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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q   (Mark One)
 [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
 For the quarterly period ended March 31, 2004 OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
 For the transition period from to 0-49813
(Commission file number)   MARINER HEALTH CARE, INC.    Delaware
    
    74-2012902(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)One Ravinia Drive, Suite 1500Atlanta, Georgia
    
    30346(Address of Principal Executive Offices)
    
    (Zip Code)
 (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 o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o There were 20,011,250 shares of Common Stock of the registrant outstanding
as of May 6, 2004. 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 x No o




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TABLE OF CONTENTS PagePart I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements
    
    
    1Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4.
    
    Controls and Procedures
    
    
    25Part II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    25Item 2.
    
    Changes in Securities and Use of Proceeds
    
    
    25Item 3.
    
    Defaults Upon Senior Securities
    
    
    25Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    25Item 5.
    
    Other Information
    
    
    25Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    25EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE CFO




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PART I 
 ITEM 1. FINANCIAL STATEMENTS MARINER HEALTH CARE,
INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net revenue
    
    $
    408,808
    
    
    $
    423,156Costs and expensesOperating expensesWage and related costs
    
    
    235,123
    
    
    
    254,735Supplies
    
    
    23,288
    
    
    
    24,794Insurance
    
    
    16,041
    
    
    
    20,540Provision for bad debt
    
    
    3,020
    
    
    
    4,377Rent expense
    
    
    8,260
    
    
    
    8,810Other
    
    
    71,128
    
    
    
    71,730Total operating expenses
    
    
    356,860
    
    
    
    384,986General and administrative
    
    
    26,374
    
    
    
    22,733Depreciation and amortization
    
    
    9,705
    
    
    
    8,593Total costs and expenses
    
    
    392,939
    
    
    
    416,312Operating income
    
    
    15,869
    
    
    
    6,844Other income (expenses)Interest expense
    
    
    (9,218
    )
    
    
    (8,213
    )Interest income
    
    
    751
    
    
    
    828Other
    
    
    27
    
    
    
    (50
    )Income (loss) from continuing operations before taxes
    
    
    7,429
    
    
    
    (591
    )Income tax provision (benefit)
    
    
    893
    
    
    
    (238
    )Income (loss) from continuing operations
    
    
    6,536
    
    
    
    (353
    )Discontinued operations(Loss) gain on sale of discontinued operations,
net of tax
    
    
    (79
    )
    
    
    3,600Loss from discontinued operations, net of tax
    
    
    (228
    )
    
    
    (479
    )Net income
    
    $
    6,229
    
    
    $
    2,768Income (loss) per share - basicIncome (loss) from continuing operations
    
    $
    0.33
    
    
    $
    (0.02
    )(Loss) gain on sale of discontinued operations
    
    
    (0.01
    )
    
    
    0.18Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.02
    )Net income per share
    
    $
    0.31
    
    
    $
    0.14Weighted
average common shares outstanding - basic
    
    
    20,008
    
    
    
    20,000Income (loss) per share - dilutedIncome (loss) from continuing operations
    
    $
    0.32
    
    
    $
    (0.02
    )(Loss) gain on sale of discontinued operations
    
    
    (0.01
    )
    
    
    0.18Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.02
    )Net income per share
    
    $
    0.30
    
    
    $
    0.14Weighted
average common shares outstanding - diluted
    
    
    20,452
    
    
    
    20,000
 The accompanying notes are an integral part of these condensed consolidated financial statements. 1




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MARINER HEALTH CARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts) March 31,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    20,262
    
    
    $
    41,934Receivables, net of allowance for doubtful accounts of $99,570
and $97,448, respectively
    
    
    248,488
    
    
    
    234,098Prepaid expenses and other current assets
    
    
    23,466
    
    
    
    25,396Total current assets
    
    
    292,216
    
    
    
    301,428Property and equipment, net of accumulated depreciation
of $68,827 and $59,255, respectively
    
    
    541,253
    
    
    
    544,356Reorganization value in excess of amounts allocable to identifiable assets
    
    
    192,771
    
    
    
    192,771Goodwill, net of accumulated amortization of $970
    
    
    6,797
    
    
    
    6,797Restricted investments
    

    
    19,764
    
    
    
    19,300Other assets
    
    
    36,576
    
    
    
    43,082Total assets
    
    $
    1,089,377
    
    
    $
    1,107,734LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesCurrent maturities of long-term debt
    
    $
    9,478
    
    
    $
    9,663Accounts payable
    
    
    49,603
    
    
    
    69,914Accrued compensation and benefits
    
    
    68,543
    
    
    
    69,330Accrued insurance obligations
    
    
    60,000
    
    
    
    54,315Other current liabilities
    
    
    56,241
    
    
    
    42,202Total current liabilities
    
    
    243,865
    
    
    
    245,424Long-term debt, net of current maturities
    
    
    375,803
    
    
    
    379,973Long-term
insurance obligations
    
    
    178,654
    
    
    
    191,124Other liabilities
    
    
    25,217
    
    
    
    31,741Minority interest
    
    
    3,324
    
    
    
    3,319Total liabilities
    
    
    826,863
    
    
    
    851,581Stockholders equityPreferred stock, $.01 par value; 10,000,000 shares
authorized; none issued or outstanding
    
    
    
    
    
    
    Common stock, $.01 par value; 80,000,000 shares authorized;
20,011,250 and 20,007,500 shares issued and outstanding, respectively
    
    
    200
    
    
    
    200Warrants to purchase common stock
    
    
    935
    
    
    
    935Capital surplus
    
    
    359,955
    
    
    
    360,141Unearned compensation
    
    
    (301
    )
    
    
    (616
    )Accumulated deficit
    
    
    (98,615
    )
    
    
    (104,844
    )Accumulated other comprehensive income
    
    
    340
    
    
    
    337Total stockholders equity
    
    
    262,514
    
    
    
    256,153Total liabilities and stockholders equity
    
    $
    1,089,377
    
    
    $
    1,107,734
 The accompanying notes are an integral part of these condensed consolidated financial statements. 2




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MARINER HEALTH CARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited) Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Cash flows from operating activitiesNet income
    
    $
    6,229
    
    
    $
    2,768Adjustments to reconcile net income to net cash
provided by operating activitiesProvision for bad debts
    
    
    3,086
    
    
    
    3,999Gain from divestitures and
sales of property and equipment and other assets
    
    
    (1,812
    )
    
    
    (3,600
    )Depreciation and amortization
    
    
    9,705
    
    
    
    8,593Amortization of deferred financing costs
    
    
    495
    
    
    
    268Stock compensation
    
    
    129
    
    
    
    Minority interest and other
    
    
    6
    
    
    
    50Provision (benefit) for income taxes
    
    
    893
    
    
    
    (238
    )Loss from discontinued operations
    
    
    228
    
    
    
    479Changes in operating assets and liabilitiesReceivables
    
    
    (19,132
    )
    
    
    (22,008
    )Prepaid expenses and other current assets
    
    
    1,563
    
    
    
    (5,726
    )Accounts payable
    
    
    (14,019
    )
    
    
    20,828Accrued and other current liabilities
    
    
    9,068
    
    
    
    3,348Insurance
obligations
    
    
    (6,785
    )
    
    
    782Other
    
    
    (6,067
    )
    
    
    (867
    )Net cash (utilized) provided by operating activities from
continuing operations before reorganization items
    
    
    (16,413
    )
    
    
    8,676Net cash provided by discontinued operations
    
    
    498
    
    
    
    43Payment of reorganization items, net
    
    
    (2,019
    )
    
    
    (1,343
    )Cash flows from investing activitiesPurchases of property and equipment
    
    
    (7,216
    )

    
    
    (15,757
    )Proceeds from divestitures and
sales of property and equipment and other assets
    
    
    2,395
    
    
    
    6,132Restricted investments
    
    
    (461
    )
    
    
    9,660Collections on notes receivable
    
    
    5,899
    
    
    
    42Insurance proceeds
    
    
    
    
    
    
    2,840Net cash provided by investing activities
    
    
    617
    
    
    
    2,917Cash flows from financing activitiesRepayment of long-term debt
    
    
    (4,355
    )
    
    
    (1,481
    )Net cash utilized by financing activities
    
    
    (4,355
    )
    
    
    (1,481
    )(Decrease) increase in cash and cash equivalents
    
    
    (21,672
    )
    
    
    8,812Cash and cash equivalents, beginning of period
    
    
    41,934
    
    
    
    38,618Cash and cash equivalents, end of period
    
    $
    20,262
    
    
    $
    47,430
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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MARINER HEALTH CARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) NOTE 1     GENERAL Nature of Business Mariner
Health Care, Inc. through its subsidiaries (collectively, the
Company) provides long-term health care services, primarily through the
operation of skilled nursing facilities. As of March 31, 2004, the Company
operated 254 skilled nursing facilities and eight stand-alone assisted living
facilities with an aggregate of 31,116 licensed beds. The Company owns 70% of
its facilities. The Company also operates eleven long-term acute care hospitals
(LTACs) in four states, with 613 licensed beds. The Companys facilities are
located in 23 states with significant concentrations in Texas, North Carolina,
California, Colorado, South Carolina and Maryland and clusters in twelve
geographic markets in nine of the states in which the Company operates. Skilled
nursing services and LTACs represent the Companys two reportable segments (see
Note 5). 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 (the SEC). Certain information and disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States (GAAP) have been condensed or
omitted pursuant to such rules and regulations. Accordingly, these unaudited
condensed consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto included in the
Companys Annual Report for the year ended December 31, 2003 on Form 10-K filed
with the SEC. In the opinion of management, the financial information included
herein reflects all adjustments considered necessary for a fair presentation of
interim results and 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. Use of Estimates The
preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Although these estimates
are based on managements knowledge of current events, they may ultimately
differ from actual results. Comprehensive Income Comprehensive income includes net income, as well as charges and credits
to stockholders equity not included in net income. The components of
comprehensive income, net of income taxes, consist of the following (in
thousands of dollars): Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net income
    
