<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                        
                                   FORM 10-Q

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
  ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999

                                       or

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

                          Commission File No. 1-10968

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

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

       One Ravinia Drive, Suite 1500              30346
             Atlanta, Georgia                  (Zip Code)
  (Address of Principal Executive Office)

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



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

  There were 73,688,331 shares of Common Stock of the registrant issued and
outstanding as of May 12, 1999, including approximately 6,702 shares issuable
upon the exchange of certificates formerly representing the common stock of
predecessor corporations acquired by the registrant.
<PAGE>
 
               Mariner Post-Acute Network, Inc. and Subsidiaries
                                        
                                   FORM 10-Q
                               TABLE OF CONTENTS
                                 March 31, 1999

Part I - FINANCIAL INFORMATION

<TABLE>
<CAPTION> 
<S>                 <C>                                                       <C>
                                                                              PAGE
                                                                              ----

     Item 1.        Condensed Consolidated Financial Statements and Notes     1
 
     Item 2.        Management's Discussion and Analysis of Financial           
                    Condition and Results of Operations                       23
 
     Item 3.        Quantitative and Qualitative Disclosure About Market     
                    Risk                                                      41

Part II - OTHER  INFORMATION

     Item 1.        Legal Proceedings                                         42
 
     Item 2.        Changes in Securities and Use of Proceeds                 43
 
     Item 3.        Defaults Upon Certain Securities                          43
 
     Item 4.        Submission of Matters to a Vote of Security Holders       44
 
     Item 5.        Other Information                                         44
 
     Item 6.        Exhibits and Reports on Form 8-K                          45

SIGNATURE PAGE                                                                46 
</TABLE>

                                      (i)
<PAGE>
 
PART 1  FINANCIAL INFORMATION
Item 1.  Condensed Consolidated Financial Statements

               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                  CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                (dollars in thousands, except per share amounts)
                                  (unaudited)

<TABLE>
<CAPTION>
                                                                                  Three Months               Six Months
                                                                                Ended March 31,            Ended March 31,
                                                                               1999        1998        1999            1998
                                                                            ----------  ----------  -----------  ----------------
<S>                                                                         <C>         <C>         <C>          <C>
Net Revenues
    Nursing home revenue:
     Net patient services..................................................  $474,721    $362,670   $  973,385          $668,379
     Other.................................................................     5,163       3,579       13,023             5,162
    Non-nursing home revenue:                                              
     Pharmacy services.....................................................    70,180      55,263      147,916           106,849
     Therapy services......................................................    53,372      39,371      129,552            80,259
     Home health, hospital services, and other.............................    11,274      26,278       23,514            48,118
                                                                             --------    --------   ----------          --------
                                                                              614,710     487,161    1,287,390           908,767
Costs and Expenses:                                                        
    Salaries and wages.....................................................   261,715     178,655      538,387           338,676
    Employee benefits......................................................    62,185      38,327      110,287            68,719
    Nursing, dietary and other supplies....................................    30,528      23,861       63,880            44,039
    Ancillary services.....................................................   103,663     107,867      231,183           201,650
    General and administrative.............................................    68,437      45,993      133,578            81,648
    Insurance expense......................................................    13,482      12,091       32,908            24,777
    Rent...................................................................    26,723      21,483       53,719            39,142
    Depreciation and amortization..........................................    32,525      17,963       63,109            33,326
    Provision for bad debts................................................    42,139       4,694       78,623            13,399
    Recapitalization, indirect merger and other expenses...................     5,099      13,636        7,114            54,621
                                                                             --------    --------   ----------          --------
                                                                              646,496     464,570    1,312,788           899,997
                                                                             --------    --------   ----------          --------
    Income (loss) from operations..........................................   (31,786)     22,591      (25,398)            8,770
Other Income and Expense:                                                  
    Interest expense.......................................................    49,343      30,422       96,072            52,034
    Interest and dividend income...........................................    (2,416)     (2,460)      (4,859)           (4,744)
                                                                             --------    --------   ----------          --------
                                                                               46,927      27,962       91,213            47,290
    Loss before income taxes, minority interest, and                       
     extraordinary loss....................................................   (78,713)     (5,371)    (116,611)          (38,520)
Provision (Benefit) for Income Taxes.......................................       500      (1,025)       1,000            (4,828)
                                                                             --------    --------   ----------          --------
    Loss before minority interest and extraordinary loss...................   (79,213)     (4,346)    (117,611)          (33,692)
Minority Interest..........................................................       460        (127)        (165)             (299)
                                                                             --------    --------   ----------          --------
    Loss before extraordinary loss.........................................   (78,753)     (4,473)    (117,776)          (33,991)
Extraordinary Loss on Early Extinguishment of Debt, net of $6,034          
 Income Tax Benefit........................................................       ---         ---          ---           (11,275)
                                                                             --------    --------   ----------          --------
Net Loss...................................................................  $(78,753)   $ (4,473)  $ (117,776)         $(45,266)
                                                                             ========    ========   ==========          ========
                                                                           
Loss Per Share:                                                            
    Basic and Diluted......................................................  $  (1.07)   $  (0.11)  $    (1.61)         $  (1.02)
                                                                             ========    ========   ==========          ========
Weighted Average Common Shares Outstanding:                                
    Basic and Diluted......................................................    73,333      41,208       73,319            44,434
                                                                             ========    ========   ==========          ========
</TABLE>
                                                                                
