>

NOTE 8 - INCOME TAXES

         Due to the nature and composition of the Company's deferred tax assets
and the changes in the Company's valuation allowance, the Company does not
expect to incur income tax expense regarding the net profits generated during
the current fiscal year. Additionally, the Company has not reduced its deferred
asset valuation allowance any further due to the continuing uncertainty of
future profitability. Consequently, the Company maintains a valuation allowance
which completely offsets all net deferred tax assets generated from the
Company's losses.

NOTE 9 - COMMITMENTS AND CONTINGENCIES

       LITIGATION

         As is typical in the healthcare industry, the Company is and will be
subject to claims that its services have resulted in resident injury or other
adverse effects, the risks of which will be greater for higher acuity residents
receiving services from the Company than for other long-term care residents. In
addition, resident, visitor, and employee injuries will also subject the Company
to the risk of litigation. The Company has experienced an increasing trend in
the number and severity of litigation and claims asserted against the Company.
Management believes that this trend is endemic to the long-term care industry
and is a result of the increasing number of large judgments, including large
punitive damage awards, against long-term care providers in recent years
resulting in an increased awareness by plaintiff's lawyers of potentially large
recoveries. In certain states in which the Company has significant operations,
including California and Florida, insurance coverage for the risk of punitive
and certain other damages arising from general and professional liability
litigation is not available due to state law public policy prohibitions. There
can be no assurance that the Company will not be liable for punitive or other
damages awarded


                                       15


<PAGE>   18


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


in litigation arising in states for which insurance coverage is not available
for such damages. The Company also believes that there has been, and will
continue to be, an increase in governmental investigations of long-term care
providers, particularly in the area of Medicare/Medicaid false claims as well as
an increase in enforcement actions resulting from these investigations. While
the Company believes that it provides quality care to the patients in its
facilities and materially complies with all applicable regulatory requirements,
given the Company's current financial difficulties and lack of liquidity, an
adverse determination in a legal proceeding or governmental investigation,
whether currently asserted or arising in the future, could have a material
adverse effect on the Company.

         From time to time, the Company and its subsidiaries have been parties
to various legal proceedings in the ordinary course of their respective
businesses. In the opinion of management, except as described below, there are
currently no proceedings which, individually, if determined adversely to the
Company and after taking into account the insurance coverage maintained by the
Company, would have a material adverse effect on the Company's financial
position or results of operations. Although the Company believes that any of the
proceedings not discussed below will not individually have a material adverse
impact on the Company if determined adversely to the Company, given the
Company's current financial condition, lack of liquidity and change in the
Company's GL/PL insurance policies, settling a large number of cases within the
Company's $1 million self-insured retention limit could have a material adverse
effect on the Company.

         On August 26, 1996, a class action complaint was asserted against
GranCare, Inc. ("GranCare"), a wholly-owned subsidiary of the Company, in the
Denver, Colorado District Court, Salas, et al v. GranCare, Inc. and AMS
Properties, Inc. d/b/a Cedars Healthcare Center, Inc., case no. 96-CV-4449. On
March 15, 1998, the Court entered an Order in which it certified a class action
in the matter. On June 10, 1998, the Company filed a Motion to Dismiss all
claims and Motion for Summary Judgment Precluding Recovery of Medicaid Funds and
these motions were partially granted by the Court on October 30, 1998.
Plaintiffs' Motion for Reconsideration was denied by the Court on November 19,
1998, the Court's decision was certified as a final judgment on December 10,
1998, and plaintiffs then filed a writ with the Colorado Supreme Court, which
was denied, and an appeal with the Colorado Court of Appeal. In accordance with
the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more
particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000.
However, the Company did agree to limited relief from the stay in order to allow
for certain parts of the appeal to continue. On January 4, 2001, the Court of
Appeal reversed the District Court's decision. On February 1, 2001, the Company
filed a request for rehearing. The Company intends to vigorously contest all
remaining allegations.

         On March 18, 1998, a complaint was filed under seal by a former
employee against the Company, certain of its predecessor entities and affiliates
in the United States District Court for the Northern District of Alabama,
alleging, inter alia, employment discrimination, wrongful discharge, negligent
hiring, violation of the Federal False Claims Act, and retaliation under the
False Claims Act. The action is titled Powell, et al. v. Paragon Health Inc., et
al., civil action No. CV-98-0630-S. The complaint has been unsealed and the
Company has been advised that the government has declined to intervene in this
matter under the Federal False Claims Act. In accordance with the Company's
voluntary filing under chapter 11 of the Bankruptcy Code and more particularly,
ss. 362 of that Code, this matter was stayed on January 18, 2000.

         On August 25, 1998, a complaint was filed by the United States against
the Company's GranCare and International X-Ray subsidiaries and certain other
parties under the Civil False Claims Act and in common law and equity. The
lawsuit, U.S. v. Sentry X-Ray, Ltd., et al., civil action no. 98-73722, was
filed in United States District Court for the Eastern District of Michigan.
Valley X-Ray operates a mobile X-Ray company in Michigan. A Company subsidiary,
International X-Ray, owns a minority partnership interest in defendant Valley X-
Ray. The case asserts five claims for relief, including two claims for violation
of the Civil False Claims Act, two alternative claims of common law fraud and
unjust enrichment, and one request for application of the Federal Debt
Collection


                                       16


<PAGE>   19




                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)

Procedures Act. The two primary allegations of the complaint are that (i) the
X-Ray company received Medicare overpayments for transportation costs in the
amount of $657,767; and (ii) the X-Ray company "upcoded" Medicare claims for EKG
services in the amount of $631,090. The United States has requested treble
damages as well as civil penalties of $5,000 to $10,000 for each of the alleged
388 submitted Medicare claims. The total damages sought varies from $5.3 million
to $7.2 million. As the result of a motion filed by the Company on November 23,
1998, GranCare was dismissed from the case. In accordance with the Company's
voluntary filing under chapter 11 of the Bankruptcy Code and more particularly,
ss. 362 of that Code, this matter was stayed on January 18, 2000.

         On October 1, 1998, a class action complaint was asserted against
certain of the Company's predecessor entities and affiliates and certain other
parties in the Tampa, Florida, Circuit Court, Ayres, et al v. Donald C. Beaver,
et al, case no. 98-7233. The complaint asserted three claims for relief,
including breach of fiduciary duty against one group of defendants, breach of
fiduciary duty against another group of defendants, and civil conspiracy arising
out of issues involving facilities previously operated by the Brian Center
Corporation or one of its subsidiaries, and later by a subsidiary of Living
Centers of America, Inc. ("LCA"), a wholly-owned subsidiary of the Company, as a
result of the merger with Brian Center Corporation. All defendants submitted
Motions to Dismiss which were heard by the Court on September 15, 1999. The
Court granted Defendant Donald C. Beaver's Motion to Dismiss on December 6,
1999. Very little discovery has been conducted and accordingly, this case is not
in a position to be evaluated in regard to the probability of a favorable
outcome or in regard to the range of potential loss. In accordance with the
Company's voluntary filing under chapter 11 of the Bankruptcy Code and more
particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000.
On or about April 19, 2000 plaintiffs filed an Amending Petition seeking to
bring Donald C. Beaver back into the case as a defendant. Mr. Beaver has filed a
Motion to Dismiss the Amending Petition and no date for hearing has been set. In
accordance with the Company's voluntary filing under chapter 11 of the
Bankruptcy Code, and more particularly, ss. 362 of the Bankruptcy Code, all
proceedings against the Company have been stayed. Very little discovery has been
conducted and accordingly, this case is not in a position to be evaluated in
regard to the probability of a favorable outcome or in regard to the range of
potential loss. The Company intends to vigorously contest the request for class
certification, as well as all alleged claims made.

         On November 16, 1998, a complaint was filed under seal by a former
employee against the Company, certain of its predecessor entities and affiliates
in the United States District Court for the Southern District of Texas, alleging
violation of the Federal False Claims Act. The action is titled United States ex
rel. Nelius, et al., v. Mariner Health Group, Inc., et al., civil action No.
H-98-3851. To date, the Government has declined to intervene. The complaint
which was unsealed, has been amended to add additional relators and allegations
under the Federal False Claims Act. In response to the Notice of Stay submitted
under 11 U.S.C. ss. 362, the District Court, on January 26, 2000, dismissed the
plaintiffs' claims against defendants subject to reinstatement within thirty
(30) days after the stay is discontinued. The Company intends to vigorously
contest the alleged claims herein.

         On approximately June 8, 1999 and December 13, 2000, the OIG issued
subpoenas duces tecum to Mariner of Catonsville. The subpoenas request medical
records pertaining to eighteen residents and employment and business records.
The subpoenas also request other broad categories of documents. The Company has
produced a substantial amount of documents responsive to the subpoenas. The
Company is cooperating with the investigation and has retained experienced
counsel to assist in responding to the subpoenas and to advise the Company with
respect to this investigation. The Company has been informed by the United
States that this investigation is now closed.

         On October 27, 1999, the Company was served with a Complaint in United
States ex rel. Cindy Lee Anderson Rutledge and Partnership for Fraud Analysis
and State of Florida ex rel. Cindy Lee Anderson Rutledge Group, Inc., ARA Living
Centers, Inc. and Living Centers of America, Inc., No. 97-6801, filed in the
United States


                                       17

<PAGE>   20



                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


District Court for the Eastern District of Pennsylvania. This action originally
was filed under seal on November 5, 1997, by relators Cindy Lee Anderson
Rutledge and the Partnership for Fraud Analysis under the Federal False Claims
Act and the Florida False Claims Act. The Complaint alleges that the Company is
liable under the Federal False Claims Act and the Florida False Claims Act for
alleged violations of regulations pertaining to the training and certification
of nurse aides at former LCA facilities. After conducting an investigation in
which the Company cooperated by producing documents responsive to an
administrative subpoena and allowing certain employee interviews, the United
States Department of Justice elected not to intervene. The district court
unsealed the Complaint on October 15, 1999. On December 14, 1999, the Company
filed a motion to dismiss the relators' complaint. In accordance with the
Company's voluntary filing under chapter 11 of the Bankruptcy Code and more
particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000.
The Company intends vigorously to defend this action.

         On approximately January 20, 2000, the OIG issued subpoenas duces tecum
to the Company and Summit Medical Management (a subsidiary of the Company). The
subpoenas request documents relating to the purchase of Summit Medical
Management and other subsidiaries. In addition, the subpoenas request other
broad categories of documents. The Company is cooperating with the investigation
and has retained experienced counsel to assist in responding to the subpoenas
and advise the Company with respect to this investigation. This investigation is
still in its preliminary stages; therefore, the Company is unable to predict the
outcome of this matter.

         On approximately August 31, 2000, the United States Attorney for
Eastern District of Michigan issued a subpoena duces tecum to Cambridge East.
The subpoena requests medical records and other broad categories of documents.
The Company has produced a substantial amount of documents responsive to the
subpoena. The Company is cooperating with the investigation and has retained
experienced counsel to assist in responding to the subpoena and to advise the
Company with respect to this investigation. This investigation is still in its
preliminary stages; therefore, the Company is unable to predict the outcome of
this matter.