    $
    6,229
    
    
    $
    2,768Net unrealized gain (loss) on available-for-sale securities
    
    
    3
    
    
    
    (1
    )Comprehensive income
    
    $
    6,232
    
    
    $
    2,767
 4




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Reclassifications Certain prior year amounts have been reclassified to conform to the
current period financial statement presentation. NOTE
2    STOCK BASED COMPENSATION As of March 31, 2004, the Company maintained two stock-based compensation
plans that are described in Note 3 in the Companys Annual Report on Form 10-K
for the year ended December 31, 2003. The Company accounts for these plans
under the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. The Company recognized stock based compensation expense of
$0.1 million for the three months ended March 31, 2004 and there was no stock
based compensation expense for the three months ended March 31,
2003. The Companys pro forma net income and net income per share, assuming the
election had been made to recognize compensation expense on stock-based awards,
are as follows (in thousands of dollars, except per share amounts): Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net income
    
    $
    6,229
    
    
    $
    2,768Deduct: total stock-based employee compensation expense determined
under fair value based methods for all awards, net of tax
    

    
    (1,073
    )
    
    
    (858
    )Pro forma net income
    
    $
    5,156
    
    
    $
    1,910Basic net income per shareAs reported
    
    $
    0.31
    
    
    $
    0.14Pro forma
    
    $
    0.26
    
    
    $
    0.10Diluted net income per shareAs reported
    
    $
    0.30
    
    
    $
    0.14Pro forma
    
    $
    0.25
    
    
    $
    0.10
 NOTE
3    NET REVENUE Revenue is recorded based on estimated net realizable amounts due from
patients and third-party payors for health care services provided, including
anticipated settlements under reimbursement agreements with Medicare, Medicaid
and other third-party payors, and is recognized in the period in which the
services are provided. Revenue is recorded net of provisions for discount
arrangements with commercial payors and contractual allowances with third-party
payors, primarily Medicare and Medicaid. Revenue realizable under third-party
payor agreements are subject to change due to examination and retroactive
adjustment. The methods of making such estimates are
reviewed periodically, and differences between the net amounts accrued and
subsequent settlements or estimates of expected settlements are reflected in
the current period results of operations. All providers participating in the Medicare and Medicaid programs are
required to meet certain financial cost
reporting requirements. Federal and state regulations generally require the
submission of annual cost reports covering revenues, costs and expenses
associated with the services provided to Medicare beneficiaries and Medicaid 5




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recipients. Annual cost reports are subject to routine audits and retroactive
adjustments. These audits often require several years to reach the final
determination of amounts due to, or by, the Company under these programs. Retroactive adjustments are estimated in the recording of revenues in the
period the related services are rendered. These amounts are adjusted in future
periods as adjustments become known or as cost reporting years are no longer
subject to audits, reviews or investigations. Changes in estimates related to
third party receivables resulted in an increase in net revenue of
$0.2 million during the three months ended March 31, 2004. Changes in estimates
related to third party receivables did not have a material impact on net
revenues for the three months ended March 31, 2003. The Company believes
adequate provision has been made to reflect any adjustments that could result
from audit of cost reports. However, due to the complexity of the laws and
regulations governing the Medicare and Medicaid programs, there is a
possibility that recorded estimates will change by a material amount in future
periods. The following is a summary by dollars and percentage of net revenue by
payor type for the periods indicated (in thousands of dollars): Three Months EndedMarch 31, 2004
    
    March 31, 2003Medicaid
    
    $
    187,395
    
    
    
    45.8
    %
    
    $
    200,361
    
    
    
    47.4
    %Medicare
    
    
    145,391
    
    
    
    35.6
    %
    
    
    144,081
    
    
    
    34.0
    %Private and other
    
    
    76,022
    
    
    
    18.6
    %
    
    
    78,714
    
    
    
    18.6
    %Net revenue
    
    $
    408,808
    
    
    
    100.0
    %
    
    $
    423,156
    
    
    
    100.0
    %
 NOTE
4    DISCONTINUED OPERATIONS AND OTHER DIVESTITURES Discontinued Pharmacy Operations During the three months ended March 31, 2003, the Company earned and
received the payments for post-closing operating results (Earnout Payments)
in connection with the sale of the institutional pharmacy services business
(APS Division) to Omnicare, Inc. of $6.0 million, at which time it recorded a gain
of $3.6 million, net of taxes of $2.4 million. Other Discontinued Operations and Other Divestitures The results of operations and cash flows of any divested facilities that
qualify for discontinued operations under Statement of Financial Accounting
Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS No. 144) are reclassified to discontinued operations
for all periods presented. There were no assets held for sale at March 31, 2004,
however, the operations and cash flows of any divested facilities that
qualify for discontinued operations have been reclassified to discontinued
operations. During the three months ended March 31, 2004, the Company recorded
a loss on sale of $0.08 million, net of a tax benefit of
$0.05 million for discontinued operations. In addition, during the three months ended March 31,
2004, the Company recorded a gain of $1.9 million primarily related to the sale
of certain non-operating assets, which is included in other operating expenses
in the unaudited condensed consolidated statements of operations. 6




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Operating results for the discontinued operations were as follows for the
periods indicated (in thousands of dollars): Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net revenue
    
    $
    653
    
    
    $
    8,621Total costs and expenses
    
    
    1,131
    
    
    
    9,349Operating loss
    
    
    (478
    )
    
    
    (728
    )Other income
    
    
    250
    
    
    
    249Loss from discontinued operations, net of tax
    
    $
    (228
    )
    
    $
    (479
    )
 NOTE
5    SEGMENT INFORMATION The Company has two reportable segments, skilled
nursing services, which provides long-term health care through the operation of
skilled nursing facilities and assisted living facilities in the United States,
and LTACs, which provide services for the relatively high sub-acute clinical
needs patients. The Company primarily evaluates segment performance and allocates
resources based on operating profit, which is defined as net revenue less
operating, and general and administrative expenses. The Companys reportable
segments are strategic business units that offer different services to
different types of patients. They are each managed separately because they
provide services to patients with different acuity levels, and because the
conditions of participation in the Medicare and Medicaid programs, as well as
the reimbursement methodologies, for each business under these programs are
different. The following table summarizes revenues, operating profit, depreciation
and amortization and total assets for the Company for the three months ended
March 31, 2004 and 2003 for the two reportable segments, excluding the results
of discontinued operations. The income statement items included in the Other
category consist of corporate items not considered to be an operating segment
and eliminations. The assets included in the Other
category consist primarily of cash,
non-facility related property and equipment, excess reorganization value,
goodwill, restricted investments, notes receivable and deferred financing costs
(in thousands of dollars). SkilledNursingServices
    
    LTACs
    
    Other
    
    TotalThree Months Ended March 31, 2004Revenue from external customers
    
    $
    375,490
    
    
    $
    33,245
    
    
    $
    73
    
    
    $
    408,808Operating profit (loss) (1)
    
    
    47,262
    
    
    
    4,613
    
    
    
    (26,301
    )
    
    
    25,574Depreciation and amortization
    
    
    8,015
    
    
    
    392
    
    
    
    1,298
    
    
    
    9,705Total assets
    
    
    790,649
    
    
    
    26,996
    
    
    
    271,732
    
    
    
    1,089,377Three Months Ended March 31, 2003Revenue from external customers
    
    $
    393,400
    
    
    $
    29,324
    
    
    $
    432
    
    
    $
    423,156Operating profit (loss) (1)
    
    
    34,727
    
    
    
    3,011
    
    
    
    (22,301
    )
    
    
    15,437Depreciation and amortization
    
    
    7,753
    
    
    
    294
    
    
    
    546
    
    
    
    8,593Total assets
    
    
    819,501
    
    
    
    47,604
    
    
    
    340,168
    
    
    
    1,207,273
  (1)
    
    The operating profit (loss) does not include depreciation and
amortization. Total operating profit less depreciation and amortization
is $15.9 million and $6.8 million for the three months ended March 31,
2004 and 2003, respectively. 7




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NOTE
6    SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION Certain subsidiaries (the Guarantor
Subsidiaries) guarantee repayment of
debt under both the Companys $225.0 million senior credit facility (the Senior
Credit Facility), which consists of a $135.0 million term loan facility and a
$90.0 million revolving credit facility, and the Companys $175.0 million
aggregate principal amount of 8 1/4% senior subordinated notes due 2013 (the
Notes). Separate complete financial statements of the respective Guarantor
Subsidiaries are not presented because the Guarantor Subsidiaries are wholly
owned (directly or indirectly) by the Company and fully and unconditionally
guarantee the debt under the Senior Credit Facility and the Notes on a joint
and several basis. The following unaudited condensed consolidating financial data is
presented to illustrate the composition of Mariner Health Care, Inc. (the
Parent Company), the Guarantor Subsidiaries, and the Companys subsidiaries
that do not guarantee the debt under the Senior Credit Facility and the Notes
(the Non-Guarantor Subsidiaries) for the periods indicated. The Non-Guarantor Subsidiaries include the Professional Health Care
Management, Inc. (PHCMI) Entities, certain joint ventures and our captive
insurance subsidiaries. There are certain restrictions on the ability of the
Non-Guarantor Subsidiaries to pay dividends, make loans or advances and
transfer certain property and assets to the Company and its other subsidiaries. The Company does not have any subsidiaries that are accounted for by the
Parent Company on the equity method. As such, the principal elimination entries
eliminate intercompany balances and transactions. Information regarding the
Guarantor Subsidiaries and Non-Guarantor Subsidiaries is as follows for the
periods presented (in thousands of dollars): CONDENSED SELECTED COMBINING BALANCE SHEET
March 31, 2004 Guarantor
    