   The accompanying notes are an integral part of these financial statements.
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                (dollars in thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                                                             (unaudited)
                                                                                              March 31,      September 30,
                                                                                                 1999             1998
                                                                                            ------------------------------
<S>                                                                                          <C>             <C>
ASSETS                                                                                      
Current Assets:                                                                             
    Cash and cash equivalents...............................................................  $   55,836        $    3,314
    Receivables (less allowances of $105,296 and $68,581)...................................     563,183           617,380
    Supplies................................................................................      38,916            31,516
    Income tax refund receivable............................................................      52,076            57,323
    Deferred income taxes...................................................................      36,296            58,875
    Prepaid expenses and other current assets...............................................      34,355            39,515
                                                                                              ----------        ----------  
     Total current assets...................................................................     780,662           807,923
Property and Equipment:                                                                     
    Land, buildings and improvements........................................................     892,138           863,451
    Furniture, fixtures and equipment.......................................................     259,708           231,682
    Leased property under capital leases....................................................      89,302            89,718
                                                                                              ----------        ----------  
                                                                                               1,241,148         1,184,851
    Less accumulated depreciation...........................................................     317,277           257,698
                                                                                              ----------        ----------  
                                                                                                 923,871           927,153
Goodwill, net...............................................................................   1,073,039         1,084,473
Restricted Investments......................................................................      72,260            88,467
Notes Receivable, net.......................................................................      21,087            20,861
Other Assets................................................................................     111,892           107,774
                                                                                              ----------        ----------  
                                                                                              $2,982,811        $3,036,651
                                                                                              ==========        ==========
LIABILITIES AND STOCKHOLDERS' EQUITY                                                        
Current Liabilities:                                                                        
    Notes payable and current maturities of long-term debt..................................  $1,321,568        $   46,250
    Accounts payable........................................................................     141,933           165,484
    Accrued payroll and related expenses....................................................     129,659           127,774
    Accrued interest........................................................................      42,773            35,057
    Other accrued expenses..................................................................      72,789            83,142
                                                                                              ----------        ----------  
     Total current liabilities..............................................................   1,708,722           457,707
Long-Term Debt, net of current maturities...................................................     829,532         1,977,865
Long-Term Insurance Reserves................................................................      46,765            61,310
Deferred Income Taxes and Other Noncurrent Liabilities......................................     121,571           142,755
Commitments and Contingencies                                                               
Stockholders' Equity:                                                                       
    Preferred stock, par value $.01; 5,000,000 shares authorized; none issued...............          --                --
    Common stock, par value $.01; 500,000,000 shares authorized;                            
     73,316,157 shares issued...............................................................         733               733
    Capital surplus.........................................................................     980,269           980,142
    Accumulated deficit.....................................................................    (700,887)         (583,111)
    Accumulated other comprehensive income..................................................      (3,894)             (750)
                                                                                              ----------        ----------  
     Total stockholders' equity.............................................................     276,221           397,014
                                                                                              ----------        ----------  
                                                                                              $2,982,811        $3,036,651
                                                                                              ==========        ==========
</TABLE>
                                                                                
   The accompanying notes are an integral part of these financial statements.

                                       2
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
            CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                                 (in thousands)
                                  (unaudited)
                                        
<TABLE>
<CAPTION>
 
                                                                                        Accumulated 
                                                                                           Other    
                                               Common Stock    Capital   Accumulated   Comprehensive 
                                              Shares  Amount   Surplus     Deficit         Income        Total
                                              ------  ------  ---------  ------------  --------------  ----------
<S>                                           <C>     <C>     <C>        <C>           <C>             <C>
Balance, September 30, 1998.................  73,277    $733   $980,142    $(583,111)        $  (750)  $ 397,014
      Net Loss                                    --      --         --     (117,776)             --    (117,776)
      Issuance of common stock                    39      --        127           --              --         127
      Unrealized losses on                        --      --         --           --          (3,144)     (3,144)
       available-for-sale
           securities
                                              ------    ----   --------    ---------         --------  ---------  
Balance, March 31, 1999.....................  73,316    $733   $980,269    $(700,887)        $(3,894)  $ 276,221
                                              ======    ====   ========    =========         =======   =========
</TABLE>
                                                                                
   The accompanying notes are an integral part of these financial statements.

                                       3
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
                             (dollars in thousands)
                                  (unaudited)

                                        
<TABLE>
<CAPTION>
                                                                                           Six Months
                                                                                        Ended March 31,
                                                                               -------------------------------
                                                                                      1999            1998
                                                                                 --------------  --------------
<S>                                                                              <C>             <C>
Cash Flows From Operating Activities:
    Net loss...................................................................      $(117,776)      $ (45,266)
    Adjustments to reconcile net loss to net cash used in
     operating activities:
     Depreciation and amortization.............................................         63,109          33,326
     Interest accretion on Senior Notes........................................         10,408           7,640
     Income taxes deferred.....................................................             --           2,137
     Equity earnings/minority interest.........................................            165             299
     Provision for bad debts...................................................         78,623          13,399
    Changes in noncash working capital:
     Receivables...............................................................        (34,893)        (42,201)
     Supplies..................................................................         (7,400)          1,872
     Prepayments and other current assets......................................         25,902          (8,268)
     Accounts payable..........................................................        (23,551)        (28,676)
     Accrued expenses and other current liabilities............................         (2,664)          2,003
    Changes in long-term insurance reserves....................................        (14,693)          4,994
    Other......................................................................        (10,733)          1,898
                                                                                     ---------       ---------
Net Cash Used In Operating Activities..........................................        (33,503)        (56,843)
 
Cash Flows Used In Investing Activities:
    Acquisitions and investments...............................................             --         (10,831)
    Purchases of property and equipment........................................        (35,135)        (21,934)
    Disposals of property, equipment and other assets..........................            810           2,252
    Restricted investments.....................................................         13,063          (2,175)
    Net collections on notes receivable........................................          4,471           1,529
    Other......................................................................         (7,733)         (9,238)
                                                                                     ---------       ---------
Net Cash Used In Investing Activities..........................................        (24,524)        (40,397)
 
Cash Flows From Financing Activities:
    Issuance of shares to Apollo Management, L.P...............................             --         232,750
    Proceeds from Senior Credit Facility.......................................             --         740,000
    Proceeds from Senior Notes.................................................             --         448,871
    Net draws under credit line................................................        125,619           5,500
    Repayment of long-term debt................................................         (8,382)       (564,468)
    Repurchase of shares in recapitalization...................................             --        (735,223)
    Deferred financing fees....................................................         (6,688)        (30,178)
    Other......................................................................             --           5,097
                                                                                     ---------       ---------
Net Cash Provided By Financing Activities......................................        110,549         102,349
                                                                                     ---------       ---------
Increase in Cash and Cash Equivalents..........................................         52,522           5,109
Cash and Cash Equivalents, beginning of period.................................          3,314          14,355
                                                                                     ---------       ---------
Cash and Cash Equivalents, end of period.......................................      $  55,836       $  19,464
                                                                                     =========       =========
</TABLE>
   The accompanying notes are an integral part of these financial statements.