         On October 5, 2000, NovaCare Holdings, Inc. ("NCH") filed a complaint
(the "NCH Complaint") in the Chapter 11 Proceedings commencing Adversary
Proceeding No. 00-1577 (MFW), NovaCare Holdings, Inc. v. Mariner Post-Acute
Network, Inc., et al. The Company and various subsidiaries (the "defendant
subsidiaries") are named as defendants in the NCH Complaint. In the NCH
Complaint, NCH alleges that its predecessors in interest (hereinafter also
referred to as "NCH") were party to contracts with various subsidiaries of the
Company under which NCH provided services to patients at various facilities of
such subsidiaries. It further alleges that pursuant to these contracts, NCH
provided certain services for which it was paid, but with respect to which the
Health Care Financing Administration ("HCFA") disallowed the facilities' claims
for reimbursement (the "NCH HCFA Disallowances"). After the NCH HCFA
Disallowances, NCH allegedly provided credits to the facilities equal to the
amount of the NCH HCFA Disallowances. Appeals of the NCH HCFA Disallowances were
filed, and NCH alleges that it holds a constructive trust or equitable lien on
any amounts which may be recovered from HCFA as a result of such appeals. In the
alternative, NCH alleges that it holds an administrative priority claim for any
such amounts that are paid by HCFA and not turned over to NCH. The aggregate
amount of the credits that are related to the NCH HCFA Disallowances and with
respect to which NCH asserts a constructive trust, an equitable lien, and/or an
administrative priority claim is $8,163,930. In addition, NCH asserts
administrative priority claims as well as claims for an equitable lien and
constructive trust for attorneys fees and expenses relating to the appeals of
other disallowance decisions by HCFA (the "Other HCFA Disallowances"); the NCH
Complaint states that NCH has incurred at least $275,000 of such expenses. On
November 9, 2000, the Company and the defendant subsidiaries filed a motion
("Motion to Dismiss") to dismiss the NCH Complaint, arguing that the
constructive trust/equitable lien claims are barred by res judicata based upon
prior financing orders of the Bankruptcy Court, and that the claims seeking
administrative priority fail to state claims upon which such relief may be
granted. On December 12, 2000,


                                       18


<PAGE>   21


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


the Bankruptcy Court heard oral argument with respect to the motion to dismiss,
took the matter under submission, and requested further briefing. In early
November, NCH filed a motion ("Motion to Enjoin Settlement") which seeks to
enjoin the Company and the defendant subsidiaries from settling claims against
HCFA relating to the NCH HCFA Disallowances and to require that any funds
recovered with respect to such claims be segregated. The Company and the
defendant subsidiaries have filed an opposition. In addition the Company has
filed a motion for summary judgement ("Motion for Summary Judgement") on those
counts of the complaint which are directed against the Company and its
subsidiaries. A hearing on the Motion to Enjoin Settlement and on the Motion for
Summary Judgement has been deferred until the Bankruptcy Court rules on the
Motion to Dismiss. The parties are currently waiting for the Bankruptcy Court to
rule on the Motion to Dismiss. The Company and the defendant subsidiaries intend
to contest the case vigorously.

NOTE 10 - SEGMENT INFORMATION

         The following tables exhibit the segment reporting of the Company for
the three and six months ended March 31, 2001 and 2000 (in thousands):


<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED              SIX MONTHS ENDED,
                                                                  MARCH 31,                      MARCH 31,
                                                           -------------------------     -------------------------
                                                              2001           2000          2001            2000
                                                           ----------     ----------     ----------     ----------
<S>                                                        <C>            <C>            <C>            <C>
Revenues from external customers:
  Nursing home services                                    $  439,428     $  451,416     $  883,957     $  895,628
  Pharmacy services                                            53,113         62,554        106,906        128,397
  Other                                                        28,242         27,544         54,062         54,695
                                                           ----------     ----------     ----------     ----------
                                                           $  520,783     $  541,514     $1,044,925     $1,078,720
                                                           ==========     ==========     ==========     ==========

Intersegment revenues:
  Pharmacy services                                        $   12,843     $   12,920     $   24,926     $   26,261
  Other                                                            72             72            142            143
                                                           ----------     ----------     ----------     ----------
                                                           $   12,915     $   12,992     $   25,068     $   26,404
                                                           ==========     ==========     ==========     ==========

Net income (loss):
  Nursing home services                                    $   45,758     $   40,196     $   83,301     $   75,155
  Pharmacy services                                              (968)          (155)          (587)        (2,866)
  Other                                                         2,101          2,207          3,768          1,150
                                                           ----------     ----------     ----------     ----------
                                                           $   46,891     $   42,248     $   86,482     $   73,439
                                                           ==========     ==========     ==========     ==========

<CAPTION>

                                                                                                         MARCH 31,
                                                                                                           2001
                                                                                                        ----------
<S>                                                                                                     <C>
Assets:
  Nursing home services                                                                                 $  960,840
  Pharmacy services                                                                                         97,846
  Other                                                                                                     96,340
                                                                                                        ----------
                                                                                                        $1,155,026
                                                                                                        ==========
</TABLE>


                                       19


<PAGE>   22


                MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  (DEBTOR IN POSSESSION AS OF JANUARY 18, 2000)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (unaudited)


         The following tables reconcile the Company's segment reporting to the
totals on the Company's unaudited condensed consolidated financial statements
for the three and six months ended March 31, 2001 and 2000 (in thousands):

<TABLE>
<CAPTION>
                                                              THREE MONTHS ENDED             SIX MONTHS ENDED
                                                                   MARCH 31,                      MARCH 31,
                                                           -------------------------     --------------------------
                                                              2001           2000           2001           2000
                                                           ----------     ----------     ----------     -----------
<S>                                                        <C>            <C>            <C>            <C>
Revenues:
  External revenues for reportable segments                $  520,783     $  541,514     $1,044,925     $ 1,078,720
  Intersegment revenues for reportable segments                12,915         12,992         25,068          26,404
  Elimination of intersegment revenue                         (12,915)       (12,992)       (25,068)        (26,404)
                                                           ----------     ----------     ----------     -----------
Consolidated revenues                                      $  520,783     $  541,514     $1,044,925     $ 1,078,720
                                                           ==========     ==========     ==========     ===========

Net income (loss):
  Net income for reportable segments                       $   46,891     $   42,248     $   86,482     $    73,439
  Corporate overhead                                          (33,715)       (56,477)       (63,396)       (145,709)
                                                           ----------     ----------     ----------     -----------
Consolidated net income (loss)                             $   13,176     $  (14,229)    $   23,086     $   (72,270)
                                                           ==========     ==========     ==========     ===========

<CAPTION>

                                                                                                         MARCH 31,
                                                                                                           2001
                                                                                                        -----------
<S>                                                                                                     <C>
Assets:
      Assets for reportable segments                                                                    $ 1,155,026
      Corporate overhead                                                                                  1,417,172
      Elimination of intersegment assets                                                                 (1,294,516)
                                                                                                        -----------
                                                                                                        $ 1,277,682
                                                                                                        ===========
</TABLE>


                                       20
<PAGE>   23
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

     OVERVIEW

         The Company through its subsidiaries is one of the nation's largest
providers of post-acute health care services, primarily through the operation of
skilled nursing facilities. At March 31, 2001, the Company's significant
operations consisted of (i) approximately 350 inpatient and assisted living
facilities containing approximately 42,000 beds; (ii) approximately 33
institutional pharmacies servicing more than 1,500 long-term care centers; and
(iii) 13 long-term acute care hospitals with approximately 620 licensed beds.
The Company operates in 25 states with significant concentrations of facilities
and beds in five states and several metropolitan markets.

         On January 18, 2000 (the "Petition Date"), the Company and
substantially all of its subsidiaries (the "Company Debtors"), including Mariner
Health Group, Inc. ("Mariner Health") and its subsidiaries (the "Mariner Health
Subsidiaries" and collectively with Mariner Health, the "Mariner Health
Debtors"), filed voluntary petitions (collectively, the "Chapter 11 Filings") in
the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court") under chapter 11 title 11 of the United States Code (the "Bankruptcy
Code"). The Company is presently operating its business as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court while a
plan of reorganization is formulated. As a debtor-in-possession, the Company is
authorized to operate its business but may not engage in transactions outside
its ordinary course of business without the approval of the Bankruptcy Court
(the "Chapter 11 Proceedings").

         The Company's cumulative operating losses, liquidity issues and the
Chapter 11 Proceedings raise substantial doubt about the Company's ability to
continue as a going concern. The ability of the Company to continue as a going
concern and the appropriateness of using the going concern basis of accounting
is dependent upon, among other things, the ability of the Company to comply with
the terms of its various commitments of debtor-in-possession financing,
confirmation of a plan of reorganization, success of future operations after
such confirmation and the ability to generate sufficient cash from operations
and financing sources to meet obligations. Any plan of reorganization and other
actions during the Chapter 11 Proceedings could change materially the amounts
currently recorded in the unaudited condensed consolidated financial statements
(see Note 3 of the unaudited condensed consolidated financial statements).

     RESULTS OF OPERATIONS

         The following discussion and analysis should be read in conjunction
with the business segment data in Note 10 of the unaudited condensed
consolidated financial statements.

         Net revenues for inpatient nursing home services accounted for $439.4
million and $884.0 million of the Company's $520.8 million and $1,044.9 million
total revenues for the three and six months ended March 31, 2001, respectively.
Nursing home services revenues are derived from the provision of routine and
ancillary services and are a function of occupancy rates in the Company's
nursing facilities and payor mix.

         Weighted average occupancy, as identified in the following table,
increased by 1.3% and 0.9%, respectively, over the comparable three and six
month periods from fiscal year 2000 to fiscal year 2001.

<TABLE>
<CAPTION>
                                                            THREE MONTHS ENDED             SIX MONTHS ENDED
                                                                 MARCH 31,                     MARCH 31,
                                                           ---------------------         ---------------------
                                                            2001           2000           2001           2000
                                                           ------         ------         ------         ------
             <S>                                           <C>            <C>            <C>            <C>
             Weighted average licensed bed count           40,621         45,949         41,647         46,572
             Total average residents                       35,646         39,759         36,295         39,866
             Weighted average occupancy                      87.8%          86.5%          87.1%          85.6%
</TABLE>


                                       21

<PAGE>   24

         Payor mix is the source of payment for the services provided and
consists of Medicare, Medicaid and private pay. Private pay includes revenue
from individuals who pay directly for services (without government assistance
through the Medicare and Medicaid programs) and from managed care companies,
commercial insurers, health maintenance organizations, Veteran's Administration
contractual payments and payments for services provided under contract
management programs. Managed care as a payor source to nursing home operators is
likely to increase over the next several years. However, revenue from managed
care payors does not constitute a significant portion of the Company's revenue
at this time.

         Reimbursement rates from government sponsored programs, such as
Medicare and Medicaid, are strictly regulated and subject to funding
appropriations from federal and state governments. Changes in reimbursement
rates, including the implementation of the Prospective Payment System ("PPS")
for Medicare Part A patients beginning July 1, 1998 and the fee screen schedules
and therapy caps for Medicare Part B patients beginning January 1, 1999, have
adversely affected the Company resulting in significantly lower Medicare
revenues than the Company would have received under the previous cost based
payment methodology. Ongoing efforts of third-party payors to contain healthcare
costs by limiting reimbursement rates, increasing case management review and
negotiating reduced contract pricing continue to affect the Company's revenues
and profitability. The federal Medicare program restricts inpatient coverage to
patients who require skilled care. State-administered Medicaid programs
generally provide more restricted coverage and lower reimbursement rates than
private pay sources.

         In addition, the administrative procedures associated with the Medicare
cost reimbursement program, with respect to facilities and periods not subject
to PPS, generally preclude final determination of amounts due the Company until
annual cost reports are audited or otherwise reviewed and settled with the
applicable fiscal intermediaries and administrative agencies. Certain Medicare
fiscal intermediaries have made audit adjustments to settle cost reports for
some of the Company's facilities that reduce the amount of reimbursement that
was previously received by the facilities. The Company believes that it has
properly recorded revenue under cost reimbursement programs based on the facts
and current regulations. If the Company were to receive adverse adjustments that
it had not contemplated in recording its revenue in the past, the differences
could be significant to the Company's results of operations in the period of
final determination. See "--Liquidity and Capital Resources." Under PPS, the
Company is still required to file cost reports; however, the audit and
settlement process of Medicare cost reports is not expected to have a material
impact on total Medicare revenue. See "--Liquidity and Capital Resources." As
part of the bankruptcy process the Company, Mariner Health and their respective
subsidiaries are engaged in discussions with the Health Care Financing
Administration ("HCFA") to potentially settle some or all matters related to
historical cost-based reimbursement (the "HCFA Global Settlement"). It is not
possible to estimate at this time whether this process will result in material
differences of amounts previously recorded or the effects on future cash flows.