    Non-GuarantorParent
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedCurrent assets
    
    $
    22
    
    
    $
    314,761
    
    
    $
    30,506
    
    
    $
    (53,073
    )
    
    $
    292,216Total assets
    
    
    629,826
    
    
    
    966,144
    
    
    
    106,592
    
    
    
    (613,185
    )
    
    
    1,089,377Current liabilities
    
    
    7,212
    
    
    
    224,910
    
    
    
    64,815
    
    
    
    (53,072
    )
    
    
    243,865Total liabilities
    
    
    325,041
    
    
    
    420,220
    
    
    
    134,674
    
    
    
    (53,072
    )
    
    
    826,863Stockholders equity (deficit)
    
    
    304,785
    
    
    
    545,924
    
    
    
    (28,082
    )
    
    
    (560,113
    )
    
    
    262,514
 CONDENSED SELECTED COMBINING BALANCE SHEET
December 31, 2003 Guarantor
    
    Non-GuarantorParent
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedCurrent assets
    
    $
    
    
    
    $
    330,562
    
    
    $
    23,394
    
    
    $
    (52,528
    )
    
    $
    301,428Total assets
    
    
    636,064
    
    
    
    982,313
    
    
    
    101,997
    
    
    
    (612,640
    )
    
    
    1,107,734Current liabilities
    
    
    2,881
    
    
    
    234,674
    
    
    
    60,396
    
    
    
    (52,527
    )
    
    
    245,424Total liabilities
    
    
    324,618
    
    
    
    449,299
    
    
    
    130,191
    
    
    
    (52,527
    )
    
    
    851,581Stockholders
equity (deficit)
    
    
    311,446
    
    
    
    533,014
    
    
    
    (28,194
    )
    
    
    (560,113
    )
    
    
    256,153
 8




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CONDENSED SELECTED COMBINING STATEMENT OF OPERATIONS
For the three months ended March 31, 2004

Guarantor
    
    Non-GuarantorParent
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    
    
    
    $
    372,935
    
    
    $
    36,727
    
    
    $
    (854
    )
    
    $
    408,808Operating (loss) income
    
    
    (494
    )
    
    
    11,747
    
    
    
    4,616
    
    
    
    
    
    
    
    15,869(Loss) income from continuing
operations before income taxes
    
    
    (6,661
    )
    
    
    13,980
    
    
    
    110
    
    
    
    
    
    
    
    7,429Net (loss) income
    
    
    (6,661
    )
    
    
    12,780
    
    
    
    110
    
    
    
    
    
    
    
    6,229


CONDENSED SELECTED COMBINING STATEMENT OF OPERATIONS
For the three months ended March 31, 2003

Guarantor
    
    Non-GuarantorParent
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    
    
    
    $
    387,648
    
    
    $
    36,277
    
    
    $
    (769
    )
    
    $
    423,156Operating (loss) income
    
    
    (418
    )
    
    
    4,242
    
    
    
    3,020
    
    
    
    
    
    
    
    6,844(Loss) income from continuing
operations before income taxes
    
    
    (6,061
    )
    
    
    4,451
    
    
    
    562
    
    
    
    457
    
    
    
    (591
    )Net (loss) income
    
    
    (6,061
    )
    
    
    7,810
    
    
    
    562
    
    
    
    457
    
    
    
    2,768


CONDENSED SELECTED COMBINING STATEMENT OF CASH FLOWS
For the three months ended March 31, 2004

Guarantor
    
    Non-GuarantorParent
    
    Subsidiaries
    
    Subsidiaries
    
    ConsolidatedNet cash
provided (utilized) by operating activities (1)
    
    $
    3,908
    
    
    $
    (20,446
    )
    
    $
    (1,396
    )
    
    $
    (17,934
    )Net cash (utilized) provided by
investing activities
    
    
    
    
    
    
    (320
    )
    
    
    937
    
    
    
    617Net cash utilized by
financing activities
    
    
    (3,908
    )
    
    
    (126
    )
    
    
    (321
    )
    
    
    (4,355
    )Decrease in cash and
cash equivalents
    
    
    
    
    
    
    (20,892
    )
    
    
    (780
    )
    
    
    (21,672
    )Cash and cash equivalents,
beginning of period
    
    
    
    
    
    
    39,465
    
    
    
    2,469
    
    
    
    41,934Cash and cash equivalents,
end of period
    
    
    
    
    
    
    18,573
    
    
    
    1,689
    
    
    
    20,262


CONDENSED SELECTED COMBINING STATEMENT OF CASH FLOWS
For the three months ended March 31, 2003 Guarantor
    
    Non-GuarantorParent
    
    Subsidiaries
    
    Subsidiaries
    
    ConsolidatedNet cash provided (utilized) by
operating activities (1)
    
    $
    530
    
    
    $
    8,033
    
    
    $
    (1,187
    )
    
    $
    7,376Net cash provided by
investing activities
    
    
    
    
    
    
    1,908
    
    
    
    1,009
    
    
    
    2,917Net cash utilized by
financing activities
    
    
    (530
    )
    
    
    (631
    )
    
    
    (320
    )
    
    
    (1,481
    )Increase (decrease) in cash and
cash equivalents
    
    
    
    
    
    
    9,310
    
    
    
    (498
    )
    
    
    8,812Cash and cash equivalents,
beginning of period
    
    
    
    
    
    
    37,734
    
    
    
    884
    
    
    
    38,618Cash and cash equivalents,
end of period
    
    
    
    
    
    
    47,044
    
    
    
    386
    
    
    
    47,430
  (1)
    
    Net cash provided by operating activities includes net cash provided by
discontinued operations and payment of reorganization items. 9




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NOTE
7    VARIABLE INTEREST ENTITIES In
January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46), which
addresses the consolidation of entities whose equity holders have either (a)
not provided sufficient equity at risk to allow the entity to finance its own
activities or (b) do not possess certain characteristics of a controlling
financial interest. FIN 46 sets forth a model to evaluate potential
consolidation of these entities, known as variable interest entities (VIEs),
based on an assessment of which party to the VIE, if any, absorbs a majority of
the exposure to its expected losses, receives a majority of its expected
residual returns, or both, which is referred to for purposes of FIN 46 as the
primary beneficiary. FIN 46 also requires disclosures about VIEs that a
company is not required to consolidate but in which it has a significant
variable interest. FIN 46 is effective for all new VIEs created or acquired
after January 31, 2003. For VIEs created or acquired prior to February 1, 2003,
the provisions of FIN 46 must be applied for the first interim or annual period
beginning after March 15, 2004, except for companies with special purpose
entities which must apply the provisions of FIN 46 to those special purpose
entities no later than the first reporting period ending after December 15,
2003. The Company has evaluated the impact of FIN 46 on its unaudited condensed
consolidated financial statements and identified three joint ventures
as VIEs for which it has determined that it is the primary
beneficiary. These joint ventures, which operate skilled nursing
facilities that are managed by the Company, are fifty
percent owned and have historically been consolidated due to control. The
Company has historically provided funds for working capital and have other
long-term notes from these joint ventures, which are eliminated in
consolidation. The joint ventures have revenues, which are included
in the unaudited condensed consolidated financial statements of $9.8 million
and $8.7 million, for the three months ended March 31, 2004 and 2003,
respectively. These joint ventures have net liabilities that are
included in the accompanying unaudited condensed consolidated financial
statements of approximately $40.0 million and $39.9 million at March 31, 2004
and December 31, 2003, respectively. During
the three months ended December 31, 2003, the Company entered
into an administrative services agreement with a new operator of
certain facilities that the Company divested. The services are for
26 facilities and include accounting support, procurement of
business supplies, billing and collections, and information
technology services. Applying the principles of FIN 46, the
Company has determined that the new operator of the divested
facilities is a VIE. The Company has also determined that it is not
the primary beneficiary and accordingly, the Company is
not required to consolidate the new operator. The total receivable
from this new operator at March 31, 2004 is $3.7 million. 10




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NOTE
8    EARNINGS PER SHARE As required by SFAS No. 128, Earnings Per Share, the Company has
presented basic and diluted income (loss) per common share amounts in the
accompanying unaudited condensed consolidated financial statements.
Basic income (loss) per common share is calculated based on the weighted average common
shares outstanding during the period. Diluted income (loss) per
common share is
calculated similarly to basic income (loss) per common share except that the
weighted average shares outstanding are increased to include additional shares
from the assumed exercise of stock options, if dilutive. The number of
additional shares is calculated by assuming that outstanding stock options that
are dilutive were exercised and that the proceeds from such exercises were used
to acquire shares of common stock at the average market price during the
period. Below
is the reconciliation of basic and diluted income from continuing
operations per weighted average common
share (in thousands, except per share data): Income FromContinuing
    
    
    
    
    
    Per ShareOperations
    
    Shares
    
    AmountQuarter ended March 31, 2004Basic income per common share
    
    $
    6,536
    
    
    
    20,008
    
    
    $
    0.33Effect of dilutive stock options
    
    
    
    
    
    
    444
    
    
    
    (0.01
    )Diluted
income per common share
    
    $
    6,536
    
    
    