                                       4
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)


NOTE 1.  Organization and Basis of Presentation

 Organization

     Mariner Post-Acute Network, Inc. (the "Company") changed its name
effective August 1, 1998 from its former name, Paragon Health Network, Inc.
("Paragon"), following the consummation of the merger (the "Mariner Merger")
with Mariner Health Group, Inc. ("Mariner Health") on July 31, 1998 pursuant
to an agreement and plan of merger dated as of April 13, 1998 (the "Mariner
Merger Agreement"). See Note 4. The Company had previously changed its name
from Living Centers of America, Inc. ("LCA") to Paragon on November 4, 1997.
At the time of the Mariner Merger, Mariner Health operated long-term health care
facilities that provided skilled nursing and residential care services in 16
states and comprehensive rehabilitation services. The Company was formed in
November 1997 through the recapitalization by merger of LCA with a newly-formed
entity owned by certain affiliates of Apollo Management, L.P. (together with its
affiliates, "Apollo") and certain other investors (the "Recapitalization
Merger"), and the subsequent merger of GranCare, Inc. ("GranCare") with a
wholly-owned subsidiary of LCA (the "GranCare Merger" and collectively with
the Recapitalization Merger, the "Apollo/LCA/GranCare Mergers") pursuant to an
agreement and plan of merger dated as of May 7, 1997, as amended and restated as
of September 17, 1997 (the "GranCare Merger Agreement"). See Notes 3 and 4. At
the time of the GranCare Merger, GranCare operated long-term health care
facilities that provided skilled nursing and residential care services in 15
states, a specialty hospital geriatric services company, and home health
operations. The accompanying consolidated financial statements include the
accounts of the Company and its subsidiaries and all significant intercompany
accounts and transactions have been eliminated in consolidation.

 Basis of Presentation

  The accompanying unaudited condensed consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission.  Accordingly, they do not
include all of the information and notes required by generally accepted
accounting principles for annual financial statements.  In the opinion of
management, all adjustments (which include normal recurring adjustments)
considered necessary for a fair presentation have been included.  Operating
results for the three and six months ended March 31, 1999 are not necessarily
indicative of the results that may be expected for the year ended September 30,
1999.  These financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended September
30, 1998 included in the Company's Annual Report filed with the Securities and
Exchange Commission on Form 10-K, file No. 1-10968.

  Certain prior year amounts have been reclassified to conform with the fiscal
year 1999 presentation.

                                       5
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)

                                        
 Recent Accounting Pronouncements

     In June 1997 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 requires public
business enterprises to report information about operating segments and related
disclosures about products and services, geographic areas, and major customers.
SFAS 131 is effective for fiscal years beginning after December 15, 1997 and is
applicable to interim periods in the second year of application. Comparative
information for earlier years is required to be restated in the initial year of
application.

     In February 1998 the Financial Accounting Standards Board adopted Statement
of Financial Accounting Standards No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits--an amendment of FASB Statements No.
87, 88, and 106" ("SFAS 132"). SFAS 132 standardizes disclosure requirements
for pensions and other postretirement benefits, requires additional information
on changes in the benefit obligations and fair values of plan assets, and
eliminates certain existing disclosure requirements. SFAS 132 is effective for
fiscal years beginning after December 15, 1997.

     SFAS Nos. 131, and 132 become effective in the Company's fiscal year ending
September 30, 1999. The adoption of these statements is not expected to have a
material impact on the Company's financial statements.

     In June 1998 the Financial Accounting Standards Board adopted Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. SFAS
133 is effective for all fiscal quarters of fiscal years beginning after June
15, 1999. SFAS No. 133 will become effective in the Company's fiscal year ending
September 30, 2000. The adoption of this statement is not expected to have a
material impact on the Company's financial statements.

     In March 1998 the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 provides guidance as to whether certain
costs for internal-use software should be capitalized or expensed when incurred.
SOP 98-1 is effective for fiscal years beginning after December 15, 1998, but
earlier application is encouraged. The Company does not expect the adoption of
SOP 98-1 to have a material impact on its financial statements.

     In June 1998 the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"). SOP 98-5
provides guidance on the financial reporting of start-up costs. It requires
costs of start-up activities to be expensed as incurred. SOP 98-5 is effective
for fiscal years beginning after December 15, 1998, but earlier application is
encouraged. The Company does not expect the adoption of SOP 98-5 to have a
material impact on its financial statements.

                                       6
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
NOTE 2.  Issues Affecting Liquidity

     Mariner Health was not in compliance with certain of the financial
covenants contained in the Mariner Health Senior Credit Facility (See Note 7)
and the Mariner Health Term Loan Facility (See Note 7) as of March 31, 1999.
The Company is engaged in active discussions with the agent and lenders under
these credit facilities regarding a waiver of such noncompliance, but the
requisite lender consents to such waiver have not yet been received.  If and
when such waiver is obtained, loan pricing under those credit facilities will
likely increase.  The maturity date of the Mariner Health Senior Credit Facility
and the Mariner Health Term Loan Facility is January 3, 2000 and therefore such
debt is classified as a current obligation of the Company at March 31, 1999.  At
March 31, 1999, the Company had invested cash of $41.7 million for supporting
operations covered by the Mariner Health Senior Credit Facility.

     Subsequent to March 31, 1999, the Medicare fiscal intermediary for the
Mariner Health facilities has notified the Company it intends to reopen cost
reports for fiscal years 1995 and 1996 which would result in lower reimbursable
costs for various matters (See Note 12).  If an accommodation is not reached and
extended repayment terms are not achieved, Mariner Health would be required to
repay a significant amount of cash to the Medicare program in a short period,
which would have a material adverse effect on both Mariner Health and the
Company.

     The Company has obtained a waiver under the Senior Credit Facility (See
Note 7) with respect to certain financial covenant defaults existing at March
31, 1999. This waiver expires June 28, 1999. Based on the waiver expiration date
and based on the fact that the Company's current projected operating results for
the next fiscal quarter ended June 30, 1999 indicate continued non-compliance
with certain financial covenants, the Senior Credit Facility has been classified
as a current liability at March 31, 1999. There can be no assurance that working
capital and availability under the Senior Credit Facility will be sufficient to
finance the Company's liquidity needs during the waiver period or that an
extension of such waiver or other arrangements to permit the Company to continue
to borrow will be obtained. The current waiver under the Senior Credit Facility
stipulates that the first $10 million of proceeds from any asset sales are
available for the Company's liquidity needs along with 25% of any additional
asset sales proceeds occurring during the waiver period.

     In addition to amounts owing to its senior lenders, the Total Return Swap
Agreement (see Note 7) with respect to the $46.7 million of Mariner Notes
purchased by a financial institution expires on August 15, 1999, at which time
the Company will be required to purchase such notes, extend the Total Return
Swap Agreement, or cause such notes to be sold in the open market. Management is
unable to predict whether the Total Return Swap Agreement will be extended. If
the Mariner Notes are sold in the open market, the Company will be required to
reimburse the financial institution for the difference between the price at
which the Mariner Notes are sold and the price at which the Mariner Notes were
purchased (101%). At March 31, 1999, there was a $15 million letter of credit on
the Mariner Health Senior Credit Facility and $5 million in cash serving as
collateral against the $46.7 Total Return Swap Agreement.