         The table below presents the approximate percentage of the Company's
net patient revenues derived from the various sources of payment for the periods
indicated:

<TABLE>
<CAPTION>
                                       THREE MONTHS ENDED          SIX MONTHS ENDED
                                            MARCH 31,                  MARCH 31,
                                       ------------------          ----------------
                                       2001          2000          2001        2000
                                       ----          ----          ----        ----
            <S>                        <C>           <C>           <C>         <C>
            Medicaid                   48.4%         49.2%         49.2%       49.7%
            Medicare                   28.1%         24.9%         26.7%       24.6%
            Private and other          23.5%         25.9%         24.1%       25.7%
</TABLE>

     SECOND QUARTER FISCAL 2001 COMPARED TO SECOND QUARTER FISCAL 2000

         Net revenues totaled $520.8 million for the three months ended March
31, 2001, a decrease of approximately $20.7 million, or 3.8%, as compared to the
same period in fiscal year 2000. The decrease is primarily attributable to a
decrease of approximately $12.0 million, or 2.7%, in net revenues for inpatient
nursing home services due to the impact of the divestiture of facilities which
resulted in a decrease in net revenues of $41.1 million for the three months
ended March 31, 2001 as compared to the three months ended March 31, 2000. The
decrease in net


                                       22

<PAGE>   25
revenues was partially offset by an increase of approximately $29.1 million
which resulted primarily from higher average per diem rates during the three
months ended March 31, 2001 as compared to the three months ended March 31, 2000
mainly due to an increase in Medicare rates and a slight improvement in revenue
by payor mix (see "-Healthcare Regulatory Matters"). Net revenues for pharmacy
services decreased approximately $9.4 million, or 15.1%, to $53.1 million for
the three months ended March 31, 2001 as compared to the three months ended
March 31, 2000. The decrease was primarily attributed to a decline in the number
of beds served during the three months ended March 31, 2001 as compared to the
three months ended March 31, 2000. In addition, the closure of five
institutional pharmacies during fiscal year 2000 also contributed to the
decrease in pharmacy services revenue.

         Costs and expenses, excluding other expenses and loss (gain) on
disposal of assets, totaled $508.3 million for the three months ended March 31,
2001, a decrease of $27.5 million as compared to the three months ended March
31, 2000. These costs and expenses primarily consist of salaries, wages, and
employee benefits. Various federal, state and local regulations impose,
depending on the services provided, a variety of regulatory standards for the
type, quality and level of personnel required to provide care or services. The
regulatory requirements have an impact on staffing levels, as well as the mix of
staff, and therefore impact salaries, wages and employee benefits. Salaries,
wages and benefits decreased $14.6 million, or 4.7%, for the three months ended
March 31, 2001 as compared to the three months ended March 31, 2000. The
decrease was due to multiple factors including the impact of the divestiture of
facilities and the Company's continued efforts to reduce overhead costs. In
addition, the reduction has been partially offset by rising labor costs in
certain of its markets and the Company expects this trend to continue for the
foreseeable future. See "--Liquidity and Capital Resources." The cost of
ancillary services, which includes pharmaceuticals and therapy, is also affected
by the level of service provided and patient acuity. Ancillary services
decreased $6.0 million, or 9.1%, for the three months ended March 31, 2001 as
compared to the three months ended March 31, 2000. The decrease is primarily a
result of a reduction in pharmacy services volume offset in part by an increase
in per unit drug costs and a change in pharmacy product mix. General and
administrative expenses, which include the indirect administrative costs
associated with operating the Company and its lines of business, decreased $6.1
million, or 10.8%, for the three months ended March 31, 2001 as compared to the
same period in fiscal year 2000 mainly as a result of the Company's continued
efforts to reduce overhead costs. Rent totaled approximately $18.4 million for
the three months ended March 31, 2001, a decrease of $5.2 million, or 22.1%
compared to the same period in fiscal year 2000. The decrease is mainly due to
the impact of the divestiture of facilities.

         Interest expense decreased $10.0 million for the three months ended
March 31, 2001 as compared to the same period in fiscal year 2000 due to the
fact that the Company has discontinued accruing interest relating to its debt
facilities currently classified as liabilities subject to compromise effective
January 18, 2000 in accordance with the American Institute of Certified Public
Accountants Statement of Position 90-7, "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code" ("SOP 90-7"). Contractual interest for
the three months ended March 31, 2001 was $49.6 million which is $49.6 million
in excess of interest expense included in the unaudited condensed consolidated
financial statements for the three months ended March 31, 2001.

         Reorganization items totaled $0.6 million for the three months ended
March 31, 2001 as compared to $12.4 million for the three months ended March 31,
2001. The decrease of approximately $11.9 million is attributable to
approximately $12.8 million of net gain on divestitures included in
reorganization items for the three months ended March 31, 2001. Reorganization
items consist of income, expenses and other costs directly related to the
reorganization of the Company incurred in connection with the Chapter 11 Filings
(see Note 3 of the unaudited condensed consolidated financial statements).

     FISCAL 2001 YEAR TO DATE COMPARED TO FISCAL 2000 YEAR TO DATE

         Net revenues totaled $1,044.9 million for the six months ended March
31, 2001, a decrease of approximately $33.8 million, or 3.1%, as compared to the
six months ended March 31, 2000. The decrease is primarily attributable to a
decrease of approximately $21.5 million, or 16.7%, in net revenues for pharmacy
services due to a decline in the number of beds served during the six months
ended


                                       23

<PAGE>   26

March 31, 2001 as compared to the six months ended March 31, 2000. In addition,
the closure of five institutional pharmacies during fiscal year 2000 also
contributed to the decrease in pharmacy services revenue. Net revenues for
inpatient nursing home services decreased approximately $11.7 million, or 1.3%,
to $884.0 million for the six months ended March 31, 2001 as compared to the six
months ended March 31, 2000. The decrease is primarily due to the impact of the
divestiture of facilities which resulted in a decrease in net revenues of $73.1
million for the six months ended March 31, 2001 as compared to the six months
ended March 31, 2000. The decrease in net revenues was partially offset by an
increase of approximately $61.4 million which resulted primarily from higher
average per diem rates during the six months ended March 31, 2001 as compared to
the six months ended March 31, 2000 mainly due to an increase in Medicare rates
and a slight improvement in revenue by payor mix (see "-Healthcare Regulatory
Matters").

         Costs and expenses, excluding other expenses and loss (gain) on
disposal of assets, totaled $1,012.3 million for the six months ended March 31,
2001, a decrease of $57.5 million compared to the same period in fiscal year
2000. These costs and expenses primarily consist of salaries, wages, and
employee benefits. Various federal, state and local regulations impose,
depending on the services provided, a variety of regulatory standards for the
type, quality and level of personnel required to provide care or services. The
regulatory requirements have an impact on staffing levels, as well as the mix of
staff, and therefore impact salaries, wages and employee benefits. Salaries,
wages and benefits decreased $29.3 million, or 4.7%, for the six months ended
March 31, 2001 as compared to the same period in fiscal year 2000. The decrease
was due to multiple factors including the impact of the divestiture of
facilities and the Company's continued efforts to reduce overhead costs. In
addition, the reduction has been partially offset by rising labor costs in
certain of its markets and the Company expects this trend to continue for the
foreseeable future. See "--Liquidity and Capital Resources." The cost of
ancillary services, which includes pharmaceuticals and therapy, is also affected
by the level of service provided and patient acuity. Ancillary services
decreased $15.7 million, or 12.0%, for the six months ended March 31, 2001 as
compared to the six months ended March 31, 2000. The decrease is primarily a
result of a reduction in pharmacy services volume offset in part by an increase
in per unit drug costs and a change in pharmacy product mix. General and
administrative expenses, which include the indirect administrative costs
associated with operating the Company and its lines of business, decreased $15.9
million, or 13.5%, for the six months ended March 31, 2001 as compared to the
same period in fiscal year 2000 mainly as a result of the Company's continued
efforts to reduce overhead costs. Rent totaled approximately $37.5 million for
the six months ended March 31, 2001, a decrease of $8.8 million, or 19.0%
compared to the same period in fiscal year 2000. The decrease is mainly due to
the impact of the divestiture of facilities. For the six months ended March 31,
2000, other expenses totaled approximately $8.4 million and included
approximately $5.5 million of costs incurred to outside professionals related to
the Company's defaults in connection with its prepetition indebtedness.

         Interest expense totaled $3.3 million for the six months ended March
31, 2001, a decrease of $64.0 million as compared to the same period in fiscal
year 2000. The decrease is due to the fact that the Company has discontinued
accruing interest relating to its debt facilities currently classified as
liabilities subject to compromise effective January 18, 2000 in accordance with
SOP 90-7. Contractual interest for the six months ended March 31, 2001 was
$112.0 million which is $108.8 million in excess of interest expense included in
the unaudited condensed consolidated financial statements for the six months
ended March 31, 2001.

         Reorganization items totaled $8.7 million for the six months ended
March 31, 2001 as compared to $12.4 million for the six months ended March 31,
2001. The decrease of approximately $3.7 million is attributable to
approximately $10.0 million of net gain on divestiture included in
reorganization items for the six months ended March 31, 2001. Included in the
decrease is also an increase of approximately $3.4 million in interest income
earned on accumulated cash resulting from the Chapter 11 Filings classified as
reorganization items in accordance with SOP 90-7. This decrease was partially
offset by an increase in professional fees and other reorganization costs of
approximately $5.7 million and $3.8 million, respectively, for the six months
ended March 31, 2001 as compared to the six months ended March 31, 2000.
Reorganization items consist of income, expenses and other costs directly
related to the reorganization of the Company incurred in connection with the
Chapter 11 Filings (see Note 3 of the unaudited condensed consolidated financial
statements).


                                       24

<PAGE>   27


     SEASONALITY

         The Company's revenues and operating income generally fluctuate from
quarter to quarter. This seasonality is related to a combination of factors
which include the timing of third party payment rate changes, the number of work
days in a given period and seasonal census cycles.

     LIQUIDITY AND CAPITAL RESOURCES OF THE COMPANY

         Overview. Cash and cash equivalents were $203.7 million at March 31,
2001. The Company and its subsidiaries also have available $75.0 million in DIP
financing, as described below, none of which was borrowed as of such date except
for approximately $5.2 million of letters of credit issued under the Company DIP
Financing. Additionally, the Company anticipates issuing a $7.85 million letter
of credit under the Mariner Health DIP Financing in connection with the issuance
of certain surety bonds, which amount will be cash collateralized. During the
six months ended March 31, 2001 working capital increased $54.9 million from
$309.5 million at September 30, 2000 to $364.4 million at March 31, 2001.

         Cash provided by operating activities was $54.5 million in the six
months ended March 31, 2001 as compared to $51.7 million provided by operating
activities for the six months ended March 31, 2000. Receivables increased $36.8
million in the six months ended March 31, 2001 principally in the Company's
nursing home segment resulting from an increase in average days outstanding due
to multiple factors including increased nursing home services revenues in the
six month period ended March 31, 2001 as compared to the six month period ended
September 30, 2000 and seasonal cycles, including timing of third party
payments. Prepaid expenses and other assets decreased $11.9 million primarily as
a result of current period amortization of prepaid insurance premiums. Long-term
insurance reserves increased approximately $30.8 million resulting from the
provision for the current period and reduction in claims settled due to the
automatic stay protection afforded by the Chapter 11 Filings.