    20,452
    
    
    $
    0.32
 Options to purchase 11,000 shares of common stock at $21.55 per share and
warrants to purchase 754,000 shares of common stock at $28.04 were not included
in the computation of diluted income per share because the exercise price was
greater than the average market price of the common shares. The options and
warrants were still outstanding at March 31, 2004. The exercise period for the
warrants began on the May 13, 2002 and expires on May 13, 2004. Each warrant
unexercised at the expiration of this period will become void, and all rights
will terminate. NOTE
9    COMMITMENTS AND CONTINGENCIES From
time to time, the Company is party to various legal proceedings
in the ordinary course of business. As is typical in the health care industry,
the Company expects to remain subject to claims that its services have resulted
in resident injury or other adverse effects. In addition, resident, visitor and
employee injuries will also subject the Company to the risk of litigation. The
health care industry in general continues to experience an increasing trend in
the frequency and severity of litigation and claims. There are currently no
outstanding uninsured litigation matters against the Company that it believes
could have a material adverse effect on its operations or cash flows. Below is
a summary of the major outstanding litigation to which the Company is a party. Royal Surplus Lines Litigation On June 11, 2001, one of the Companys prior liability insurance carriers,
Royal Surplus Lines Insurance Company (Royal), commenced an adversary
proceeding in the Bankruptcy Court, styled Royal Surplus Lines Insurance
Company v. Mariner Health Group (MHG) et al., Adversary Proceeding No.
A-01-4626 (MFW). In its
complaint, Royal sought among other things, declaratory judgments that it
would not be required to insure some claims falling under two PL/GL policies
issued to one of the Companys subsidiaries by Royal. One of the
Companys
prior excess liability insurance carriers, Northfield Insurance Company
(Northfield), moved to intervene in the Royal adversary proceeding on July
25, 2001. The Company did not oppose the motion to intervene, and it was
granted. Prior to the parties engaging in any significant discovery, they agreed to
mediate the issues arising out of the Royal adversary proceeding. After the
mediation, Royal agreed to dismiss its complaint without prejudice, the Company
agreed to dismiss its counterclaim without prejudice, and Royal and the Company
agreed to work together 11




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to resolve claims in an alternative dispute resolution
procedure. Northfield did not agree to dismiss its complaint in intervention.
Accordingly, Northfield and the Company are currently engaging in discovery.
The Company has also filed a bad faith counterclaim against Northfield arising
out of its claims handling and litigation tactics. In April 2003, Northfield filed an insurance coverage action against the
Company in the United States District Court for the Northern District of
Georgia. Northfield sought a declaration that it was not obligated to provide
insurance coverage to us in connection with a personal injury and wrongful
death lawsuit filed against the Company styled Louise Sherry Fisher,
Individually, as Representative of all Wrongful Death Beneficiaries, and Legal
Heir of the Estate of Vestal Grant Fisher, deceased v. Mariner Post-Acute
Network, Inc. (MPAN), et al., No. 2000-40818 (28th Judicial District, Harris
County, Texas), (the Fisher Action). The Fisher Action
settled in May 2004. PricewaterhouseCoopers Litigation In August 2002, the Company filed a complaint in the State Court of Fulton
County, Georgia against PricewaterhouseCoopers, LLP (PwC) and several former
officers of MHG referred to as the Individual Defendants. The Fulton County
action asserts claims for fraud and breach of fiduciary duty against the
Individual Defendants and claims for fraud, professional negligence, negligent
misrepresentation and aiding and abetting breach of fiduciary duty against PwC.
Many of these claims arise from the July 1998 acquisition of MHG by Paragon,
one of the Companys predecessors. Other claims arise from duties that the
Company believes the Individual Defendants breached as officers of MHG and
MPAN, the Companys successor following the MHG acquisition. In the Fulton
County action, the Company is seeking actual damages (including compensatory
and consequential damages) and punitive damages, in an amount to be determined
at trial. Discovery is ongoing. In response to the action commenced by the Company in Fulton County, the
Individual Defendants filed an action in Chancery Court in Delaware in
September 2002 styled Stratton et al.v. Mariner Health Care, Inc., Civil
Action No. 19879-NC. In the Chancery Court action, the Individual Defendants
generally claim they are not liable for the claims asserted in the Fulton
County action and that the Company is contractually and statutorily obligated
to indemnify them against the claims in the Fulton County action. The Company
removed the Chancery Court action to the Bankruptcy Court, at which time the
action was assigned Adversary Case Nos. 02-5604 and 02-5606 in Chapter 11 Case
Nos. 00-0113 (MFW) and 00-00215 (MFW). After removal, the Company answered the
complaint and filed counterclaims. The Individual Defendants moved to remand
the action back to the Chancery Court. The Company
opposed the motion. On December 16, 2003, the Bankruptcy Court denied the
Individual Defendants remand motion and dismissed their claims holding, among
other things, that the Individual Defendants indemnification claims had been
discharged by confirmation of the Companys Joint Plan. The Individual
Defendants have filed a motion to alter or amend judgment, which is pending. After the Individual Defendants filed the Chancery Court action, the
Company also filed an adversary proceeding in the Bankruptcy Court styled
Mariner Health Care, Inc. v. Stratton et al., United States Bankruptcy Court
for the District of Delaware, Chapter 11 Case Nos. 00-00113 (MFW) and 00-00215
(MFW), Adversary Case No. 02-05598 (consolidated with Adversary Case No.
02-05599). In this enforcement action, the Company generally 12




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alleged that it
does not have any obligation to indemnify the Individual Defendants and the
Individual Defendants pursuit of their indemnification claims violated the
Companys discharge in bankruptcy. The Individual Defendants filed
counterclaims generally alleging that the Company has an obligation to
indemnify them against the claims in the Fulton County action and that it is
estopped from asserting those claims. The Company has moved to dismiss the
Individual Defendants estoppel counterclaim. The Individual Defendants opposed
the motion, and on April 10, 2003, the Bankruptcy Court granted the motion to
dismiss. After the Company filed the Fulton County action, William R. Bassett as
Trustee for the Charlotte R. Kellett Irrevocable Trust, as Trustee for the
Samuel B. Kellett, Jr. Irrevocable Trust, as Trustee for the Stiles A. Kellett,
III Irrevocable Trust and as Trustee for the Barbara K. Kellett Irrevocable
Trust, Kellett Family Partners, L.P. f/k/a Kellett Partners, L.P., Samuel B.
Kellett, Stiles A. Kellett, Jr. and SSK Partners, L.P., filed an action in the
Superior Court of Cobb County, Georgia against PwC and the Individual
Defendants based on claims arising out of MHGs acquisition of Convalescent
Services, Inc. in 1995 because of the Individual Defendants and PwCs alleged
misrepresentations. This action is William R. Bassett, et al.v.
PricewaterhouseCoopers, LLP, et al., Superior Court of Cobb County, Georgia,
Case No. 02-1-8314-35. The plaintiffs in the Cobb County action seek damages in
excess of $200 million. The Individual Defendants added the Company as a
third-party defendant in the Cobb County action seeking to recover on
indemnification claims similar to those made by them in the Chancery Court
action, and which are now pending, and subject to resolution before the
Bankruptcy Court in the enforcement action. In November 2003, the Individual
Defendants dismissed the Company without prejudice from the Cobb County action. Indemnity Insurance Company of North America Litigation In May 2003, the Company filed a complaint in the United States District
Court for the Eastern District of Texas, Beaumont Division, entitled Mariner
Health Care, Inc. v. Indemnity Insurance Company of North America, Inc.
(IINA), Case No. 103 CV 0279. The Company is seeking a declaratory judgment
determining its rights and the obligations of IINA, under an IINA policy of
insurance regarding property damage and related losses at the Companys
facilities in Beaumont and Houston, Texas caused by Tropical Storm Allison in
June 2001. The Company additionally asserts breach of contract and unfair
claims handling practices claims against IINA. The Company further seeks
statutory damages, punitive damages and attorneys fees under Texas Insurance
Code and the Texas Civil Practice and Remedies Code. IINA has answered the
Companys complaint and the parties are in the process of pretrial discovery,
with an anticipated trial date in the second quarter of 2005. On January 30, 2004, the Company moved to amend its complaint to include,
as plaintiffs, the Companys affiliates Cornerstone Health Management Company,
Mariner Health Care of Nashville, Inc. and Living Centers of Texas, Inc., and
to make other conforming amendments. Our motion to amend the complaint to add
parties, etc. was granted on February 7, 2004. While the Company is not able to predict the outcome of any of these
matters, based on currently available facts it does not believe that the
resolution of any of these proceedings will have a material adverse effect on
its financial position, results of operations or cash flows. 
 ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 The following is a discussion of our results of operations and current
financial position. This discussion should be read in conjunction with our
unaudited condensed consolidated financial statements and related notes
included elsewhere in this report and the audited consolidated financial
statements and related notes and the selected
financial data included in Item 6, both included in our Annual Report on
Form 10-K for the year ended December 31, 2003. Our discussion of our results
of operations and financial position includes various forward-looking
statements about our markets, the demand for our services, and our future
results. These statements are based on certain assumptions that we consider
reasonable. For information about risks and exposures relating to our business
and our company, you should read the section entitled Risk Factors included
in our Annual Report onForm 10-Kfor the year ended December 31, 2003. The
following discussion includes EBITDA, which is not a financial
measure compliant with accounting principles generally accepted in
the United States, or GAAP. For purposes of
Regulation G promulgated by the SEC, or Regulation G, a non-GAAP financial 13