     The Company has presented a preliminary plan to its senior lenders for
restructuring its operations (See Note 12) to meet its obligations as part of
the waiver requests.  In addition, the Company has engaged a financial advisor
and legal counsel to assist in developing more detailed cash forecasts and
reviewing its restructuring plan. There can be no assurance that the invested
cash credit facilities and restructuring plan will be sufficient to provide for
all the liquidity necessary to sustain operations and to meet all of the
Company's interest and principle obligations on the Company's debt as they
become due.

                                       7
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
     In the event that the Company is unable to obtain the necessary waivers and
amendments or comply with or maintain covenant waivers, the lenders under the
Senior Credit Facility, Mariner Health Senior Credit Facility and Mariner Health
Term Loan Facility are entitled, at their discretion, to exercise certain
remedies, including acceleration of the outstanding borrowings.  There can be no
assurance that these lenders will provide the Company with an amendment or
waiver of defaults after June 28, 1999, or will not seek to declare an event of
default or credit freeze prior to such date.  In addition, other remaining
portions of the Company's debt including the Senior Subordinated Notes and the
Mariner Notes contain provisions which allow the creditors to accelerate
their debt and seek certain other remedies if the Company has a payment default
under its senior debt instruments or if the obligations thereunder have been
accelerated.

     If the Company's senior lenders, or the holders of the Notes or the Mariner
Notes, elect to exercise their right to accelerate the obligations under the
Company's senior debt instruments, the Notes or the Mariner Notes, or if the
Company's senior lenders do not continue to provide covenant waivers, such
events would have a material adverse effect on the Company's liquidity and
financial position.  Furthermore, if such obligations were to be accelerated, in
whole or in part, management does not believe that it would currently be
successful in identifying or consummating financing necessary to satisfy such
obligations.

                                       8
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        

NOTE 3.  Recapitalization Merger

     During 1997 the Company entered into the Recapitalization Merger which was
completed effective November 1, 1997 for accounting purposes. In connection with
the Recapitalization Merger, certain affiliates of Apollo and certain other
investors (the "Apollo Investors") invested $240 million to purchase
approximately 17.8 million shares of newly issued common stock of LCA.
Concurrent with the Recapitalization Merger, LCA changed its name to Paragon
Health Network, Inc.

     On November 4, 1997, the Company sold $275 million of its 9.5% Senior
Subordinated Notes due 2007, at a price of 99.5% of face value and $294 million
of its 10.5% Senior Subordinated Discount Notes due 2007, at a price of 59.6% of
face value (collectively, the "Notes"), in a private offering to institutional
investors. Concurrent with the private Notes offering, the Company entered into
a new Senior Credit Facility which is composed of $740 million in Term Loans and
a Revolving Credit Facility which provides for borrowings of up to an additional
$175 million. See Note 7.

     The Company used the $240 million invested by the Apollo Investors and the
$1.189 billion of net proceeds provided by the Notes offering and the Term Loans
to (i) purchase approximately 90.5% of the issued and outstanding common stock
of the Company for a per share price of $13.50, (ii) to repay substantially all
amounts outstanding under the Company's and under GranCare's (see Note 4 for
description of the GranCare Merger) previous credit facilities and (iii) pay for
certain costs associated with the Apollo/LCA/GranCare Mergers.

                                       9
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
NOTE 4.  GranCare Merger

     Effective November 1, 1997 for accounting purposes, and subsequent to the
Company's recapitalization, the Company completed the acquisition by merger of
GranCare pursuant to the GranCare Merger Agreement. In the GranCare Merger
approximately 17.4 million shares of the Company's common stock were exchanged
for GranCare common stock and approximately 1.3 million options to purchase
shares of the Company's common stock were exchanged for options to purchase
GranCare common stock. The Company's total purchase price of the acquisition was
approximately $250.6 million including legal, consulting and other direct costs.
The acquisition was accounted for under the purchase method of accounting and,
accordingly, the results of GranCare's operations are included in the Company's
consolidated financial statements since the date of acquisition. The assets and
liabilities of GranCare have been recorded at fair market value based on the
total purchase price allocation as follows (in thousands):

<TABLE>
<S>                                                                                    <C>
     Current assets..................................................................             $ 225,617
     Property and equipment..........................................................               215,455
     Goodwill........................................................................               370,120
     Restricted investments..........................................................                40,987
     Other long-term assets..........................................................                40,066
     Current liabilities.............................................................              (117,827)
     Long-term debt..................................................................              (369,871)
     Other non-current liabilities...................................................              (153,948)
                                                                                                  ---------
     Total purchase price............................................................             $ 250,559
                                                                                                  =========
</TABLE>
                                                                                
     In the quarter ended June 30, 1998, an adjustment was made to record
GranCare's property and equipment at its fair value, assign a purchase price to
unfavorable operating leases for property and equipment and other unfavorable
contract rights, and assign a value to identifiable intangible assets. The
unfavorable operating lease obligation in the amount of $36.4 million is
amortized over the lives of the respective leases and is reflected in the
accompanying consolidated balance sheet as other liabilities. Goodwill resulting
from the GranCare Merger is being amortized on a straight-line basis over 30
years. The Omega Note (See Note 7) assumed by the Company in the GranCare Merger
has been recorded at its fair value with the excess of fair value over the
principle being amortized over the remaining life of the mortgage notes. Such
amount is being amortized using the effective interest method over the expected
life of the note. Amortization, which was approximately $0.9 million and $1.9
million for the three and six month periods ended March 31, 1999, respectively,
was recorded as a reduction to interest expense.

                                       10
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
NOTE 5.  Mariner Merger

     Effective July 31, 1998 the Company completed the acquisition by merger of
Mariner Health pursuant to the terms of the Mariner Merger Agreement. In the
Mariner Merger approximately 29.6 million shares of the Company's common stock
were exchanged for Mariner Health common stock. The Company's total purchase
price of the acquisition was approximately $535.7 million including cash
payments for options, legal, consulting and other direct costs. The acquisition
was accounted for under the purchase method of accounting and, accordingly, the
results of Mariner Health's operations are included in the Company's
consolidated financial statements since the date of acquisition. The assets and
liabilities of Mariner Health have been recorded at fair market value based on a
preliminary purchase price allocation. The total purchase price has been
allocated as follows (in thousands):

<TABLE>
<S>                                                                                    <C>
     Current assets..................................................................    $ 213,862
     Property and equipment..........................................................      420,047
     Goodwill........................................................................      564,566
     Restricted investments..........................................................        3,227
     Other long-term assets..........................................................       36,378
     Current liabilities.............................................................      (55,853)
     Long-term debt..................................................................     (600,202)
     Other non-current liabilities...................................................      (46,344)
                                                                                         ---------
     Total purchase price............................................................    $ 535,681
                                                                                         =========
</TABLE>
                                                                                
     During the three months ended December 31, 1998, company management
reviewed Mariner Health's allowance for doubtful accounts and concluded that an
additional charge was necessary. As a result, included in the provision for bad
debts is a charge of approximately $24.3 million.