         Cash used in investing activities was $7.5 million for the six months
ended March 31, 2001 as compared to $2.9 million provided by investing
activities for the six months ended March 31, 2000. Cash used in investing
activities primarily consisted of the use of $15.5 million related to capital
expenditures for the six months ended March 31, 2001. Cash used in investing
activities also included $6.0 million of proceeds from the sale of property,
equipment and other assets (see Note 4 of the unaudited condensed consolidated
financial statements).

         Cash used in financing activities was $13.8 million in the six months
ended March 31, 2001 as compared to cash provided by financing activities of
$1.6 million for the six months ended March 31, 2000. Cash used in financing
activities included principal repayments of prepetition long-term debt of $13.8
million for the six months ended March 31, 2001.

         The primary sources of revenue for the Company are the federal Medicare
program and the state Medicaid programs. Although payment cycles for these
programs vary, payments generally are made within 30 to 60 days after services
are provided. For Medicare cost reporting periods beginning July 1, 1998 and
thereafter, the federal Medicare program converted to PPS for skilled nursing
facility services. Since the end of the third quarter of 1999, all of the
Company's skilled nursing facilities have been reimbursed under PPS, which
provides acuity-based rates that are established at the beginning of the
Medicare reporting year. See "-- Healthcare Regulatory Matters." Payments for
nursing facility services that are provided to Medicaid recipients are paid at
rates that are set by each individual state's Medicaid program.

         For cost reporting periods that ended before the start of PPS, the
facilities were (and to the extent final cost reports for prior periods are not
settled, still are) reimbursed under Medicare on the basis of reasonable and
necessary cost as determined from annual cost reports. This retrospective
settlement system resulted in final cost report settlements that generally were
not finally settled until two years after the end of the cost reporting period
and that could be further delayed by appeals and litigation. PPS has had a
material adverse effect on the Company's financial condition and, although the
effects of PPS have been somewhat ameliorated by recent legislation, PPS is in


                                       25

<PAGE>   28

large part responsible for the inability of the Company to operate under its
existing capital structure. See "-- Healthcare Regulatory Matters."

         The Company provides certain services and supplies 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 organization
principle" generally requires that services and supplies furnished to nursing
facilities by related entities be included in the nursing facility's
reimbursable cost at the cost of the supplying entity. The Company believes that
the services and supplies furnished to nursing facilities at market rates
qualify for exception to the related organization principle. Certain of the
Company's Medicare fiscal intermediaries have taken the position that the
related party transactions do not qualify for this exception to the related
party rules and have made adjustments that reduce Medicare allowable cost to the
cost of the supplying entity. During the third quarter of fiscal 1999, the
intermediaries for the Mariner Health facilities reopened previously settled
cost reports to impose such related party adjustments for services furnished to
the facilities by Mariner Health's rehabilitation subsidiary. All related party
adjustments have been or will be appealed, if not resolved in connection with
the HCFA Global Settlement, to the Provider Reimbursement Review Board (the
"PRRB") and through the full appeal process as is warranted. The adjustments
affect only periods during which the facilities were reimbursed for Medicare on
the basis of reasonable and necessary cost; there would not be any impact for
periods that are reimbursed under PPS.

         During the third quarter of fiscal 1999, the Medicare fiscal
intermediaries for the subsidiaries operated by Mariner Health reopened
approximately fifty 1995 and 1996 cost reports and issued revised notices of
program reimbursement ("NPRs") imposing prudent buyer or related party
adjustments as well as applying an administrative resolution related to the cost
report treatment of admissions cost. The reopenings resulted in reductions in
reimbursable costs of approximately $16.9 million. The Company believes that it
has substantial arguments for both issues and will appeal the adjustments to the
PRRB. In lieu of recoupment by the fiscal intermediary, the Company reached an
agreement with HCFA and the intermediary and implemented an extended repayment
plan. The balance as of the date of the agreement was approximately $15.9
million, which was repaid over a period of one year. The intermediary has
completed audit procedures but has not issued NPR's for the remaining Mariner
Health cost reports (1997 through 1999). As part of the chapter 11 process,
Mariner Health entered into a stipulation with the U.S. Department of Health and
Human Services whereby, among other things, HCFA will not recoup certain
prepetition overpayments for the pendancy of Mariner Health's DIP Financing (as
defined below) obligations. Accordingly, repayment obligations which may arise
from the issuance of NPRs may be stayed for an interim period. Should the NPRs
result in a repayment requirement not within the purview of the stipulation, or
after the pendancy of the DIP obligations, the Company and Mariner Health would
seek to enter into an extended repayment plan with HCFA at that time. However,
the Company expects that all of the open cost-based cost reporting periods will
be included in the HCFA Global Settlement. See "-Results of Operations."
However, there can be no assurance that the HCFA Global Settlement will include
all open cost-based cost reporting periods.

         Although the Company has over the course of the last year seen a
reduction in its labor costs through the divestiture of facilities and various
business lines as well as corporate overhead reductions, this reduction has been
partially offset by wage increases for various nursing staff positions in
certain markets in which the Company plans to continue operations. While this
has not yet had a material adverse effect on the Company's operations, there can
be no assurance that an increase in nursing staff wages will not have such an
effect in the future. The Company believes that these increases are a result of
a decrease in the number of people entering the nursing profession and an
increased demand for nurses in the healthcare industry. The Company has
experienced increased staffing requirements in order to maintain compliance with
various Medicaid Programs. The Company anticipates that the nursing staff
shortage will accelerate, especially in light of a demographic review indicating
that a significant percentage of people engaged in the nursing profession
are nearing retirement age with no significant group of younger nursing staff
candidates to fill anticipated vacancies. The Company is exploring ways in which
to address this problem, including recruiting labor from overseas and providing
incentives for nurses to remain in the Company's employment.


                                       26

<PAGE>   29

         General liability and professional liability ("GL/PL") insurance costs
for the long-term care industry, particularly in Florida and Texas, where the
Company maintains significant operations, continue to rise at a dramatic rate.
Significant increases in the number of claims and the amount of an average claim
continue. Insurance markets have responded to this significant increase by
severely restricting the availability of long-term care GL/PL coverage. As a
result of the changes described above, fewer companies are engaged in insuring
long-term care companies and those that do offer insurance coverage do so at a
very high cost. This is in large part a result of plaintiff lawyer activity in
certain markets in which the Company operates. The Company anticipates that this
trend will continue, and that its PL/GL costs will continue to increase. These
increases have already had an adverse effect on the Company's operations. While
the Company is attempting to address this issue through supporting tort reform
initiatives in certain markets, and has had very limited success in this regard,
no assurance can be given that the Company's PL/GL costs will not continue to
rise, that PL/GL coverage will be available to the Company in the future, or
that the tort reform initiatives will be successful or have the desired outcome.

         Prepetition Debt. Due to the failure to make scheduled payments, comply
with certain financial covenants and the commencement of the Chapter 11
Proceedings, the Company is in default on all, or substantially all, of its
prepetition debt obligations. Except as otherwise may be determined by the
Bankruptcy Court, the automatic stay protection afforded by the Chapter 11
Filings prevents any action from being taken with regard to any of the defaults
under the prepetition debt obligations. These obligations are classified as
liabilities subject to compromise at March 31, 2001 and September 30, 2000.

         The obligations of the Company under its senior credit facility are
guaranteed by substantially all of the Company's subsidiaries other than Mariner
Health and the Mariner Health Subsidiaries, and are secured by substantially all
of the otherwise unencumbered owned assets of the Company and such subsidiaries.
Mariner Health's obligations under its senior credit facility are guaranteed by
substantially all of the Mariner Health Subsidiaries and are secured by
substantially all of the otherwise unencumbered assets of Mariner Health and
such subsidiary guarantors. Unlike other subsidiaries of the Company (the
"Non-Mariner Health Subsidiaries"), Mariner Health and the Mariner Health
Subsidiaries neither guarantee the Company's obligations under the Company's
debt facilities nor pledge their assets to secure such obligations.
Correspondingly, the Company and the Non-Mariner Health Subsidiaries do not
guarantee or assume any obligations under the Mariner Health debt facilities.
Mariner Health and the Mariner Health Subsidiaries are not subject to the
covenants contained in the Company's debt facilities, and the covenants
contained in the Mariner Health debt facilities are not binding on the Company
and the Non-Mariner Health Subsidiaries.

         No principal payments have been made on prepetition indebtedness since
the Petition Date with the exception of repayments made against the Company's
senior credit facility as a result of the application of certain cash proceeds
received from the sales of certain facilities and other assets and notional
amounts related to certain capital equipment leases as adequate protection
payments, as more particularly described below. See "--Debtor-in-Possession
Financing for the Company."

         Debtor-in-Possession Financing for the Company. In connection with the
Chapter 11 Filings, the Company entered into a $100.0 million
debtor-in-possession financing agreement (as amended from time to time, the
"Company DIP Credit Agreement") with a group of banks (the "Company DIP
Lenders") led by The Chase Manhattan Bank ("Chase"). On March 20, 2000 the
Bankruptcy Court granted final approval (the "Final Company DIP Order") of the
Company DIP Financing.

         The Company DIP Credit Agreement initially established a $100.0 million
secured revolving credit facility to provide funds for working capital and other
lawful corporate purposes for use by the Company and the other Company Debtors.
At the request of the Company, the size of the Company DIP Financing was reduced
to $50.0 million on January 11, 2001. The Company DIP Credit Agreement provides
that amounts outstanding under the Company DIP Financing may not at any time
exceed the maximum borrowing amounts established for the Company under the Final
Company DIP Order or the Company's borrowing base of eligible accounts
receivable (the "Company Borrowing Base"). Up to $10.0 million of the Company
DIP Financing may be utilized for the


                                       27

<PAGE>   30

issuance of letters of credit as needed in the business of the Company Debtors.
Interest accrues on the principal amount outstanding under the Company DIP
Financing at a per annum rate of interest equal to the Alternative Base Rate of
Chase ("ABR") plus three percent (3%) and is payable monthly in arrears. During
the existence and continuation of a default in the payment of any amount due and
payable by the Company Debtors under the Company DIP Credit Agreement, interest
will accrue at the default rate of ABR plus five percent (5%) per annum.

         The terms of the Company DIP Financing require that the Company prepay
principal to the extent that the principal amount outstanding under the Company
DIP Financing at any time exceeds the Company Borrowing Base then in effect. To
the extent proceeds of loans under the Company DIP Financing are used to
complete the construction of certain healthcare facilities (which proceeds are
not permitted to exceed $8.8 million), proceeds from the sale of any such
properties must be used first to repay any portion of the loans made pursuant to
the Company DIP Financing, with 75% of any remaining net cash proceeds to be
applied as an adequate protection payment to the lenders under the Company's
prepetition senior credit facility, and the remaining 25% of such excess net
cash proceeds to be retained by the Company or its applicable subsidiary as
additional working capital. Pursuant to the terms of the Final Company DIP
Order, 75% of the net cash proceeds of other asset sales approved by the
Bankruptcy Court and the requisite Company DIP Lenders are to be applied as an
adequate protection payment to the lenders under the Company's prepetition
senior credit facility. The Company has the right to make optional prepayments
in increments of $1.0 million, and to reduce the commitment under the Company
DIP Credit Agreement in increments of $5.0 million.