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measure is a numerical measure of a registrants historical or future financial
performance, financial position or cash flows that excludes amounts, or is
subject to adjustments that have the effect of excluding amounts, that are
included in the most directly comparable financial measure calculated and
presented in accordance with GAAP in the statement of operations, statement of
stockholders equity, balance sheet or statement of cash flows (or equivalent
statements) of the registrant; or includes amounts, or is subject to
adjustments that have the effect of including amounts, that are excluded from
the most directly comparable financial measure so calculated and presented.
Pursuant to the requirements of Regulation G, we have provided reconciliations
of the non-GAAP financial measures to the most directly comparable GAAP
financial measures. Management believes that the presentation of EBITDA provides useful
information to investors regarding our results of operations because it is
useful for trending, analyzing and benchmarking the performance and value of
our business. We use EBITDA primarily as a performance measure and believe that
the GAAP financial measure most directly comparable to EBITDA is net income.
Although we use EBITDA as a financial measure to assess the performance of our
business, the use of EBITDA is limited because it does not consider certain
material costs necessary to operate our business. These costs include the cost
to service our debt, the non-cash depreciation and amortization associated with
our long-lived assets, and the cost of our federal and state tax obligations.
Because EBITDA does not consider these important elements of our cost
structure, a user of our financial information who relies on EBITDA as the only
measure of our performance could draw an incomplete or misleading conclusion
regarding our financial performance. Consequently, a user of our financial
information should consider net income an important measure of our financial
performance because it provides the most complete measure of our performance. We define EBITDA as net income before taxes, interest expense, interest
income, and depreciation and amortization. Other companies may define EBITDA
differently and, as a result, our measure of EBITDA may not be directly
comparable to EBITDA of other companies. EBITDA does not represent net income,
as defined by GAAP. We also present certain adjustments to EBITDA that exclude loss (gain) on
sale of discontinued operations, net of tax, loss from discontinued operations,
net of tax, and loss from operations of divested facilities that did not
qualify for discontinued operations. These adjustments are presented because
this is the formula used to calculate compliance with certain ratios appearing
in our $225.0 million senior credit facility, or the Senior Credit Facility,
which consists of a $135.0 million term loan facility and a $90.0 million
revolving credit facility, and our $175.0 million aggregate principal amount of
8 1/4% senior subordinated notes due 2013, or the Notes. The adjustments to
EBITDA presented below are reconciled to net income, which we believe is the
most directly comparable GAAP financial measure. Overview The accompanying unaudited condensed consolidated financial statements set
forth certain information with respect to our financial position, results of
operations and cash flows which should be read in conjunction with the
following discussion and analysis. As used in this report, references to we,
us, our, Mariner or similar terms include Mariner Health Care, Inc. and
its operating subsidiaries. We are one of the largest providers of long-term health care services in
the United States, based on net revenue, the number of facilities operated and
licensed beds. We provide these services primarily through the operation of
skilled nursing facilities (which include skilled nursing facilities under
Medicare and nursing facilities under Medicaid) and long-term acute care
hospitals, or LTACs. Skilled nursing services and LTACs also constitute our
reportable business segments under GAAP. We currently operate 254 skilled nursing
facilities and eight stand-alone assisted living facilities with an aggregate
of 31,116 licensed beds. We own 70% of our facilities. We also operate eleven
LTACs with 613 licensed beds. Our facilities are located in 23 states with
significant concentrations in Texas, North Carolina, California, Colorado,
South Carolina, and Maryland and clusters in twelve geographic markets in nine
of the states in which we operate. Services provided at our skilled nursing facilities and assisted living
facilities are our primary service offering and account for 92% of our
revenue. Through our skilled nursing facilities, we provide 24-hour care
to patients requiring skilled nursing services, including assistance with
activities of daily living, or ADL, therapy and rehabilitation services. Our
LTACs accommodate the relatively high acuity needs of patients discharged from 14




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short-term, acute-care hospitals when the patients condition warrants more
intensive care than can be provided in a typical nursing facility. The following table sets forth our revenues, operating profit,
depreciation and amortization and total assets for our two reportable segments,
skilled nursing services and LTACs. The operating profit is defined as net
revenue less operating and general and administrative expenses. The income
statement items included in the Other category consist of corporate items not
considered to be an operating segment and eliminations. The assets included in
the Other category consist primarily of cash, non-facility property and equipment,
excess reorganization value, goodwill, restricted investments, notes receivable
and deferred financing costs (in thousands of dollars). SkilledNursingServices
    
    LTACs
    
    Other
    
    TotalThree Months Ended March 31, 2004Revenue from external customers
    
    $
    375,490
    
    
    $
    33,245
    
    
    $
    73
    
    
    $
    408,808Operating profit (loss) (1)
    
    
    47,262
    
    
    
    4,613
    
    
    
    (26,301
    )
    
    
    25,574Depreciation and amortization
    
    
    8,015
    
    
    
    392
    
    
    
    1,298
    
    
    
    9,705Total assets
    
    
    790,649
    
    
    
    26,996
    
    
    
    271,732
    
    
    
    1,089,377Three Months Ended March 31, 2003Revenue from external customers
    
    $
    393,400
    
    
    $
    29,324
    
    
    $
    432
    
    
    $
    423,156Operating profit (loss) (1)
    
    
    34,727
    
    
    
    3,011
    
    
    
    (22,301
    )
    
    
    15,437Depreciation and amortization
    
    
    7,753
    
    
    
    294
    
    
    
    546
    
    
    
    8,593Total assets
    
    
    819,501
    
    
    
    47,604
    
    
    
    340,168
    
    
    

    1,207,273
  (1)
    
    The operating profit (loss) does not include depreciation and
amortization. Total operating profit less depreciation and amortization
is $15.9 million and $6.8 million for the three months ended March 31,
2004 and 2003, respectively. Critical Accounting Policies and Estimates General The unaudited condensed consolidated financial statements are based on the
application of critical accounting policies and estimates, which require
management to make estimates and assumptions. We believe that some
of the more critical judgment areas in the application of accounting policies
that affect our financial condition and results of operations are estimates and
assumptions pertaining to (a) revenue recognition, (b) collectibility of
accounts receivable, (c) insurance and professional liability risks and (d)
income taxes. Revenue Recognition We have agreements with third-party payors that provide for payments to
our skilled nursing facilities. These payment arrangements may be based upon
prospective rates, reimbursable costs, established charges, discounted charges
or per diem payments. Revenue is reported at the estimated net realizable
amounts from Medicare, Medicaid, other third-party payors and individual
patients for services rendered. Retroactive adjustments that are likely to
result from future examinations by third-party payors are accrued on an
estimated basis in the period the related services are rendered and adjusted as
necessary in future periods based on final settlements. There is a possibility
that recorded estimates may change by a material amount. Consistent with health
care industry accounting practices, changes to these third-party revenue
estimates are recorded in the year of change or at the time the adjustment
becomes known. Receivables Receivables consist primarily of amounts due from the Medicare and
Medicaid programs, other government 15




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programs, managed care health plans,
commercial insurance companies and individual patients. Allowances for doubtful
accounts are established to the extent that a portion of these receivables may
become uncollectible. In establishing the allowance for doubtful accounts, we
consider a number of factors, including the age of the accounts, changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors and general industry
conditions. Changes in these estimates are charged or credited to the results
of operations in the period of the change. If circumstances occur, such as an
economic downturn, higher than expected defaults or denials, or reduced
collections, the estimates of the recoverability of our receivables could be
reduced by a material amount. During the three months ended March 31, 2004, we
collected net cash of $3.9 million of previously reserved accounts receivable
balances related to facilities divested during the three months ended December
31, 2003. Our provision for bad debt totaled $3.1 million and $4.0 million for
the three months ended March 31, 2004 and March 31, 2003, respectively, which
represented 0.8% and 0.9%, of net revenue for the respective periods. Our
allowance for doubtful accounts related to patient accounts receivable was
$99.6 million and $97.4 million as of March 31, 2004 and December 31, 2003
respectively, which represented 30.0% and 30.8% of patient accounts receivable
at March 31, 2004 and December 31, 2003, respectively. Accrued Insurance Obligation for Professional and General Liability Professional and general liability, or PL/GL costs for the long-term care
industry have become increasingly expensive and difficult to estimate.
Specifically, rising costs of eldercare malpractice litigation, losses stemming
from these malpractice lawsuits and a declining number of insurers willing to
write insurance policies in our industry has caused many insurance carriers to
raise the cost of insurance premiums. We are currently self-insured for individual claims up to $1.0 million for
professional liability, except in Colorado, where we maintain first dollar
coverage. The accrued insurance obligation related to self-insured losses for
professional liability are recorded on an undiscounted basis and are based upon
internal and external evaluations of the merits of individual claims, analysis
of claims history and independent actuarially determined estimates. We
periodically review the methods of determining these estimates and establishing
the resulting accrued insurance obligation and provision for loss with any
resulting adjustments being reflected in current earnings. Insurance expense
for PL/GL was $15.5 million and $19.8 million for the three months ended March
31, 2004 and 2003, respectively. The decrease in insurance expense for PL/GL
is due primarily to facilities divested during the three months ended December
31, 2003, partially offset by rising rates. Although we believe that the accrued insurance obligation is adequate, the
ultimate liability may be in excess of or less than the amounts recorded.
Changes in the number of PL/GL claims and increases in costs to settle these
claims could significantly impact our accrued insurance obligation. A
relatively small variance between our estimated and ultimate actual number of
claims or average cost per claim could have a material impact, either favorable
or unfavorable, on the adequacy of the accrued insurance obligation. Accounting for Income Taxes The provision (benefit) for income taxes is allocated between continuing
operations, discontinued operations, and extraordinary items in accordance with
SFAS No. 109, Accounting for Income Taxes, or SFAS No. 109. For the
three months ended March 31, 2004, no federal income tax provision and a state
income tax provision of $0.9 million was recorded. During the three months
ended March 31, 2004, we also reported loss from discontinued operations of
$0.2 million and loss from sale of discontinued operations of $0.08 million.
The loss from discontinued operations is shown net of a tax benefit of $0.2
million and the loss on sale of discontinued operations is shown net of a
tax benefit of $0.05 million. The effective tax rate varies from statutory federal
and state tax rates primarily due to the utilization of net operating loss
carryforward in the first quarter. The provision for income taxes is based upon our estimate of taxable
income or loss for each respective accounting period. We recognize an asset or
liability for the deferred tax consequences of temporary differences between
the tax basis of assets and liabilities and their reported amounts in the
financial statements. These temporary differences will result in taxable or
deductible amounts in future years when the reported amounts of assets are
recovered or liabilities are settled. We also recognize as deferred tax assets
the future tax benefits from net operating and capital loss carryforwards. 16