NOTE 6.  Indirect Merger and Other Related Expenses

     For the three and six month periods ended March 31, 1999, the Company
recognized and paid charges for indirect merger and other costs of approximately
$5.1 million and $7.1 million, respectively, related to the Mariner Merger and
for the three and six month periods ended March 31, 1998, the Company recognized
and paid charges for recapitalization, indirect merger and other costs of
approximately $13.6 million and $54.6 million, respectively, related to the
Apollo/LCA/GranCare Merger. The costs incurred are as follows:

<TABLE>
<CAPTION>
                                                                                                        Six Months
                                                                           Three Months Ended              Ended
                                                                                March 31,                 March 31,
                                                                       ------------------------  ------------------------
                                                                          1999         1998         1999         1998
                                                                       -----------  -----------  -----------  -----------
 
<S>                                                                    <C>          <C>          <C>          <C>
Change of control, severance and retention                                   2,191        4,095        3,664       18,274
Bridge financing fees                                                           --           --           --        8,139
Investment banking, accounting and legal                                     1,077          312        1,077        4,723
Relocation, recruitment and other                                            1,831        9,229        2,373       23,485
                                                                             -----       ------        -----       ------
                                                                             5,099       13,636        7,114       54,621
                                                                             =====       ======        =====       ======
</TABLE>

                                       11
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
 
 
NOTE 7.    Debt

           Long-term debt at March 31, 1999 is summarized in the following table
           (in thousands):

<TABLE>
<CAPTION>
<S>                                                                      <C>
Senior Debt:
       Senior Credit Facility:
          Revolving Credit Facility....................................       $    92,800
          Term Loans...................................................           798,235
       Mariner Health Senior Credit Facility...........................           208,000
       Mariner Health Term Loan........................................           210,000
       Mortgage notes..................................................            55,207
       Other notes payable.............................................            94,332
 
Subordinated Debt:
       Senior Subordinated Notes (due 2007)............................           273,947
       Senior Subordinated Discount Notes (due 2007)...................           194,157
       Mariner Health Senior Subordinated Notes (due 2006).............           149,766
                                                                              -----------
                                                                                  617,870
     Obligations under capital leases..................................            74,656
                                                                              -----------
                                                                                2,151,100
     Less short-term notes payable and current portion.................        (1,321,568)
                                                                              -----------
     Total long-term debt..............................................       $   829,532
                                                                              ===========
</TABLE>
                                                                                

Senior Credit Facility

     As of March 31, 1999, outstanding indebtedness under the Revolving Credit
Facility was $92.8 million (out of a possible $175.0 million) which excluded
$6.1 million of letters of credit. In addition, $300.2 million of the Tranche A
Term Loan Facility, $249.0 million of the Tranche B Term Loan Facility, and
$249.0 million of the Tranche C Term Loan Facility were outstanding.

     In connection with the July 1998 Amendments, aggregate amortization of the
Term Loans increased to the following approximate quarterly amounts: $8.4
million (formerly $6.6 million), $15.8 million (formerly $12.3 million), $16.6
million (formerly $12.9 million), $16.6 million (formerly $12.9 million), $18.2
million (formerly $14.1 million), $48.5 million (formerly $46.5 million), $59.8
million (unchanged) and $20.0 million (unchanged) in fiscal years 1999 through
2006, respectively.

     Interest on outstanding borrowings under the Revolving Credit Facility
accrue, at the option of the Company, at the Alternate Base Rate (the "ABR") of
The Chase Manhattan Bank ("Chase") or at a reserve adjusted Eurodollar Rate (the
"Eurodollar Rate") plus, in each case, an Applicable Margin.  The term
"Applicable Margin" means a percentage that will vary in accordance with a
pricing matrix based upon the respective term loan tenor and the Company's
leverage ratio.

                                       12
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
     Prior to the effectiveness of the December 22, 1998 amendment to the Senior
Credit Facility (the "December Amendment"), the Applicable Margins for the
Revolving Credit Facility and the Tranche A Term Loan Facility in the pricing
matrix ranged from 0% to 1.25% for ABR loans and 0.08% to 1.25% for loans under
the Eurodollar rate. The applicable interest rate margin for Tranche B Term
Loans was 1.50% for loans under the ABR and 2.50% for Eurodollar loans.  The
applicable interest rate margin for Tranche C Term Loans was 1.75% for loans
under the ABR and 2.75% for Eurodollar loans.  Immediately prior to the
Amendment, the Applicable Margins for ABR Loans and Eurodollar Loans under the
Revolving Credit Facility and the Tranche A Term Loan Facility were 1.25% and
2.25%, respectively.  The resultant interest rates under the Senior Credit
Facility (in each case first for ABR Loans and then for Eurodollar Loans)
immediately prior to the December Amendment, were as follows: for Revolving
Loans and Tranche A Term Loans, 9.00% and 7.83%; for Tranche B Term Loans, 9.25%
and 8.08%; and for Tranche C Term Loans, 9.5% and 8.33%.

     Following the December Amendment, the Applicable Margins in the pricing
matrix pertaining to the Revolving Credit Facility and Tranche A Term Loans
range from 0.25% to 1.25% for ABR loans and 1.75% to 2.75% for loans under the
Eurodollar. The applicable interest rate margin for Tranche B Term Loans is
2.25% for loans under the ABR and 3.25% for Eurodollar loans.  The applicable
interest rate margin for Tranche C Term Loans is 2.25% for loans under the ABR
and 3.50% for Eurodollar loans.  As of December 31, 1998, the Applicable Margins
for ABR Loans and Eurodollar Loans under the Revolving Credit Facility and the
Tranche A Term Loan Facility were 1.25% and 2.75%, respectively.  The resultant
interest rates under the Senior Credit Facility (in each case first for ABR
Loans and then for Eurodollar Loans) as of December 31, 1998, were as follows:
for Revolving Loans and Tranche A Term Loans, 9.00% and 8.33%; for Tranche B
Term Loans, 10.00% and 8.83%; and for Tranche C Term Loans, 10.25% and 9.08%.