         The obligations of the Company under the Company DIP Credit Agreement
are jointly and severally guaranteed by each of the other Company Debtors,
except for certain Company Debtors owning facilities mortgaged to Omega
Healthcare Investors, Inc. (the "Omega Debtors") whose guarantee is limited to
the negative cash flows of the Omega Debtors, pursuant to the Company DIP Credit
Agreement, the Final Company DIP Order and the Final Company Cash Collateral
Order (defined below). Under the terms of the Final Company DIP Order, the
obligations of the Company Debtors under the Company DIP Credit Agreement (the
"Company DIP Obligations") constitute allowed superiority administrative expense
claims pursuant to section 364(c)(1) of the Bankruptcy Code (subject to a carve
out for certain professional fees and expenses incurred by the Company Debtors).
The Company DIP Obligations are secured by perfected liens on all or
substantially all of the assets of the Company Debtors (excluding bankruptcy
causes of action), the priority of which liens (relative to prepetition
creditors having valid, non avoidable, perfected liens in those assets and to
any "adequate protection" liens granted by the Bankruptcy Court) is established
in the Final Company DIP Order and the related cash collateral order entered by
the Bankruptcy Court (the "Final Company Cash Collateral Order"). The Bankruptcy
Court has also granted certain prepetition creditors of the Company Debtors
replacement liens and other rights as "adequate protection" against any
diminution of the value of their existing collateral that may result from
allowing the Company Debtors to use cash collateral in which such creditors had
valid, non-avoidable and perfected liens as of the Petition Date. The discussion
contained in this paragraph is qualified in its entirety by reference to the
Final Company DIP Order, the Final Company Cash Collateral Order, and related
stipulations, and reference should be made to such orders (which are available
from the Bankruptcy Court) and stipulations for a more complete description of
such terms.

         The Company DIP Credit Agreement contains customary representations,
warranties and other affirmative and restrictive covenants of the Company
Debtors, as well as certain financial covenants relating to minimum EBITDA,
maximum capital expenditures, and minimum patient census. The breach of such
representations, warranties or covenants, to the extent not waived or cured
within any applicable grace or cure periods, could result in the Company being
unable to obtain further advances under the Company DIP Financing and possibly
the exercise of remedies by the Company DIP Lenders, either of which events
could materially impair the ability of the Company to successfully reorganize in
chapter 11 and to operate as a going concern. Such a default may also impair the
ability of the Company to use cash collateral to fund operations. At March 31,
2001, no revolving loans were outstanding under the Company DIP Financing and
approximately $5.2 million of letters of credit issued under the Company DIP
Credit Agreement were outstanding.


                                       28

<PAGE>   31

         The outstanding principal of the Company DIP Financing, together with
all accrued and unpaid interest and all other obligations thereunder, was
originally due and payable one year from the Petition Date. With the approval of
the Bankruptcy Court, the Company Debtors, Chase and the requisite Company DIP
Lenders amended the Company DIP Credit Agreement as of January 11, 2001, to
(among other things) extend the maturity date of the Company DIP Financing from
January 19, 2001 to August 31, 2001. Effective as of January 19, 2001, the
Company exercised its right under the Company DIP Credit Agreement to reduce the
$100.0 million Company DIP Financing commitment to $50.0 million.

         Debtor-in-Possession Financing for Mariner Health. Among the orders
entered by the Bankruptcy Court on the Petition Date in the Chapter 11
Proceedings of Mariner Health and its subsidiaries were orders approving (a) the
use of cash collateral by the Mariner Health Debtors, and (b) the funding of up
to $50.0 million in principal amount at any time outstanding under a
debtor-in-possession financing arrangement (the "Mariner Health DIP Financing"
and together with the Company DIP Financing, the "DIP Financings") pursuant to
that certain Debtor-in-Possession Credit Agreement dated as of January 20, 2000
(as amended from time to time, the "Mariner Health DIP Credit Agreement") by and
among Mariner Health and each of the other Mariner Health Debtors, as
co-borrowers thereunder, the lenders signatory thereto as lenders (the "Mariner
Health DIP Lenders"), First Union National Bank, as Syndication Agent, PNC
Capital Markets, Inc. and First Union Securities, Inc., as co-arrangers, and PNC
Bank, National Association ("PNC"), as Administrative Agent and Collateral
Agent. After a final hearing on February 16, 2000, the Bankruptcy Court entered
into an order granting final approval of the Mariner Health DIP Financing (the
"Final Mariner Health DIP Order").

         The Mariner Health DIP Credit Agreement initially established a $50.0
million secured revolving credit facility comprised of a $40.0 million tranche A
revolving loan commitment and a $10.0 million tranche B revolving loan
commitment. At the request of Mariner Health, the size of the Mariner Health DIP
Financing was reduced to $25.0 million on January 19, 2001. As a result of such
reduction, the $10.0 million tranche B revolving loan commitment was eliminated.
Under the Mariner Health DIP Credit Agreement's terms, advances under the
Mariner Health DIP Financing may be used by the Mariner Health Debtors (and to a
limited degree, by certain joint venture subsidiaries of Mariner Health that are
not debtors in the Mariner Health Chapter 11 Proceedings) for working capital
and other lawful corporate purposes. Amounts outstanding under the Mariner
Health DIP Financing may not at any time exceed the maximum borrowing amounts
established for the Mariner Health Debtors under the Final Mariner Health DIP
Order. Up to $5.0 million of the Mariner Health DIP Financing may be utilized
for the issuance of letters of credit as needed in the businesses of the Mariner
Health Debtors.

         Interest accrues on the principal amount outstanding under the Mariner
Health DIP Financing at a per annum rate of interest equal to the "base rate" of
PNC (i.e., the higher of the PNC prime rate or a rate equal to the federal funds
rate plus 50 basis points) plus the applicable spread, which is 250 basis
points. Such interest is due and payable monthly in arrears. During the
existence and continuation of any event of default under the Mariner Health DIP
Credit Agreement, the interest rates normally applicable to loans under the
Mariner Health DIP Financing will be increased by another 250 basis points per
annum.

         The outstanding principal of the Mariner Health DIP Financing, together
with all accrued and unpaid interest and all other obligations thereunder, are
due and payable on the Commitment Termination Date, defined as the first to
occur of (i) January 19, 2001, unless extended (such date has been extended to
July 19, 2001 as discussed below); (ii) the effective date of a joint plan of
reorganization for the Mariner Health Debtors; (iii) the date of termination of
the exclusivity rights of the Mariner Health Debtors to file a plan of
reorganization; (iv) the filing by the Mariner Health Debtors of any plan of
reorganization (or the modification of any such plan previously filed with the
Bankruptcy Court) not previously approved by the holders of at least 66-2/3% of
the outstanding loans or commitments under the Mariner Health DIP Financing; (v)
the date of termination of the commitments under the Mariner Health DIP Credit
Agreement during the continuation of an event of default thereunder; or (vi) the
date on which all or substantially all of the assets or stock of the Mariner
Health Debtors is sold or otherwise transferred. Under the Mariner Health DIP
Credit Agreement's current terms, the Mariner Health Debtors must also prepay
principal to the extent that the principal amount outstanding under the Mariner
Health DIP Financing at any time


                                       29

<PAGE>   32


exceeds the Mariner Health borrowing base then in effect. The Mariner Health
borrowing base for any month is an amount equal to $7.5 million in excess of the
"Working Capital Facility" borrowings projected for such month in Mariner
Health's year 2000 DIP budget.

         The Mariner Health DIP Credit Agreement also provides for mandatory
prepayments under the following circumstances: (a) with net cash proceeds from
asset sales, the incurrence of certain debt, the issuance of new equity, the
receipt of tax refunds exceeding $100,000 in the aggregate, and the receipt of
casualty proceeds in excess of $100,000 that are not applied within 60 days
after receipt to the repair, rebuilding, restoration or replacement of the
assets damaged or condemned (or committed within such period of time to be so
applied); and (b) on each business day, the amount of cash held by the Mariner
Health Debtors in excess of the sum of $5.0 million plus the aggregate sum of
the minimum amount required by depositary banks to be kept in deposit accounts,
concentration accounts and other accounts with such banks. Amounts prepaid
pursuant to clause (a) of the immediately preceding sentence will permanently
reduce the amount of the Mariner Health DIP Financing commitments on a dollar
for dollar basis. Amounts prepaid pursuant to clause (b) of the same sentence
will not permanently reduce such commitments. The Mariner Health Debtors have
the right to make optional prepayments in the minimum principal amount of $1.0
million, and in increments of $100,000 in excess thereof, and, on three business
days' notice, to reduce the commitments under the Mariner Health DIP Credit
Agreement in the minimum amount of $5.0 million, or in increments of $1.0
million in excess thereof.

         As provided in the Final Mariner Health DIP Order, the obligations of
the Mariner Health Debtors under the Mariner Health DIP Credit Agreement
(together with certain potential cash management system liabilities secured on a
pari passu basis therewith, the "Mariner Health DIP Obligations") constitute
allowed super priority administrative expense claims pursuant to section
364(c)(1) of the Bankruptcy Code (subject to a carve-out for certain
professional fees and expenses incurred by the Mariner Debtors). The Mariner
Health DIP Obligations are secured by perfected liens on all or substantially
all of the assets of the Mariner Health Debtors (excluding bankruptcy causes of
action), the priority of which liens (relative to prepetition creditors having
valid, non-avoidable, perfected liens in those assets and to any "adequate
protection" liens granted by the Bankruptcy Court) is established in the Final
Mariner Health DIP Order and the related cash collateral orders entered by the
Bankruptcy Court (the "Mariner Health Cash Collateral Order"). The Bankruptcy
Court has also granted certain prepetition creditors of the Mariner Health
Debtors replacement liens and other rights as "adequate protection" against any
diminution of the value of their existing collateral that may result from
allowing the Mariner Health Debtors to use cash collateral in which such
creditors had valid, non-avoidable and perfected liens as of the Chapter 11
Filings. The discussion contained in this paragraph is qualified in its entirety
by reference to the Final Mariner Health DIP Order, the related Mariner Health
Cash Collateral Orders, and related stipulations, and reference should be made
to such orders (which are available from the Bankruptcy Court) and stipulations
for a more complete description of such terms.

         The Mariner Health DIP Credit Agreement contains customary
representations, warranties and other affirmative and restrictive covenants of
the Mariner Health Debtors, as well as certain financial covenants relating to
minimum EBITDAR, minimum patient census, minimum eligible accounts receivable,
maximum variations from Mariner Health's year 2000 DIP budget and maximum
capital expenditures. The breach of such representations, warranties or
covenants, to the extent not waived or cured within any applicable grace or cure
periods, could result in the Mariner Health Debtors being unable to obtain
further advances under the Mariner Health DIP Financing and possibly the
exercise of remedies by the Mariner Health DIP Lenders, either of which events
could materially impair the ability of the Mariner Health Debtors to
successfully reorganize in chapter 11 and to operate as a going concern.
Included among the events of default is the termination of the Mariner Health
Debtors' exclusive right to file a plan or plans of reorganization in any of
their chapter 11 cases other than as the result of the filing of a plan or plans
of reorganization acceptable to the lenders.


                                       30

<PAGE>   33

The occurrence of an event of default under the Mariner Health DIP Credit
Agreement may impair the ability of the Mariner Health Debtors to use cash
collateral to fund operations. At March 31, 2001, there were no outstanding
borrowings or letters of credit issued under the Mariner Health DIP Credit
Agreement.

         Among its other restrictive covenants, the Mariner Health DIP Credit
Agreement limits affiliate transactions with the Company Debtors, but does
contemplate weekly overhead payments to the Company equal to 1.25% of projected
net inpatient revenues for the then-current month, subject to a monthly
"true-up," such that the payments for such month equal 5% of actual net
inpatient revenues of the Mariner Health Debtors. Such payments may be suspended
by the Mariner Health Debtors if certain defaults specified in the Mariner
Health DIP Credit Agreement occur and are continuing, though such fees will
still accrue and will become due and payable if and when the subject default has
been cured or waived.