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SFAS No. 109 requires that a valuation allowance be established when it is
more likely than not that all or a portion of a deferred tax asset will not be
realized. The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which those temporary
differences are deductible. In making this determination, we consider all
available positive and negative evidence affecting specific deferred tax
assets, including our past and anticipated future performance, the reversal of
deferred tax liabilities, and the implementation of tax planning strategies. Objective positive evidence is necessary to support a conclusion that a
valuation allowance is not needed for all or a portion of deferred tax assets
when significant negative evidence exists. Cumulative losses in recent years
are the most compelling form of negative evidence considered by management in
this determination. We believe the deferred tax assets will not be recognized
under the more likely than not standard. As the bankruptcy pre-emergence net
deferred tax assets are realized, a reduction in the valuation allowance
established in connection with fresh-start reporting will be recorded. Pursuant
to American Institute of Certified Public Accountants Statement of Position
90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy
Code, any reduction in the valuation allowance will first reduce reorganization
value in excess of amount allocable to identified assets recorded in
fresh-start reporting and other intangible assets, with any excess being
treated as an increase to capital surplus. As of March 31, 2004, we had approximately $563.5 million of net operating
loss, or NOL, carryforwards utilization of which is subject to limitations
pursuant to Section 382 of the Internal Revenue Code. Of the total NOL
carryforward, $118.4 million is unencumbered by any Section 382 limitations. If there is a cumulative ownership change involving shareholders who own
5% or more of our common stock of more than 50% during the two year period
following our emergence from bankruptcy (May 13, 2002), the remaining NOL
carryforwards will be forgone with no net impact to our consolidated financial
statements. This could result in higher future tax payments if we are
profitable. Asset Impairment Long-lived Assets We review the carrying value of our long-lived assets for impairment
whenever events or circumstances indicate that the carrying amount may not
exceed the future undiscounted cash flows or an adjustment to the amortization
period is necessary in accordance with Statement of Financial Accounting
Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, or SFAS No. 144. These indicators of impairment can include, but are
not limited to, a history of operating losses with expected future losses,
changes in the regulatory environment affecting reimbursement, decreases in
cash flows or cash flow deficiencies, changes in the way an asset is used in
the business, and commitment to a plan to sell or otherwise dispose of an
asset. Impairment of Reorganization Value in Excess of Amounts Allocable to
Identifiable Assets and Goodwill Reorganization value in excess of amounts allocable to identifiable
assets, or excess reorganization value, represents the portion of
reorganization value that could not be attributed to specific tangible or
identified intangible
assets recorded in connection with our adoption of fresh-start reporting. In lieu of amortization, we are required to review the excess
reorganization value and goodwill for impairment at least annually or more
frequently if events or changes in circumstances indicate the asset might be
impaired. Assets Held for Sale and Discontinued Operations SFAS No. 144 also addresses the accounting for and disclosure of
long-lived assets to be disposed of by sale. Under SFAS No. 144, when a
long-lived asset or group of assets or disposal group meets certain criteria
set forth in SFAS No. 144, including a commitment by a company to a plan to
sell the long-lived asset or disposal group within one year, the long-lived
asset or disposal group will be measured at the lower of its carrying value or
fair value less costs to sell and classified as held for sale on the
consolidated balance sheet and is no longer depreciated. We must estimate the
fair value less costs to sell in order to determine if there is any potential
impairment of the assets held for sale. Estimates may include comparable
sales, future cash flows and the use of an outside experts in determining 17




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the
fair value. If additional criteria are met under SFAS No. 144, the related operations
and cash flows of the long-lived asset or disposal group will be reported as
discontinued operations in the consolidated statements of operations, with all
comparable periods restated. Recent Accounting Pronouncements In
January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51, or FIN 46, which
addresses the consolidation of entities whose equity holders have either (a)
not provided sufficient equity at risk to allow the entity to finance its own
activities or (b) do not possess certain characteristics of a controlling
financial interest. FIN 46 sets forth a model to evaluate potential
consolidation of these entities, known as variable interest entities, or VIEs,
based on an assessment of which party to the VIE, if any, absorbs a majority of
the exposure to its expected losses, receives a majority of its expected
residual returns, or both, which is referred to for purposes of FIN 46 as the
primary beneficiary. FIN 46 also requires disclosures about VIEs that a
company is not required to consolidate but in which it has a significant
variable interest. FIN 46 is effective for all new VIEs created or acquired
after January 31, 2003. For VIEs created or acquired prior to February 1, 2003,
the provisions of FIN 46 must be applied for the first interim or annual period
beginning after March 15, 2004 except for companies with special purpose
entities which must apply the provisions of FIN 46 to those special purpose
entities no later than the first reporting period ending after December 15,
2003. We have evaluated the impact of FIN 46 on our unaudited condensed
consolidated financial statements and identified three joint ventures as VIEs for which we have determined that we are the primary
beneficiary. These joint ventures, which operate skilled nursing
facilities that are managed by us, are fifty percent owned by us and have
historically been consolidated due to control. We have historically provided
funds for working capital and have other long-term notes from these joint
ventures, which are eliminated in consolidation. The joint ventures have revenues, which are included in our unaudited condensed consolidated
financial statements of $9.8 million and $8.7 million for the three months
ended March 31, 2004 and 2003, respectively. These joint
ventures have net liabilities that are included in the accompanying unaudited condensed
consolidated financial statements of approximately $40.0 million and $39.9
million at March 31, 2004 and December 31, 2003, respectively. During
the three months ended December 31, 2003, we entered into an
administrative services agreement with a new operator of certain
facilities that we divested. The services are for 26 facilities
and include accounting support, procurement of business supplies,
billing and collections, and information technology services.
Applying the principles of FIN 46, we have determined that the
new operator of the divested facilities is a VIE. We have also
determined that we are not the primary beneficiary and
accordingly, we are not required to consolidate the new operator. The
total receivable from this new operator at March 31, 2004 is
$3.7 million. 18




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Results of Operations The following table represents the unaudited condensed consolidated
statements of operations for the periods indicated (in thousands of dollars): Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net revenue
    
    $
    408,808
    
    
    $
    423,156Costs and expensesOperating expensesWage and related costs
    
    
    235,123
    
    
    
    254,735Supplies
    
    
    23,288
    
    
    
    24,794Insurance
    
    
    16,041
    
    
    
    20,540Provision for bad debt
    
    
    3,020
    
    
    
    4,377Rent expense
    
    
    8,260
    
    
    
    8,810Other
    
    
    71,128
    
    
    
    71,730Total operating expenses
    
    
    356,860
    
    
    
    384,986General and administrative
    
    
    26,374
    
    
    
    22,733Depreciation and amortization
    
    
    9,705
    
    
    
    8,593Total costs and expenses
    
    
    392,939
    
    
    
    416,312Operating income
    
    
    15,869
    
    
    
    6,844Other income (expenses)Interest expense
    
    
    (9,218
    )
    
    
    (8,213
    )Interest income
    
    
    751
    
    
    
    828Other
    
    
    27
    
    
    
    (50
    )Income (loss) from continuing operations before taxes
    
    
    7,429
    
    
    
    (591
    )Income tax provision (benefit)
    
    
    893
    
    
    
    (238
    )Income (loss) from continuing operations
    
    
    6,536
    
    
    
    (353
    )Discontinued operations(Loss) gain on sale of discontinued operations,
net of tax
    
    
    (79
    )
    
    
    3,600Loss from discontinued operations, net of tax
    
    
    (228
    )
    
    
    (479
    )Net income
    
    $
    6,229
    
    
    $
    2,768
 19




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Reconciliation of EBITDA to net income (in thousands of dollars) Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net income
    
    $
    6,229
    
    
    $
    2,768Add back:Provision (benefit) for income taxes
    
    
    893
    
    
    
    (238
    )Interest expense
    
    
    9,218
    
    
    
    8,213Interest income
    
    
    (751
    )
    
    
    (828
    )Depreciation and amortization
    
    
    9,705
    
    
    
    8,593EBITDA (1)
    
    $
    25,294
    
    
    $
    18,508
  (1)
    
    The table presented below contains items that are excluded when calculating
EBITDA for the purpose of
determining our compliance with certain ratios contained in our Senior
Credit Facility and the indenture pertaining to our Notes. This is our
Debt Financing EBITDA. These ratios determine our compliance with certain
covenants contained in the documents relevant to both debt obligations as
well as our ability to draw on our Revolving Credit Facility, issue
additional Notes and undertake certain desired corporate actions. If
these items were excluded from EBITDA as presented in the table above,
Debt Financing EBITDA would be $25,601 and $17,732 for the three months
ended March 31, 2004 and 2003, respectively. Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Loss (gain) on sale of discontinued operations, net of tax
    
    $
    79
    
    
    $
    (3,600
    )Loss from discontinued operations, net of tax
    
    
    228
    
    
    
    479Loss from operations of divested facilities (2)
    
    
    
    
    
    
    2,345Increase (decrease) to EBITDA
    
    $
    307
    
    
    $
    (776
    )
  (2)
    
    The loss from operations of divested facilities relates to divestitures
of facilities that did not qualify for discontinued operations
presentation. Three Months Ended March 31, 2004 Compared to the Three Months Ended March 31,
2003 We reported net revenues of $408.8 million during the quarter ended March
31, 2004, compared to $423.2 million for the quarter ended March 31, 2003. The
decrease of $14.4 million, or 3.4%, consists primarily of the following:  
    
    A decrease of $47.0 million related to divested facilities that do
not qualify for discontinued operations presentation.
    