     As of the effective date of the May 11, 1999 amendment (the "May 1999
Amendment") to the Senior Credit Facility (see discussion in Item 2.
Management's Discussion And Analysis Of Financial Condition And Results Of
Operations - Liquidity and Capital Resources of the Company"), all of the
Applicable Margins were increased by 50 basis points.  Following the May 1999
Amendment, the Applicable Margins in the pricing matrix pertaining to Revolving
Loans and Tranche A Term Loans will range from 0.75% to 1.75% for ABR loans and
2.25% to 3.25% for loans under the Eurodollar. The applicable interest rate
margin for Tranche B Term Loans will be 2.75% for loans under the ABR and 3.75%
for Eurodollar loans.  The applicable interest rate margin for Tranche C Term
Loans will be 3.00% for loans under the ABR and 4.00% for Eurodollar loans.  As
of May 12, 1999, the Applicable Margins for ABR Loans and Eurodollar Loans under
the Revolving Credit Facility and the Tranche A Term Loan Facility were 1.75%
and 3.25%, respectively.  The resultant interest rates under the Senior Credit
Facility (in each case first for ABR Loans and then for Eurodollar Loans) as of
May 12, 1999, were as follows: for Revolving Loans and Tranche A Term Loans,
9.50% and 8.25%; for Tranche B Term Loans, 10.50% and 8.75%; and for Tranche C
Term Loans, 10.75% and 9.00%.

                                       13
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
     The Senior Credit Facility contains customary covenants which, among other
things, require maintenance of certain financial ratios and limit amounts of
additional debt and repurchases of common stock.  At March 31, 1999, the Company
was in violation of certain of these financial covenants.  As discussed in Note
2, the Company has obtained a waiver of these violations of certain of these
financial covenants under the Senior Credit Facility which expires June 28,
1999. Based on the waiver expiration date and the Company's current projected
operating results for the next fiscal quarter ended June 30, 1999 indicating
continued non-compliance with certain financial covenants, the Senior
Credit Facility has been classified as current at March 31, 1999.

Mariner Health Senior Credit Facility

     As of March 31, 1999, approximately $208.0 million of loans and $27.0
million of letters of credit were outstanding under the Mariner Health Senior
Credit Facility, and $210.0 million of loans were outstanding under the Mariner
Health Term Loan Facility. Both the Mariner Health Senior Credit Facility and
the Mariner Health Term Loan Facility have a maturity date of January 3, 2000
and accordingly are classified as a current liability at March 31, 1999.

     For prime-based borrowings under the $460.0 million Mariner Health Senior
Credit Facility that existed prior to December 23, 1998, applicable interest
rate margins originally ranged between 0% and 0.25% for prime-base borrowings,
and between 0.50% and 1.75% for Eurodollar based advances.  As of December 22,
1998, the applicable margins were 0% for prime-based revolving loans and 1.25%
for Eurodollar-based loans.  After giving effect to the Mariner Health Senior
Credit Facility Amendment and the Mariner Health Term Loan Facility, the
applicable interest rate margins range from 0.25% to 1.25% for prime-based
loans, and from 1.75% to 2.75% for Eurodollar-based advances.  The applicable
margins were 0.75% for prime-based revolving loans and 2.25% for Eurodollar-
based loans under each of the Mariner Health Senior Credit Facility and the
Mariner Health Term Loan Facility as of March 31, 1999.  Accordingly, the
applicable interest rates on prime-based loans under those credit facilities was
8.50%, and for Eurodollar-based advances, 7.83%, as of March 31, 1999.

     Mariner Health was not in compliance with certain of the financial
covenants contained in the Mariner Health Senior Credit Facility and the Mariner
Health Term Loan Facility as of March 31, 1999. The Company is engaged in active
discussions with the agent and lenders under those credit facilities regarding
terms for a waiver of such noncompliance, but the requisite lender consents to
such waiver have not yet been received. If and when such waiver is obtained,
loan pricing under those credit facilities will likely increase.


     The Mariner Health Senior Credit Facility contains customary covenants
which, among other things, require maintenance of certain financial ratios and
limit amounts of additional debt and repurchases of common stock. The Company is
currently in default of certain of these financial covenants. As discussed in
Note 2, the Company has requested a waiver under the Mariner Health Senior
Credit Facility and is awaiting approval of the waiver request from its lenders.
At March 31, 1999, the Company had $41.7 million of invested cash for funding
operations and satisfying obligations under the Mariner Health Senior Credit
Facility. There can be no assurance that such invested cash will be sufficient
to finance the Company's liquidity needs during the requested waiver period or
that an extension of such waiver or other arrangements to permit the Company to
continue to borrow will be obtained.

                                       14
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
Senior Subordinated Notes

     In connection with the Apollo/LCA/GranCare Mergers, on November 4, 1997 the
Company completed a private offering to institutional investors of $275 million
of its 9.5% Senior Subordinated Notes due 2007 (the "Senior Subordinated
Notes"), at a price of 99.5% of face value and $294 million of its 10.5% Senior
Subordinated Discount Notes due 2007, at a price of 59.6% of face value
(collectively, the "Notes").  Interest on the Senior Subordinated Notes is
payable semi-annually.  Interest on the Senior Subordinated Discount Notes will
accrete until November 1, 2002 at a rate of 10.57% per annum, compounded semi-
annually, and will be cash pay at a rate of 10.5% per annum thereafter.  The
Notes will mature on November 1, 2007.  The net proceeds from this offering,
along with proceeds from the Senior Credit Facility, were used to fund a portion
of the Recapitalization Merger, refinance a significant portion of LCA's and
GranCare's pre-merger indebtedness and to pay costs and expenses associated with
the Apollo/LCA/GranCare Mergers.  Pursuant to the terms of the indenture with
respect to the Notes, in March 1998, the Company completed an exchange offer
with respect to the Notes whereby Notes registered under the Securities Act of
1933, as amended, were exchanged for unregistered Notes.  The terms of the
exchange Notes are identical to the original Notes.  Mariner Health and its
subsidiaries are "restricted subsidiaries" under the indenture pursuant to which
the Notes were issued.  The Company recently made the scheduled semi-annual
interest payment under the Senior Subordinated Notes.  The Company does not know
if it will be able to, or if its senior lenders will permit it to, make the next
scheduled interest payment due in November 1999.

Mariner Health Senior Subordinated Notes.

     Mariner Health is also the issuer of certain 9 1/2% Senior Subordinated
Notes due 2006 (the "Mariner Notes") which were issued pursuant to that
certain Indenture dated as of April 4, 1996 (the "Mariner Indenture") with
Mariner Health as issuer and State Street Bank and Trust Company as trustee, and
are outstanding in the aggregate principal amount of $150.0 million. The Mariner
Notes are unsecured senior subordinated obligations of  Mariner Health and, as
such, are subordinated  in  right of  payment  to all existing  and  future
senior indebtedness of Mariner Health, including indebtedness under the Mariner
Health Senior Credit Facility and the Mariner Health Term Loan Facility. The
Mariner Notes contain certain covenants, including, among other things,
covenants with respect to the following matters: (i) limitation on indebtedness;
(ii) limitation on restricted payments; (iii) limitation on the incurrence of
liens; (iv) restriction on the issuance of preferred stock of subsidiaries; (v)
limitation on transactions with affiliates; (vi) limitation on the sale of
assets; (vii) limitation on other senior subordinated indebtedness; (viii)
limitation on guarantees by subsidiaries; (ix) limitation on the creation of any
restriction on the ability of Mariner Health's subsidiaries to make
distributions; and (x) restriction on mergers, consolidations and the transfer
of all or substantially all of the assets of Mariner Health to another person.