         By amendment dated as of January 19, 2001, and with the approval of the
Bankruptcy Court, the Mariner Health DIP Credit Agreement was amended to extend
the stated termination date of the Mariner Health DIP Credit Agreement from
January 19, 2001 to July 19, 2001, and to reduce the maximum amount of the
Mariner Health DIP Financing from $50.0 million to $25.0 million (as a result of
which the tranche B component was eliminated). Such amendment also, among other
things, extended the deadline for filing a plan of reorganization to February
20, 2001, imposed a 25 basis point utilization fee on borrowings under the
Mariner Health DIP Financing in excess of $5.0 million and amended certain
reporting requirements. An amendment dated as of March 20, 2001, among other
things, increased the letter of credit sublimit and the borrowing base to permit
the issuance of a $7.85 million letter of credit to facilitate implementation of
a replacement surety bond program by Mariner Health, though such letter of
credit had not yet been issued as of May 11, 2001. Because such letter of
credit, when issued, is expected to expire well after the Commitment Termination
Date for the Mariner Health DIP Facility, the March 20, 2001 amendment requires
such letter of credit to be fully cash collateralized.

         On or about May 14, 2001, Mariner Health and representatives of the
Mariner Health DIP Lenders and the Mariner Health prepetition senior bank group
(the "Mariner Health Principal Secured Lenders") entered into a stipulation (the
"May 14 Stipulation") (i) extending from May 21, 2001 to July 20, 2001, the
Mariner Health Debtors' exclusive right to file a plan of reorganization, and
(ii) if they file a plan within that time, extending the Mariner Health Debtor's
exclusive right to solicit acceptances of such plan to September 20, 2001;
however, such exclusivity rights are modified in that stipulation to permit the
Mariner Health Principal Secured Lenders to file their own plan or plans of
reorganization for the Mariner Health Debtors and to solicit acceptances
thereto, or (at the sole option of the Mariner Health Principal Secured Lenders)
to file a joint plan of reorganization with the Mariner Health Debtors and
solicit acceptances thereto. The May 14 Stipulation remains subject to the
approval of the Bankruptcy Court. If approved by the Bankruptcy Court, the May
14 Stipulation would constitute a waiver by the Mariner Health DIP Lenders of
the covenant in the Mariner Health DIP Credit Agreement that the Mariner Health
Debtors file a plan of reorganization by a certain time and an agreement that
the modification of the Mariner Health Debtors' exclusivity rights pursuant to
that stipulation would not constitute an event of default under the Mariner
Health DIP Credit Agreement. No assurances can be given as to whether or not the
Bankruptcy Court will grant the Mariner Health Debtors' motion to approve the
May 14 Stipulation. Failure of the Bankruptcy Court to grant such approval could
result in the Mariner Health Debtors' losing their exclusive right to file a
plan of reorganization and an event of default occurring under the Mariner
Health DIP Credit Agreement.

         Healthcare Regulatory Matters. The Balanced Budget Act of 1997 (the
"Balanced Budget Act") contains numerous changes to the Medicare and Medicaid
programs with the intent of slowing the growth of payments under these programs
by $115.0 billion and $13.0 billion, through the end of 2001 and 2002,
respectively. Approximately 50% of the savings are to be achieved through a
reduction in the growth of payments to providers and physicians. These cuts have
had, and will continue to have, a material adverse effect on the Company.


                                       31

<PAGE>   34

         The Balanced Budget Act amended the Medicare program by revising the
payment system for skilled nursing services. Historically, nursing homes were
reimbursed by the Medicare program based on the actual costs of services
provided. However, the Balanced Budget Act required the establishment of PPS, a
system where Medicare payments are prospectively determined for nursing homes
for cost reporting periods beginning on or after July 1, 1998. During the first
three years of PPS, nursing homes will receive a fixed per diem rate for each of
their Medicare Part A patients based on a blend of facility specific rates and
Federal acuity adjusted rates. Thereafter, the per diem rates will be based
solely on Federal acuity adjusted rates. Subsumed in this per diem rate are
ancillary services, such as pharmacy and rehabilitation services, which
historically have been provided to many of the Company's nursing facilities by
the Company's pharmacy and therapy subsidiaries. The inclusion of ancillary
services in the PPS per diem payments has resulted in significantly lower
margins in the Company's pharmacy operations as a result of increased pricing
competition, a change in buying patterns by customers and the decision by the
Company to exit certain businesses previously operated by the Company such as
its third party therapy, home health and hospital contract management
businesses.

         Since the passage of the Balanced Budget Act, Congress has passed
additional legislation intended to temporarily mitigate the reduction in
reimbursement for skilled nursing facilities ("SNFs") under PPS. First, in
November 1999, Congress passed the Medicare Balanced Budget Refinement Act
("BBRA"). Second, in December of 2000, Congress passed the Medicare, Medicaid
and SCHIP Benefits Improvement and Protection Act of 2000 ("BIPA"). Effective
April 1, 2000, the BBRA temporarily increased the PPS per diem rates by 20
percent for 15 patient acuity categories, including medically complex patients,
pending revisions to PPS. The increases will remain in effect until HCFA
implements a refined schedule of payment rates for the Resource Utilization
Groups ("RUG") system that better accounts for nontherapy ancillary services
medically-complex patients. The revised payment rates may be more or less than
the temporary 20 percent increase under the BBRA. The BBRA also provides for a
4% increase in the federal per diem rate for all patient acuity categories for
the government fiscal years 2001 and 2002.

         Among other things, BIPA eliminates the scheduled reduction in the SNF
market basket update in government fiscal year 2001 and is implemented in two
phases. Specifically, the update rate for the period from October 1, 2000
through March 31, 2001 is the market basket index ("MBI") increase minus one
percentage point; the update for the period from April 1, 2001 through September
30, 2001 is the MBI increase plus one percentage point. This increase will not
be included when determining PPS payment rates for subsequent periods. In the
government fiscal years 2002 and 2003, payment updates will equal the MBI
increase minus one-half of a percentage point. Temporary increases in the
federal per diem rates under the BBRA will be in addition to these payment
increases. BIPA also increases payment for the nursing component of each RUG
payment category by 16.66% for services furnished after April 1, 2001 and before
October 1, 2002.

         Moreover, BIPA further refines the consolidated billing requirements.
Specifically, effective January 1, 2001, the law limits consolidated billing
requirements to items and services furnished to SNF residents in a Medicare Part
A covered stay and to therapy services covered under Medicare Part B. For
residents not covered under a Part A stay (e.g., Part A benefits exhausted),
SNFs may choose to bill for non-therapy Part B services and supplies, or they
may elect to have suppliers continue to bill Medicare directly for these
services. BIPA also modifies the treatment of the rehabilitation patient
categories to ensure that Medicare payments for skilled nursing facility
residents with "ultra high" and "high" rehabilitation therapy needs are
appropriate in relation to payments for residents needing "medium" or "low"
levels of therapy. Specifically, effective for services furnished on or after
April 1, 2001 and before implementation of a refined RUG payment system, BIPA
increases the federal per diem payments for 14 rehabilitation categories by
6.7%. Additionally, the 20 percent additional payment provided for under the
BBRA for three rehabilitation categories is removed to make this provision
budget neutral. BIPA also permits the Secretary of Health and Human Services
(the "Secretary") to establish a process for geographic reclassification of SNFs
based upon the method used for inpatient hospitals.

         As of July 1, 1999, all of the Company's SNFs were receiving Medicare
payments under PPS. In connection with the implementation of PPS, the government
has implemented a temporary payment system to transition SNFs


                                       32

<PAGE>   35

from the prior cost-based payment system to a payment system based entirely on
federal per diem rates. PPS transition rates vary from facility to facility
depending on each facility's base period cost that comprises the facility
specific component of the rates and the wage adjuster that is applied to the
federal component of the PPS payment rates. For many of the Company's
facilities, the facility specific base period cost is higher than the base
period cost that was used to develop the transitional PPS payment rates. For
some facilities, however, the facility base period cost is lower than the base
period cost used to develop the PPS transitional rates. Under BBRA, SNFs are
allowed to elect transition to the permanent federal rate at the beginning of
their cost reporting periods beginning on or after January 1, 2000. SNFs may
make the election up to 30 days after the start of their cost reporting period.
The Company has taken advantage of this election where appropriate.

         The Balanced Budget Act also revised the reimbursement methodology for
therapy services under Medicare Part B. Historically, Medicare Part B therapy
services were reimbursed based on the cost of the services provided, subject to
prudent buyer and salary equivalency restrictions. In November 1998, certain fee
screen schedules were published setting forth the amounts that can be charged
for specific therapy services. Additionally, the Balanced Budget Act sets forth
maximum per beneficiary limits of $1,500 per provider for physical therapy and
speech pathology and $1,500 per provider for occupational therapy. Both the fee
screens and per beneficiary limits were effective for services rendered
following December 31, 1998. The imposition of fee screens, together with the
inclusion of ancillary services in the federal per diem rate, has had a material
adverse effect on the Company's therapy business resulting in the decision by
the Company to terminate its contract and third party therapy operations. The
BBRA temporarily mitigates the Balanced Budget Act limitations by providing that
the therapy caps will not apply in government fiscal years 2000 and 2001. The
BBRA requires the Secretary to conduct focused medical reviews of therapy
services during government fiscal years 2000 and 2001, with an emphasis on
claims for services provided to residents of SNFs. The BBRA also requires the
Secretary to study and to submit recommendations to Congress on therapy
utilization patterns in government fiscal year 2000 compared to those in the
government fiscal years 1998 and 1999.

         The BBRA also excludes certain items and services from the formerly
all-inclusive SNF per diem rates under PPS. Specifically, the following items
and services will become separately reimbursable outside of PPS rates: (i)
ambulance services furnished to an individual in conjunction with renal dialysis
services; (ii) chemotherapy items and administration services (as identified by
certain HCFA Common Procedure Coding System ("HCPCS") codes); (iii) radioisotope
services (as identified by certain HCPCS codes); and (iv) customized prosthetic
devices (artificial limbs) and other custom prostheses if provided to a SNF
resident and intended to be used after discharge (as identified by certain HCPCS
codes and other instances chosen by HCFA). Payment for such items and services,
which are "passed-through" the per diem payment rates, will be made under Part B
of Medicare, in conformance with Part B payment rules. Although these items are
separately reimbursed from the PPS rate, the BBRA also directs HCFA to make
appropriate adjustments to the PPS payments rates to reflect the fact that
certain items and services have been excluded, in order to ensure budget
neutrality.

         In the process of finalizing certain Medicare cost reports or reopening
previously finalized cost reports filed by various of the Company's Medicare
provider facilities, certain Medicare fiscal intermediaries have issued NPRs,
which include significant audit adjustments that reduce the amount of
reimbursement that previously was received by the facilities. The adjustments
are based, for the most part, on denials of exception to the related
organization principles (described below) with regard to services and supplies
furnished to the Company's facilities by the Company's pharmacy and
rehabilitation companies. Adjustments are also based on reductions to costs
claimed for therapy services under prudent buyer principles (described below).

         The prudent buyer principle states, in part, "the prudent and
cost-conscious buyer not only refuses to pay more than the going price for an
item or service, he also seeks to economize by minimizing cost". Certain of the
fiscal intermediaries have alleged that the Company was not prudent in its
purchase of occupational therapy and speech pathology services prior to HCFA's
establishing salary equivalency guidelines, effective April 1998. Fiscal
intermediaries calculated facilities' costs to provide services through employed
therapists and reduced costs claimed on the cost reports for providing services
through contracts and adjusted the cost reports accordingly. Appeals were


                                       33

<PAGE>   36

filed with the PRRB and resulted in a favorable outcome. However, on review the
Social Security Administrator reversed the PRRB and restored the intermediaries'
adjustments. The Company received a favorable judicial decision on its initial
prudent buyer appeal and currently is negotiating a settlement with HCFA for all
if its prudent buyer appeals as part of the HCFA Global Settlement.