    An increase of $29.1 million in skilled nursing facilities we
operated as of March 31, 2004, or same facility operations. This
increase is due primarily to:  
    
    An increase of $14.2 million in Medicare revenues due primarily
to an increase in patient days of 14,177 20




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resulting in a $4.2 million
increase in revenues and a rate increase averaging $29.89 per patient
day resulting in a $10.0 million increase in revenues. The increase
in patient days was a direct result of our focus on attracting a
higher acuity patient population. The rate increase is due primarily
to the Medicare Administrative fix and market basket increase
effective October 1, 2003.  
    
    A net increase of $10.8 million in Medicaid revenues due
primarily to a rate increase averaging $7.20 per patient day resulting
in a $11.4 million increase, which was partially offset by a decrease
in patient days of 5,320 resulting in decrease of $0.6 million. The
rate increase was driven by increases in provider tax based rate
increases in Georgia, Massachusetts, North Carolina and Wisconsin as
well as other general increases in our other states.
    
    A net overall increase of $4.0 million in private and other
revenues due to an increase in rate of $15.94 per patient day
resulting in a $7.0 million increase in revenues, which was partially
offset by a decrease in patient days of 18,049 that resulted in a $3.0
million reduction of revenues. The increase in rate was attributable
to two rate increases we made in March 2003 and July 2003. The
reduction in days is due primarily to the market for private payors
shifting to assisted living facilities.  
    
    An increase of $3.9 million related to LTAC revenues primarily
related to an increase in patient days of 3,814 resulting in a $3.5
million increase in revenues. Operating Expenses We reported operating expenses of $356.9 million during the quarter ended
March 31, 2004, compared to $385.0 million during the quarter ended March 31,
2003. The decrease of $28.1 million, or 7.3% primarily relates to the
following:  
    
    Wage and related costs decreased $19.6 million due primarily to:  
    
    A decrease of $28.3 million related to divested facilities
that do not qualify for discontinued operations presentation.
    
    A partially offsetting increase in same facility operations
of $9.4 million, primarily related to annual salary and benefit cost
increases.  
    
    Supplies decreased $1.5 million due primarily to:  
    
    A decrease of $2.5 million related to divested facilities
that do not qualify for discontinued operations presentation.
    
    An increase of $1.0 million in supplies expense for same
facility operations and LTAC.  
    
    Insurance, which consists primarily of professional and general
liability insurance costs, decreased $4.5 million due primarily to:  
    
    A decrease of $7.3 million related to divested facilities
that do not qualify for discontinued operations presentation.
    
    An increase of $2.6 million in same facility operations due
primarily to rising PL/GL costs.  
    
    Provision for bad debt decreased $1.4 million primarily due to a $1.5
million decrease of bad debt expense related to divested facilities that
do not qualify for discontinued operations presentation. General and Administrative We reported general and administrative expenses of $26.4 million during
the quarter ended March 31, 2004, compared to $22.7 million during the quarter
ended March 31, 2003. The increase of $3.7 million, or 16.3%, relates primarily
to the following: 21




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
    
    An increase of $1.3 million in costs associated with the
implementation of new information technology infrastructure and systems
and a new centralized back office support services center business
model.
    
    An increase of $1.1 million in legal costs, primarily related to our
claim against an insurance company for certain owned and leased
facilities that were damaged by floods.
    
    An increase of $0.5 million primarily related to increases in wage
and related costs. This increase was due primarily to incentive
compensation expenses, employee benefit cost increases, annual salary
increases and hiring of additional personnel. Depreciation and Amortization We
reported depreciation and amortization expense of $9.7 million during the
quarter ended March 31, 2004, compared to $8.6 million during the quarter ended
March 31, 2003. The increase of $1.1 million, or 12.8%, primarily relates to
the following:  
    
    An increase of $1.6 million related to incremental depreciation
expense on capital expenditures in same facility operations and at
corporate locations.
    
    A decrease of $0.6 million due to the divested facilities that do not
qualify for discontinued operations presentation. Interest Expense We reported interest expense of $9.2 million during the quarter ended
March 31, 2004, compared to $8.2 million during the quarter ended March 31,
2003. The increase of $1.0 million, or 12.2%, primarily relates to an increase
of $0.6 million of interest expense resulting from a reduction in the fair
market value of a derivative instrument and $0.3 million related to periodic
debt fees associated with our mortgage loan from Omega. Discontinued Operations Loss from Discontinued Operations The results of operations of any disposed facilities that qualify for
discontinued operations under SFAS No. 144 have been reported as discontinued
operations for all periods presented in the accompanying unaudited consolidated
statements of operations. A summary of the discontinued operations for the
periods presented is as follows (in thousands of dollars): Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net revenue
    
    $
    653
    
    
    $
    8,621Total costs and expenses
    
    
    1,131
    
    
    
    9,349Operating loss
    
    
    (478
    )
    
    
    (728
    )Other income
    
    
    250
    
    
    
    249Loss from discontinued operations, net of tax
    
    $
    (228
    )
    
    $
    (479
    )
 Gain on Sale of Discontinued Operations 22




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During the three months ended March 31, 2003, we earned and received the
payments for post-closing operating results, or Earnout Payments in connection
with the sale of the institutional pharmacy services business, or APS Division
to Omnicare, Inc. of $6.0 million, at which time we recorded a gain of $3.6 million,
net of taxes of $2.4 million. Liquidity and Capital Resources At March 31, 2004, we had working capital of $48.4 million and cash and
cash equivalents of $20.3 million, compared to working capital of $56.0 million
and cash and cash equivalents of $41.9 million at December 31, 2003.
The $7.6 million decrease in working capital related primarily to an
increase of payments for PL/GL claims, costs and expenses. Net cash (utilized) provided by
operating activities of continuing operations was $(16.4) million and $8.7
million for the three months ended March 31, 2004 and 2003,
respectively. This decrease of $25.1 million relates primarily to an increase in
receivables due to the timing of payments received from the Medicare program,
the timing of payments of accounts payable and an increase in PL/GL insurance
settlement payments for the three months ended March 31, 2004. Total purchases of property and equipment, including expenditures related
to our information technology infrastructure, are projected to be approximately
$66.0 million during the year ended December 31, 2004. We expect to fund these
purchases through internally generated funds. We are in the process of developing and implementing a new information
technology infrastructure to improve customer service, enhance operating
efficiencies and provide for more effective management of business operations.
This will include a new centralized clinical billing function and enhancements
to other accounting and human resource systems. Implementation of the new
systems and software carries risks such as cost overruns, project delays and
business interruptions. If we experience a material business interruption
as a result of the implementation of our future information technology
infrastructure or are unable to obtain the projected benefits of this new
infrastructure, it could have a material impact on our liquidity and cash
flows, as well as potentially result in an impairment of the related
information technology assets. Our capitalized software costs not yet placed
into service at March 31, 2004 were $32.9 million. We were in compliance with requirements associated with our Senior Credit
Facility and Notes at March 31, 2004. We were also in compliance
with the terms of our $59.7 million mortgage loan, or Omega
Loan, from Omega Healthcare Investors, Inc. at March 31, 2004. Long-term debt at March 31, 2004
aggregated $385.3 million compared to $389.6 million at December 31, 2003. The
decrease of $4.3 million relates primarily to a repayment of our term loan of
$3.9 million. There were no outstanding borrowings under the Senior Credit
Facility at March 31, 2004, although we had net letters of
credit of $31.0 million (which decreases the amount available to
us under the revolving credit facility of our Senior Credit
Facility).  Our Notes and the Omega Loan also contain restrictions on
repurchases of stock and payment of dividends (although with respect
to the Omega Loan these restrictions apply only to our subsidiary,
Professional Healthcare Management, Inc. and its subsidiaries.) The terms of our Senior Credit Facility include certain covenants, which
limit our annual capital expenditures. In addition, this agreement generally
restricts repurchases of common stock and the payment of cash dividends. Seven of our skilled nursing facilities and one of our LTACs were damaged
during tropical storm Allison in June 2001. We have made in the past and expect
to continue to make substantial expenditures necessary to repair or replace
these facilities as a result of the damage caused by the storm. Over the next
several years we estimate that we may spend approximately $30.0 million to
complete all work necessary to complete this project. As described in more
detail in Item 3, Legal Proceedings included in our Annual Report on Form
10-K for the year ended December 31, 2003, we are currently in litigation
regarding our property insurance coverage for this loss. While we cannot
predict the outcome of this litigation, based on currently available facts, we
do not believe that the resolution of this proceeding will have a material
adverse effect on our financial position, results of operations or
cash flows. Other Factors Affecting
Liquidity and Capital Resources Revenue Sources We
derive a substantial portion of our revenue from third-party payors,
including the Medicare and Medicaid programs. For the three months
ended March 31, 2004 and 2003, we derived 81.4% of our total
revenue from the Medicare and Medicaid programs. Third-party payor
programs are highly regulated and are subject to frequent and
substantial changes. Changes in the reimbursement rate or methods of
payment from third-party payors, including the Medicare and Medicaid
programs, or the implementation of other measures to reduce
reimbursements for our services has in the past, and could in the
future, result in a substantial reduction in our revenues and
operating margins. Additionally, net revenue realizable under
third-party payor agreements can change after examination and
retroactive adjustment by payors during the claims settlement
processes or as a result of post-payment audits. Payors may disallow
requests for reimbursement based on determinations that certain costs
are not reimbursable or reasonable because additional documentation is
necessary or because certain services were not covered or were not
reasonable and medically necessary. There also continue to be new
legislative and regulatory proposals that could impose further
limitations on government and private payments to health care
providers. In some cases, states have enacted or are considering
enacting measures designed to reduce their Medicaid expenditures and
to make changes to private health care insurance. We cannot assure
you that adequate reimbursement levels will continue to be available
for the services provided by us, which are currently being reimbursed
by Medicare, Medicaid or private third-party payors. Further limits
on the scope of services reimbursed and on reimbursement rates could
have a material adverse effect on our liquidity, financial condition
and results of operations. It is possible that the effects of any of
the Medicare Reimbursement Cliff (as defined below), further
refinements to Medicare or the Medicare prospective payment system,
or PPS, that result in lower payments to us or cuts in state Medicaid
funding could have a material adverse effect on our results of
operations. Congress enacted the Medicare Balanced Budget Refinement
Act of 1999, or BBRA, to, among other things, mitigate the impact of
PPS, by temporarily increasing the PPS per diem rates for certain
patient categories. In addition, the Medicare, Medicaid and SCHIP
Benefits Improvement Act of 2000, or BIPA, brought additional relief
to long-term care providers by eliminating certain scheduled
reductions in skilled nursing facility reimbursement rates. When
Congress enacted the BBRA and BIPA, it scheduled the relief under
those acts to sunset starting October 1, 2002 unless additional
action was taken by the Center for Medicare and Medicaid Services or
Congress. Although some of the relief afforded by the BBRA and BIPA
has been extended through September 30, 2004, there can be no
assurance that it will be extended beyond such time. The sunset of
the relief afforded by the BBRA and BIPA is referred to as the
Medicare Reimbursement Cliff. Professional and General
Liability As
is typical in the health care industry, we are and will continue to
be subject to claims that our services have resulted in resident
injury or other adverse effects. We, like our industry peers, have
experienced an increasing trend in the frequency and severity of
PL/GL claims and litigation asserted against us. In some states in
which we have significant operations, insurance coverage for the risk
of punitive damages arising from PL/GL claims and/or litigation may
not, in ceratin cases, be available due to state law prohibitions or
limitations of availability. We cannot assure you that we will not be
liable for punitive damage awards that are either not covered or are
in excess of our insurance policy limits. We also believe 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. Insurance is
not available to cover such losses. Any adverse determination in a
legal proceeding or governmental investigation, whether currently
asserted or arising in the future, could have a material adverse
effect on our financial condition. In spite of the fact that we
recently exited the State of Florida, we will continue to be subject
to claims arising from our prior operations for some time.
Additionally, the enactment of Texas tort reform resulted in a
significant increase in the number of cases being filed prior to the
effective date of the new legislation. These two factors could result
in significant PL/GL costs in future years although such costs are
related to prior periods. Also, the large increase in the number of
claims filed in these states, together with rising costs in other
states, could subject us to costs in excess of the reserves we have
set aside for these periods. While our actuarial analysis indicates
that we currently have sufficient insurance and reserves set aside to
address these matters, as these claims mature no assurance can be
given that we will not be required to expend additional funds in
future periods for claims related to prior periods. Labor Costs We
could experience significant increases in our operating costs due to
shortages in qualified nurses, health care professionals and other
key personnel. The market for these key personnel is highly
competitive. We, like other health care providers, have experienced
difficulties in attracting and retaining qualified personnel,
especially facility administrators, nurses, certified nurses
aides and other important health care providers. Our LTACs are
particularly dependent on nurses for patient care. There is currently
a shortage of nurses, and trends indicate this shortage will worsen
in the future. The difficulty our skilled nursing facilities are
experiencing in hiring and retaining qualified personnel has
increased our average wage rate. We may continue to experience
increases in our labor costs primarily due to higher wages and
greater benefits required to attract and retain qualified health care
personnel. Our ability to control labor costs will significantly
affect our future operating results. In
addition, wages and other labor-related costs are especially
sensitive to inflation. Increases in wages and other labor-related
costs as a result of inflation or the increase in minimum wage
requirements without a corresponding increase in Medicaid and
Medicare reimbursement rates would, and have, adversely impacted us.
In some of our markets there is a labor shortage that could have an
adverse effect upon our ability to attract or retain sufficient
numbers of skilled and unskilled personnel at reasonable wages.
Accordingly, rising wage rates have had an adverse effect on us in
some of our markets. Rent We
also have significant rent obligations relating to our leased
facilities. Total rent expense for leased facilities, including rent
expense for discontinued operations and corporate locations was
$9.0 million and $9.7 million for the three months ended
March 31, 2004 and 2003, respectively. Based upon existing cash levels, expected operating cash flows, capital
spending, and the availability of borrowings under our revolving credit
facility, management believes that we have the necessary financial resources to
satisfy our liquidity needs for the foreseeable future. For a discussion of
items that may have an adverse impact on our future liquidity, see Cautionary
Statements below. 23