Other Significant Indebtedness.

     In connection with the GranCare Merger, the Company became a party to an
agreement between GranCare and Omega Healthcare Investors, Inc. ("Omega").

     A wholly-owned subsidiary of the Company, Professional Health Care
Management, Inc. ("PHCMI"), is the borrower under a $58.8 million mortgage
note executed on August 14, 1992 (the "Omega Note") in favor of Omega, and
under the related Michigan loan agreement dated as of June 7, 1992 as amended
(the "Omega Loan Agreement"). All $58.8 million was outstanding as of March
31, 1999.

                                       15
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
     The Omega Note bears interest at a rate which is adjusted annually based on
either (i) changes in the Consumer Price Index or (ii) a percentage of the
change in gross revenues of PHCMI and its subsidiaries from year to year,
divided by $58.8 million, whichever is higher, but in any event subject to a
maximum rate not to exceed 105% of the interest rate in effect for the Omega
Note for the prior calendar year.  The current interest rate is 15.5% per annum
which is paid monthly.  Additional interest accrues on the outstanding principal
of the Omega Note at the rate of 1% per annum and totaled $4.4 million at March
31, 1998   Such interest is compounded annually and is due and payable on a pro
rata basis at the time of each principal payment or prepayment.

     In addition to the interest on the Omega Note described in the preceding
paragraph, and as a condition to obtaining Omega's consent to a February 1997
transaction between Vitalink Pharmacy Services, Inc. and GranCare, PHCMI agreed
to pay additional interest to Omega in the amount of $20,500 per month, through
and including July 1, 2002.  If the principal balance of the Omega Note for any
reason becomes due and payable prior to that date, there will be added to the
indebtedness owed by PHCMI: (i) the sum of $1.0 million, plus (ii) interest
thereon at 11% per annum to the prepayment date; less (iii) the amount of such
additional interest paid to Omega prior to the prepayment date.

     The Company periodically enters into interest rate swap agreements (the
"Swap Agreements") to manage interest rate risk. The Swap Agreements
effectively convert a portion of the Company's floating interest rate debt to
fixed interest rate debt. Notional amounts of interest rate agreements are used
to measure interest to be paid or received relating to such agreements and do
not represent an amount of exposure to credit loss. As of March 31, 1999, the
Company had Swap Agreements in effect totaling $60.0 million notional amount of
which $40.0 million will mature in July 2005 and $20.0 million will mature in
November 2005. Under the Swap Agreements, the Company pays interest at an
average fixed rate of 6.79% and receives interest at a rate of three-month
LIBOR. At March 31, 1997, the fair market value of the Swap Agreements would
represent a loss of approximately $3.0 million for the Company. Additionally, in
September 1998 the Company entered into a total return swap agreement relating
to approximately $40.7 million par value of Mariner Notes (the "Total Return
Swap Agreement") and has since amended the Total Return Swap Agreement to
increase such notional amount to $46.7 million. The Total Return Swap Agreement
provides for the Company to receive 9.5% interest on approximately $46.7 million
of Mariner Notes and to pay interest at one-month LIBOR plus 2.25%. Upon
expiration of the Total Return Swap Agreement, if not extended, the Company has
the right, but not the obligation, to purchase the Mariner Notes. If the Company
chooses not to purchase the Mariner Notes, it is obligated for any decrease in
the market value and receives the benefit of any increase in market value
realized by the third party purchase. At March 31, 1999, the fair market value 
of the Total Return Swap Agreement would represent a loss to the Company of 
approximately $25.0 million. Although the market value of the Mariner Notes has
not been directly related to the interest rate movements in recent months, to
the extent interest rate movements impact the market value of the Mariner Notes,
fluctuations in the market value of the Mariner Notes will affect the Company's
obligation at expiration of the Total Return Swap Agreement.

     During the six months ended March 31, 1998, the Company recognized an
extraordinary charge of $11.3 million, net of a $6.0 million income tax benefit,
associated with prepayment penalties incurred on the early extinguishment of
debt and the write-off of certain deferred financing fees in conjunction with
the Apollo/LCA/GranCare Mergers.

NOTE 8.  Other Accounts Receivable Bad Debt Charge

     The Company recorded an additional $29.6 million bad debt charge during the
quarter ended March 31, 1999 in response to management's detailed review of the 
Company's other accounts receivables in non-core businesses, related principally
to the Mariner Merger.


                                       16
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
NOTE 9.  Income Taxes

  The effective income tax rate was insignificant for the three and six months
ended March 31, 1999. The effective income tax rate was for the three and six
months ended March 31, 1998 was 45.3% and 47.2%, respectively.  The difference
in the effective income tax rate between periods is attributable to the
Company's establishment of a valuation allowance which completely offsets all
net deferred tax assets generated from the Company's losses.


NOTE 10.  Earnings per Common Share

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

<TABLE>
<CAPTION>
                                                                             Three Months Ended         Six Months Ended
                                                                                  March 31,                 March 31,
                                                                       --------------------------  --------------------------
                                                                           1999          1998           1999          1998
                                                                       ------------  ------------  ------------  ------------
<S>                                                                    <C>           <C>           <C>           <C>
     Numerator for Basic and Diluted Earnings Per Share:
       Net income (loss) before extraordinary item...................     $(78,753)      $(4,473)    $(117,776)     $(33,991)
       Extraordinary item............................................           --            --            --       (11,275)
                                                                          --------       -------     ---------      --------
       Net income (loss).............................................     $(78,753)      $(4,473)    $(117,776)     $(45,266)
                                                                          ========       =======     =========      ========
     Denominator:
       Denominator for basic earnings per share-weighted
        average shares...............................................       73,333        41,208        73,319        44,434
       Effect of dilutive securities--Stock options..................           --            --            --            --
                                                                          --------       -------     ---------      --------
       Denominator for diluted earnings per share-adjusted
        weighted-average shares and assumed conversions..............       73,733        41,208        73,319        44,434
                                                                          ========       =======     =========      ========
     Basic and Diluted Earnings (Loss) Per Share:
       Net income (loss) before extraordinary item...................     $  (1.07)      $ (0.11)    $   (1.61)     $  (0.77)
       Extraordinary item............................................           --            --            --         (0.25)
                                                                          --------       -------     ---------      --------
       Net income (loss) per common share............................     $  (1.07)      $ (0.11)    $   (1.61)     $  (1.02)
                                                                          ========       =======     =========      ========
</TABLE>
                                                                                
     The effect of dilutive securities for the three and six months ended March
31, 1999 and 1998, respectively, has been excluded because the effect is
antidilutive as a result of the net loss for the period.