         The related organization principle states, in part, "a provider's
allowable cost for services, facilities, and supplies furnished by a party
related to the provider are the costs the related party incurred in furnishing
the items in question". The regulations provide for an exception to the related
organization principle if certain requirements are met and the Company believes
that it meets these requirements with respect to services its facilities
previously received from related pharmacy and rehabilitation subsidiaries. Some
fiscal intermediaries have denied the request for exception and have made
adjustments to reduce the allowable cost that is included in nursing facility
cost reports to the cost of the related organization. The Company has requested
PRRB appeals for these adjustments, but the appeals have not yet been heard.
There can be no assurance that the Company will prevail in the appeal process.

         On January 12, 2001, the Secretary issued final regulations to
implement changes to the Medicaid "upper payment limit" requirements. The
purpose of the rule is to stop states from using certain accounting techniques
to inappropriately obtain extra federal Medicaid matching funds that are not
necessarily spent on health care services for Medicaid beneficiaries. Although
the rule will be phased in over eight years to reduce the adverse impact on
certain states, the rule eventually could result in decreased federal funding to
some state Medicaid programs, which, in turn, could prompt certain states to
reduce Medicaid reimbursements to providers, including nursing facilities.

         Other federal legislation requires major changes in the transmission
and retention of health information by the Company. The Health Insurance
Portability and Accountability Act of 1996 ("HIPAA") mandates, among other
things, the adoption of standards for the exchange of electronic health
information in an effort to encourage overall administrative simplification and
enhance the effectiveness and efficiency of the healthcare industry. Among the
standards that the Department of Health and Human Services will adopt pursuant
to HIPAA are standards for the following: electronic transactions and code sets;
unique identifiers for providers, employers, health plans and individuals;
security and electronic signatures; privacy; and enforcement.

         Although HIPAA was intended ultimately to reduce administrative
expenses and burdens faced within the healthcare industry, the Company believes
that the law will result in significant and costly changes. The Department of
Health and Human Services has released two rules to date mandating the use of
new standards with respect to certain healthcare transactions and health
information. The first rule requires the use of uniform standards for common
healthcare transactions, including healthcare claims information, plan
eligibility, referral certification and authorization, claims status, plan
enrollment and disenrollment, payment and remittance advice, plan premium
payments and coordination of benefits. It also establishes standards for the use
of electronic signatures.

         The second rule released by the Department of Health and Human Services
imposes new standards relating to the privacy of individually identifiable
health information. These standards not only require the Company's compliance
with rules governing the use and disclosure of protected health information, but
they also require the Company to impose those rules, by contract, on any
business associate to whom such information is disclosed. Rules governing the
security of health information have been proposed but have not yet been issued
in final form.

         The Department of Health and Human Services finalized the new
transaction standards on August 17, 2000, and the Company will be required to
comply with them by October 16, 2002. The privacy standards were issued on
December 28, 2000, and became effective on April 14, 2001 with a compliance date
of April 14, 2003. Sanctions for failing to comply with HIPAA include criminal
penalties and civil sanctions. The Company is in the process of quantifying the
costs associated with HIPAA compliance and believes they may be material.

         Other Factors Affecting Liquidity and Capital Resources. In addition to
outstanding principal and accrued interest payments on its long-term
indebtedness which generally are suspended as the consequence of the Chapter 11
Filings, the Company has significant rent obligations relating to its leased
facilities. Without giving any effect to any potential restructuring of current
rent obligations, the Company's total estimated rent obligations for fiscal year


                                       34

<PAGE>   37

2001 are approximately $86.0 million, of which approximately $18.4 million and
$37.5 million were paid in the three and six months ended March 31, 2001,
respectively. In connection with its review of its portfolio of facilities, the
Company anticipates continuing to divest itself of under-performing facilities,
which will have a favorable impact on the Company's rent obligations.

         The Company's operations require capital expenditures for renovations
of existing facilities in order to continue to meet regulatory requirements, to
upgrade facilities for the treatment of subacute patients and accommodate the
addition of specialty medical services, and to improve the physical appearance
of its facilities for marketing purposes. In addition, there are capital
expenditures required for completion of certain existing facility expansions and
new construction projects in process, as well as supporting non-nursing home
operations. Capital expenditures totaled $15.5 million for the six months ended
March 31, 2001 as compared to $19.6 million for the comparable six months ended
March 31, 2000. Capital expenditures in six months ended March 31, 2001 and 2000
were financed principally through internally generated funds.

         The Company has experienced an increasing trend in the number and
severity of litigation claims asserted against the Company. Management believes
that this trend is endemic to the long-term care industry and is a result of the
increasing number of large judgments against long-term care providers in recent
years resulting in an increased awareness by plaintiff's lawyers of potentially
large recoveries. The Company also believes that there has been, and will
continue to be, an increase in governmental investigatory activity of long-term
care providers, particularly in the area of false claims. While the Company
believes that it provides quality care to the patients in its facilities and
materially complies with all applicable regulatory requirements, an adverse
determination in a legal proceeding or governmental investigation, whether
currently asserted or arising in the future, could have a material adverse
effect on the Company. See "--Legal Proceedings."

         The Company currently maintains two captive insurance subsidiaries to
provide for reinsurance obligations under workers' compensation, general and
professional liability, and automobile liability for losses that occurred prior
to April 1, 1998. These obligations are funded with long-term, fixed income
investments, which are not available to satisfy other obligations of the
Company.

         The Company currently purchases excess liability insurance only. Due to
the hardening of the liability insurance market for the long-term care industry,
the Company currently maintains an unaggregated $1 million self-insured
retention per claim. Prior to July 31, 1999, the Company's liability insurance
policies included aggregated stop loss features limiting the Company's
out-of-pocket exposure. With stop loss insurance unavailable to the Company, the
expected direct costs have continued to increase. This increased exposure will
have a delayed negative effect on operating cash flow as claims develop over the
next several years.

         The Mariner Health DIP Credit Agreement limits the ability of the
Mariner Health Debtors from engaging in affiliate transactions and making
restricted payments, specifically including payments to the Company Debtors.
However, the Mariner Health DIP Credit Agreement permits, among other things,
weekly overhead payments to the Company (see "- Mariner Health
Debtor-in-Possession Financing" above), the purchase of pharmaceutical goods and
services from certain Company Debtors, the allocation to, and payment by, the
Mariner Health Debtors of their share of certain taxes, insurance obligations
and employee benefit obligations paid for and administered on a consolidated
basis by the Company, and certain ordinary course transactions which are on
terms no less favorable to the subject Mariner Health Debtors than the terms
obtainable from a non-affiliate, and for which the approval of the requisite
Mariner Health DIP Lenders and the Bankruptcy Court have been obtained.

         At September 30, 2000, the Company, excluding Mariner Health, had, in
the aggregate, approximately $93.9 million in its corporate concentration bank
accounts that was available to be used for ongoing operations, subject to the
terms and restrictions of the Final Company Cash Collateral Orders and the Final
Company DIP Order. The aggregate amount in the Company's corporate concentration
account at May 4, 2001 was approximately $116.5 million. The Company expects a
significant portion of this money will be used in the funding of any plan of
reorganization. At September 30, 2000, Mariner Health had, in the aggregate,
approximately $16.2 million in its


                                       35

<PAGE>   38

corporate concentration bank accounts that was available to be used for ongoing
operations, subject to the terms and restrictions of the Mariner Health Cash
Collateral Orders and the Final Mariner Health DIP Order. The aggregate amount
in Mariner Health's corporate concentration account at May 4, 2001 was
approximately $31.4 million. Mariner Health expects a significant portion of
this money will be used in the funding of any plan of reorganization.

         While management believes that the Company's cash should be sufficient
to fund the Company's working capital needs for the foreseeable future, the use
of this cash collateral is prohibited under the Bankruptcy Code absent an order
of the Bankruptcy Court permitting the use of the cash collateral. The use of
the Company's cash collateral to fund working capital is currently permitted by
the respective DIP financings.

         While management believes that the amounts available to the Company
Debtors from the Company DIP Financing and cash collateral will be sufficient to
fund the operations of the Company Debtors until such time as the Company
Debtors are able to take the steps necessary to structure a plan of
reorganization that will be acceptable to creditors and confirmed by the
Bankruptcy Court, there can be no assurances in this regard; a default under the
Company DIP Credit Agreement may impair the ability of the Company Debtors to
use cash collateral to fund operations. Finally, there can be no assurance that
any plan of reorganization confirmed in connection with the Chapter 11 Filings
of the Company Debtors will allow the Company Debtors to operate profitably
under PPS or give the Company Debtors sufficient liquidity to meet their
operational needs. The ability of the Company Debtors to fund such requirements
will depend, among other things, on future economic conditions and on financial,
business and other factors, many of which are beyond the control of the Company
Debtors.

         While management believes that the amounts available to the Mariner
Health Debtors from the Mariner Health DIP Financing and cash collateral will be
sufficient to fund the operations of the Mariner Health Debtors until such time
as the Mariner Health Debtors are able to take the steps necessary to structure
a plan of reorganization that will be acceptable to creditors and confirmed by
the Bankruptcy Court, there can be no assurances in this regard; a default under
the Mariner Health DIP Credit Agreement may impair the ability of the Mariner
Health Debtors to use cash collateral to fund operations. Finally, there can be
no assurance that any plan of reorganization confirmed in connection with the
Chapter 11 Filings of the Mariner Health Debtors will allow the Mariner Health
Debtors to operate profitably under PPS or give the Mariner Health Debtors
sufficient liquidity to meet their operational needs. The ability of the Mariner
Health Debtors to fund such requirements will depend, among other things, on
future economic conditions and on financial, business and other factors, many of
which are beyond the control of the Mariner Health Debtors.

     CAUTIONARY STATEMENTS

         Information provided herein by the Company contains, and from time to
time the Company may disseminate materials and make statements which may contain
"forward-looking" information, as that term is defined by the Private Securities
Litigation Reform Act of 1995 (the "Act"). In particular, the information
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources" contains information
concerning the Company's plan to restructure its debt obligations and other
financial commitments. The aforementioned forward looking statements, as well as
other forward looking statements made herein, are qualified in their entirety by
these cautionary statements, which are being made pursuant to the provisions of
the Act and with the intention of obtaining the benefits of the "safe harbor"
provisions of the Act.

         The Company cautions investors that any forward-looking statements made
by the Company are not guarantees of future performance and that actual results
may differ materially from those in the forward-looking statements as a result
of various factors, including, but not limited to, the following:

(i)      There can be no assurance that the amounts available to the Company
         through the DIP Financings will be sufficient to fund the operations of
         the Company until such time as the Company is able to propose a Plan of
         Reorganization that will be acceptable to creditors and confirmed by
         the court overseeing the Company's Chapter 11 Filings.


                                       36

<PAGE>   39

(ii)     There can be no assurance that the Company will be able to continue to
         use cash collateral to fund its working capital needs.

(iii)    There can be no assurance that any Plan of Reorganization confirmed in
         connection with the Chapter 11 Filings will allow the Company to
         operate profitably under PPS or give the Company sufficient liquidity
         to meet its operational needs.

(iv)     There can be no assurance regarding the future availability or terms of
         financing in light of the Company's Chapter 11 Filings.

(v)      There can be no assurance regarding any adverse actions which may be
         taken by creditors or landlords of the Company which may have the
         effect of preventing or unduly delaying confirmation of a Plan of
         Reorganization in connection with the Company's Chapter 11 Filings.

(vi)     The Company may have difficulty in attracting patients or labor as a
         result of its Chapter 11 Filings.

(vii)    The Company may be subject to increased regulatory oversight as a
         result of its Chapter 11 Filings.