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Cautionary Note Regarding Forward-Looking Statements Certain statements in this quarterly report on Form 10-Q may constitute
forward-looking statements as defined in Section 27A of the Securities Act of
1933, or the Securities Act, Section 21E of the Securities Exchange Act of
1934, or the Exchange Act, the Private Securities Litigation Reform Act of
1995, or the PSLRA, or in releases made by the Securities and Exchange
Commission or the SEC, all as may be amended from time to time. Statements
contained in this quarterly report that are not historical facts may be
forward-looking statements within the meaning of the PSLRA. Any such
forward-looking statements reflect our beliefs and assumptions and are based on
information currently available to us. Forward-looking statements are only
predictions and involve known and unknown risks, uncertainties and other
factors that may cause our actual results, performance or achievements, or
industry results, to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. These cautionary statements are being made pursuant to the
Securities Act, the Exchange Act and the PSLRA with the intention of obtaining
the benefits of the safe harbor provisions of such laws. Mariner cautions
investors that any forward-looking statements we make are not guarantees or
indicative of future performance. For additional information regarding factors
that may cause our results of operations to differ materially from those
presented herein, please see Risk Factors contained in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2003. You can identify forward-looking statements as those that are not historical in
nature, particularly those that use terminology such as may, will,
should, expect, anticipate, contemplate, estimate, believe, plan,
project, predict, potential or continue, or the negative of these, or
similar terms. In evaluating these forward-looking statements, you should
consider the following factors, as well as others contained in our public
filings from time to time, which may cause our actual results to differ
materially from any forward-looking statement:  
    
    our existing and future indebtedness;
    
    changes in Medicare, Medicaid and certain private payors reimbursement levels;
    
    existing government regulations and changes in, or the failure to
comply with, governmental regulations;
    
    the ability to control costs and implement measures designed to enhance operating efficiencies;
    
    legislative proposals for health care or tort reform;
    
    competition;
    
    the ability to attract and retain qualified personnel at a reasonable cost;
    
    changes in current trends in the cost and volume of general and professional liability claims;
    
    possible investigations or proceedings against us initiated by states or the federal government;
    
    state regulation of the construction or expansion of health care providers;
    
    litigation;
    
    unavailability of adequate insurance coverage on reasonable terms; and
    
    an increase in senior debt or reduction in cash flow upon our purchase or sale of assets. Any subsequent written or oral forward-looking statements attributable to
us or persons acting on our behalf are expressly qualified in their entirety by
the cautionary statements set forth or referred to above, as well as the risk
factors contained in our Annual Report on Form 10-K for the year ended December
31, 2003. Except as required by
law, we disclaim any obligation to update such statements or to publicly
announce the result of any revisions to any of the forward-looking statements
contained herein to reflect future events or developments. 24




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ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
 At March 31, 2004, the fair value of our fixed rate long-term debt
approximated its carrying value. See the discussion of our market risk in our
Annual Report on Form 10-K for the year ended December 31, 2003 filed with the
SEC. 
 ITEM 4.
    
    CONTROLS AND PROCEDURES
 We currently have in place systems relating to disclosure controls and
procedures with respect to the accurate and timely recording, processing,
summarizing and reporting of information required to be disclosed in our
Exchange Act reports. We periodically review and evaluate these disclosure
controls and procedures systems to ensure this information is accumulated and
communicated to management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions about required
disclosure. In completing our review and evaluation of the effectiveness of
our disclosure controls and procedures as of March 31, 2004, our Chief
Executive Officer and Chief Financial Officer have concluded that these
controls and procedures were effective as of March 31, 2004. No changes in our
internal control over financial reporting were identified as having occurred in
the fiscal quarter ended March 31, 2004 that have materially affected, or are
reasonable likely to materially affect, our internal control over financial
reporting. 
 PART II 
 ITEM 1.
    
    LEGAL PROCEEDINGS
 See Note 9  Commitments and Contingencies to the Unaudited
Condensed Consolidated Financial Statements in PART I, Item 1
hereto, which is included elsewhere in this document.
 
 ITEM 2.
    
    CHANGES IN SECURITIES AND USE OF PROCEEDS
 Not applicable.
 
 ITEM 3.
    
    DEFAULTS UPON SENIOR SECURITIES
 Not applicable.
 
 ITEM 4.
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 Not applicable.
 
 ITEM 5.
    
    OTHER INFORMATION
 Not applicable.
 
 ITEM 6.
    
    EXHIBITS AND REPORTS ON FORM 8-K(a) Exhibits
  25




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Exhibit Number
    
    Description of Exhibit31.1
    
    Certification by Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 200231.2
    
    Certification by Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 200232.1
    
    Certification by Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 200232.2
    
    Certification by Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
    (b)
    
    Reports on Form 8-KThe Company filed a Current Report on Form 8-K on March 16, 2004
announcing its fourth quarter 2003 financial results. 
 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 HEALTH CARE, INC.By:
    /s/ C. Christian WinkleC. Christian WinklePresident and Chief Executive Officer Date: May 7, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ C. Christian Winkle
C. Christian Winkle
    
    President, Chief Executive Officer and
Director (Principal Executive Officer)
    
    May 7, 2004/s/ Michael E. Boxer
Michael E. Boxer
    
    Executive Vice President and
Chief Financial Officer (Principal
Financial Officer)
    
    May 7, 2004/s/ Bruce H. Duner
Bruce H. Duner
    
    Senior Vice President, Chief
Accounting Officer (Principal
Accounting Officer)
    
    May 7, 2004
 26