(viii)   In recent years, an increasing number of legislative proposals have
         been introduced or proposed by Congress and in some state legislatures
         which would effect major changes in the healthcare system. However, the
         Company cannot predict the type of healthcare reform legislation which
         may be proposed or adopted by Congress or by state legislatures.
         Accordingly, the Company is unable to assess the effect of any such
         legislation on its business. There can be no assurance that any such
         legislation will not have a material adverse impact on the future
         growth, revenues and net income of the Company.

(ix)     The Company derives substantial portions of its revenues from
         third-party payors, including government reimbursement programs such as
         Medicare and Medicaid, and some portions of its revenues from
         nongovernmental sources, such as commercial insurance companies, health
         maintenance organizations and other charge-based contracted payment
         sources. Both governmental and non-governmental payors have undertaken
         cost-containment measures designed to limit payments to healthcare
         providers. There can be no assurance that payments under governmental
         and non-governmental payor programs will be sufficient to cover the
         costs allocable to patients eligible for reimbursement. The Company
         cannot predict whether or what proposals or cost-containment measures
         will be adopted in the future or, if adopted and implemented, what
         effect, if any, such proposals might have on the operations and
         financial condition of the Company.

(x)      The Company is subject to extensive federal, state and local
         regulations governing licensure, conduct of operations at existing
         facilities, construction of new facilities, purchase or lease of
         existing facilities, addition of new services, certain capital
         expenditures, cost-containment and reimbursement for services rendered.
         The failure to obtain or renew required regulatory approvals or
         licenses, the failure to comply with applicable regulatory
         requirements, the delicensing of facilities owned, leased or managed by
         the Company or the disqualification of the Company from participation
         in certain federal and state reimbursement programs, or the imposition
         of harsh enforcement sanctions could have a material adverse effect
         upon the operations and financial condition of the Company.

(xi)     There can be no assurance that an adverse determination in a legal
         proceeding or governmental investigation, whether currently asserted or
         arising in the future, will not have a material adverse effect on the
         Company's financial position.

(xii)    There can be no assurance that the Company can continue to obtain
         insurance coverage similar to that it currently maintains or that such
         current or future coverage will be adequate to satisfy adverse
         determinations against the Company.


                                       37

<PAGE>   40

         In addition, the Company's Chapter 11 Filings may disrupt its
operations and may result in a number of other operational difficulties,
including the following:

(a)      The Company's ability to access capital markets will likely be limited;

(b)      The Company's senior management may be required to expend a substantial
         amount of time and effort structuring a Plan of Reorganization, which
         could have a disruptive impact on management's ability to focus on the
         operation of the Company's business;

(c)      The Company may be unable to retain top management and other key
         personnel;

(d)      The Company may experience a reduction in the census at its skilled
         nursing facilities and hospitals; and

(e)      Suppliers to the Company may stop providing supplies or services to the
         Company or provide such supplies or services only on "cash on
         delivery," "cash on order" or other terms that could have an adverse
         impact on the Company's cash flow.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

         None.


                                       38

<PAGE>   41

PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         As is typical in the healthcare industry, the Company is and will be
subject to claims that its services have resulted in resident injury or other
adverse effects, the risks of which will be greater for higher acuity residents
receiving services from the Company than for other long-term care residents. In
addition, resident, visitor and employee injuries will also subject the Company
to the risk of litigation. The Company has experienced an increasing trend in
the number and severity of litigation and claims asserted against the Company.
Management believes that this trend is endemic to the long-term care industry
and is a result of the increasing number of large judgments, including large
punitive damage awards, against long-term care providers in recent years
resulting in an increased awareness by plaintiff's lawyers of potentially large
recoveries. In certain states in which the Company has significant operations,
including California and Florida, insurance coverage for the risk of punitive
and certain other damages arising from general and professional liability
litigation is not available due to state law public policy prohibitions. There
can be no assurance that the Company will not be liable for punitive or other
damages awarded in litigation arising in states for which insurance coverage is
not available for such damages. The Company also believes that there has been,
and will continue to be, an increase in governmental investigations of long-term
care providers, particularly in the area of Medicare/Medicaid false claims, as
well as an increase in enforcement actions resulting from these investigations.
While the Company believes that it provides quality care to the patients in its
facilities and materially complies with all applicable regulatory requirements,
given the Company's current financial difficulties and lack of liquidity, an
adverse determination in a legal proceeding or governmental investigation,
whether currently asserted or arising in the future, could have a material
adverse effect on the Company.

         From time to time, the Company and its subsidiaries have been parties
to various legal proceedings in the ordinary course of their respective
businesses. In the opinion of management, other than as set forth below, there
have been no material developments in the litigation matters set forth in the
Company's Annual Report on Form 10-K for the year ended September 30, 2000. As a
result of the Chapter 11 Filings, all matters described in the Company's Annual
Report on Form 10-K for the year ended September 30, 2000 were stayed on January
18, 2000. While the automatic stay remains in effect, the Company has agreed to
relief from the automatic stay in certain limited circumstances.

         On August 26, 1996, a class action complaint was asserted against
GranCare, Inc. ("GranCare"), a wholly-owned subsidiary of the Company, in the
Denver, Colorado District Court, Salas, et al v. GranCare, Inc. and AMS
Properties, Inc. d/b/a Cedars Healthcare Center, Inc., case no. 96-CV-4449. On
March 15, 1998, the Court entered an Order in which it certified a class action
in the matter. On June 10, 1998, the Company filed a Motion to Dismiss all
claims and Motion for Summary Judgment Precluding Recovery of Medicaid Funds and
these motions were partially granted by the Court on October 30, 1998.
Plaintiffs' Motion for Reconsideration was denied by the Court on November 19,
1998, the Court's decision was certified as a final judgment on December 10,
1998, and plaintiffs then filed a writ with the Colorado Supreme Court, which
was denied, and an appeal with the Colorado Court of Appeal. In accordance with
the Company's voluntary filing under chapter 11 of the Bankruptcy Code and more
particularly, ss. 362 of that Code, this matter was stayed on January 18, 2000.
However, the Company did agree to limited relief from the stay in order to allow
for certain parts of the appeal to continue. On January 4, 2001, the Court of
Appeal reversed the District Court's decision. On February 1, 2001, the Company
filed a request for rehearing. The Company intends to vigorously contest all
remaining allegations.

         On approximately June 8, 1999 and December 13, 2000, the OIG issued
subpoenas duces tecum to Mariner of Catonsville. The subpoenas request medical
records pertaining to eighteen residents and employment and business records.
The subpoenas also request other broad categories of documents. The Company has
produced a substantial amount of documents responsive to the subpoenas. The
Company is cooperating with the investigation and has retained experienced
counsel to assist in responding to the subpoenas and to advise the Company with


                                       39

<PAGE>   42

respect to this investigation. The Company has been informed by the United
States that this investigation is now closed.

         On October 5, 2000, NovaCare Holdings, Inc. ("NCH") filed a complaint
(the "NCH Complaint") in the Chapter 11 Proceedings commencing Adversary
Proceeding No. 00-1577 (MFW), NovaCare Holdings, Inc. v. Mariner Post-Acute
Network, Inc., et al. The Company and various subsidiaries (the "defendant
subsidiaries") are named as defendants in the Complaint. In the NCH Complaint,
NCH alleges that its predecessors in interest (hereinafter also referred to as
"NCH") were party to contracts with various subsidiaries of the Company under
which NCH provided services to patients at various facilities of such
subsidiaries. It further alleges that pursuant to these contracts, NCH provided
certain services for which it was paid, but with respect to which the Health
Care Financing Administration ("HCFA") disallowed the facilities' claims for
reimbursement (the "NCH HCFA Disallowances"). After the NCH HCFA Disallowances,
NCH allegedly provided credits to the facilities equal to the amount of the NCH
HCFA Disallowances. Appeals of the NCH HCFA Disallowances were filed, and NCH
alleges that it holds a constructive trust or equitable lien on any amounts
which may be recovered from HCFA as a result of such appeals. In the
alternative, NCH alleges that it holds an administrative priority claim for any
such amounts that are paid by HCFA and not turned over to NCH. The aggregate
amount of the credits that are related to the NCH HCFA Disallowances and with
respect to which NCH asserts a constructive trust, an equitable lien, and/or an
administrative priority claim is $8,163,930. In addition, NCH asserts
administrative priority claims as well as claims for an equitable lien and
constructive trust for attorneys fees and expenses relating to the appeals of
other disallowance decisions by HCFA (the "Other HCFA Disallowances"); the NCH
Complaint states that NCH has incurred at least $275,000 of such expenses. On
November 9, 2000, the Company and the defendant subsidiaries filed a motion
("Motion to Dismiss") to dismiss the NCH Complaint, arguing that the
constructive trust/equitable lien claims are barred by res judicata based upon
prior financing orders of the Bankruptcy Court, and that the claims seeking
administrative priority fail to state claims upon which such relief may be
granted. On December 12, 2000, the Bankruptcy Court heard oral argument with
respect to the motion to dismiss, took the matter under submission, and
requested further briefing. In early November, NCH filed a motion ("Motion to
Enjoin Settlement") which seeks to enjoin the Company and the defendant
subsidiaries from settling claims against HCFA relating to the NCH HCFA
Disallowances and to require that any funds recovered with respect to such
claims be segregated. The Company and the defendant subsidiaries have filed an
opposition. In addition the Company has filed a motion for summary judgment
("Motion for Summary Judgment") on those counts of the complaint which are
directed against the Company and its subsidiaries. A hearing on the Motion to
Enjoin Settlement and on the Motion for Summary Judgment has been deferred until
the Bankruptcy Court rules on the Motion to Dismiss. The parties are currently
waiting for the Bankruptcy Court to rule on the Motion to Dismiss. The Company
and the defendant subsidiaries intend to contest the case vigorously.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

         None.

ITEM 3.  DEFAULTS UPON CERTAIN SECURITIES

         The Company made the Chapter 11 Filings on January 18, 2000. As a
result, no principal or interest payments are being made since such time on
prepetition indebtedness, with the exception of repayments made as a result of
the application of net cash proceeds received from the sales of certain
facilities and other assets and notional amounts related to certain other
indebtedness, including capital equipment leases, until a Plan of Reorganization
defining the payment terms has been approved by the Bankruptcy Court. Additional
information regarding the Chapter 11 Filings is set forth elsewhere in this Form
10-Q, including Note 3 to the unaudited condensed consolidated financial
statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

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

         None.


                                       40

<PAGE>   43

ITEM 5.  OTHER INFORMATION

         None.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)      Exhibits

<TABLE>
<S>      <C>
10.1     Ninth Amendment, dated February 20, 2001, to Debtor-in-Possession
         Credit Agreement, dated January 20, 2000 (the "Mariner Health DIP
         Credit Agreement"), by and among Mariner Health Group, Inc. ("Mariner
         Health"), the Mariner Health subsidiaries party to the Mariner Health
         DIP Credit Agreement, the lenders party to the Mariner Health DIP
         Credit Agreement, First Union National Bank as syndication agent, PNC
         Capital Markets, Inc. and First Union Securities, Inc. both as
         co-arrangers and PNC Bank, National Association as collateral and
         administrative agent and as an issuing bank for the letters of credit
         issued in connection with the Mariner Health DIP Credit Agreement.

10.2     Tenth Amendment, dated March 20, 2001, to Mariner Health DIP Credit Agreement.

10.3     Eleventh Amendment, dated April 20, 2001, to Mariner Health DIP Credit Agreement.

10.4     Order Approving Tenth Amendment to Mariner Health DIP Credit Agreement.
</TABLE>

(b)      Reports on Form 8-K

         None


                                       41

<PAGE>   44

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.



                        MARINER POST-ACUTE NETWORK, INC.
                        (Registrant)



                        By:  /s/ William C. Straub
                        --------------------------------------------------------
                        Vice President, Controller, and Chief Accounting Officer
                        (duly authorized Officer and Chief Accounting Officer)


Date: May 15, 2001


                                       42