NOTE 11.  Commitments and Contingencies

     The Company has entered into a $100 million leasing program (the "Synthetic
Lease") to be used as a funding mechanism for future assisted living and skilled
nursing facility construction, lease conversions, and other facility
acquisitions. The Sythetic Lease is an unconditional "triple net" lease for a
period of seven years (beginning in September 1996) with the annual lease
obligation a function of the amount spent by the lessor to acquire or construct
the project, a variable interest rate, and commitment and other fees. The
Company guarantees a minimum of approximately 83% of the residual value of the
leased property and also has an option to purchase the properties at any time
prior to the maturity date at a price sufficient to pay the entire amount
financed, accrued interest, and certain expenses. At March 31, 1999
approximately $51.6 million of the Synthetic lease was utilized. The Synthetic
Lease is accounted for as an operating lease. The Synthetic Lease was amended on
December 23, 1998 to mirror certain changes made to the Senior Credit Facility
and subsequently amended in May 1999 to reduce the commitment from $100 million
to $80 million, which will allow the Company to complete those facilities
currently under construction but will not allow the Company to initiate any new
projects.

                                       17
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
     As is typical in the healthcare industry, the Company is and will be
subject to claims that its services have resulted in resident injury or other
adverse effects, the risks of which will be greater for higher acuity residents
receiving services from the Company than for other long-term care residents. The
Company is, from time to time, subject to such negligence claims and other
litigation. In addition, resident, visitor, and employee injuries will also
subject the Company to the risk of litigation. The Company has experienced an
increasing trend in the past year in the number and severity of litigation
claims asserted against the Company. Management believes that this trend is
endemic to the long-term care industry and is a result of several large
judgments against long-term care providers, in the last year resulting in an
increased awareness by plaintiff's lawyers of potentially large recoveries. The
Company also believes that there has been, and will continue to be, an increase
in governmental investigations of long-term care providers, particularly in the
area of false claims as well as an increase in enforcement actions resulting
from the investigation. While the Company believes that it provides quality care
to the patients in its facilities and materially complies with all applicable
regulatory requirements, an adverse determination in a legal proceeding or
governmental investigation, whether currently asserted or arising in the future,
could have a material adverse effect on the Company.

     From time to time, the Company and its subsidiaries have been parties to
various legal proceedings in the ordinary course of their respective businesses.
In the opinion of management, except as described below, there are currently no
proceedings which, individually or in the aggregate, if determined adversely to
the Company and after taking into account the insurance coverage maintained by
the Company, would have a material adverse effect on the Company's financial
position or results of operations.

     On August 26, 1996, a class action complaint was asserted against GranCare
in the Denver, Colorado District Court, Salas, et al. v. GranCare, Inc., and AMS
Properties, Inc., d/b/a Cedars Health Care Center, Inc. Case No. 96 CV 4449,
asserting five claims for relief, including third-party beneficiary, tortious
interference and negligence per se causes of action arising out of quality of
care issues at a healthcare facility formerly owned by GranCare. Pursuant to the
Third Amended Complaint, the class claims were finally identified as third-party
beneficiary of contract; breach of contract; tortious interference with
contract; fraud; and negligence per se. In addition to the class claims, the
named plaintiffs each asserted claims for promissory estoppel and violation of
the Colorado Consumer Protection Act.

     On March 15, 1998, the court entered an order in which it certified a class
action in the matter. The court has only certified the class with respect to the
issue of liability and the various class rights to restitution. The court
determined that emotional distress damages are of such an individualized and
personal nature that the class-wide request for emotional distress damages was
not appropriate for class treatment. On May 7, 1998, plaintiff's counsel orally
dismissed her promissory estoppel claims on behalf of the named plaintiffs. In
response to the Company's Motion to Dismiss All Claims and Motion for Summary
Judgment Precluding Recovery of Medicaid Funds, on October 30, 1998, the court
partially granted the Company's motions, dismissing the claims of all plaintiffs
who

                                       18
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        

were at all times during the class period Medicare/Medicaid patients, for lack
of jurisdiction. The court further dismissed all restitution claims for the
remaining plaintiffs, except those relating to emotional distress for the period
beginning with their stay at defendants' facility and ending at the moment that
they first received any Medicare/Medicaid benefits. No restitution claims of any
sort were allowed on the claims for tortuous interference, fraud and negligence
per se. In its order, the court requested a conference relative to whether the
class was large enough to justify continuing the case as a class action. After
this order, at the request of plaintiffs' counsel, the court stayed all activity
and allowed plaintiffs to file a Motion for Reconsideration. Plaintiffs' Motion
for Reconsideration was filed, as ordered, on November 16, 1998, and the court
denied plaintiffs' motion on November 19, 1998. On December 10, 1998, the court
certified as a final judgment that portion of its order of October 30, 1998
dismissing for lack of jurisdiction all the claims of plaintiffs who were at all
relevant times Medicare or Medicaid patients. The court further stayed all
remaining proceedings pending resolution of any appeal of the certified final
judgment, and vacated the trial which had been scheduled for March 15, 1999. The
plaintiffs are currently appealing the court's October 30, 1998 order.  The
Company continues to vigorously contest the remaining alleged claims, the
certification of the various classes and plaintiff's appeal.

     The Company received a letter dated September 5, 1997 from an Assistant
United States Attorney ("AUSA") in the United States Attorney's Office for the
Eastern District of Texas (Beaumont) advising that the office was involved in an
investigation of allegations that services provided at some of the Company's
facilities may violate the Civil False Claims Act. The AUSA informed the Company
that the investigation was the result of a qui tam complaint filed under seal
against the Company.  The Company has recently been advised that the government
has declined to intervene in this matter.  The Company will vigorously contest
the alleged claims if the complaint is pursued by the private plaintiffs.

     In 1997, the Department of Justice ("DOJ") advised the Company that the
United States had declined to intervene in a qui tam complaint filed against The
Brian Center Corporation ("BCC") and one of its subsidiaries, Med-Therapy
Rehabilitation Services, Inc. ("Med-Therapy") in the federal district court
for the Western District of North Carolina. This matter has been preliminarily
settled, and the parties anticipate executing a settlement agreement in the near
future.

     On May 18, 1998, a class action complaint was asserted against the Company,
certain of its predecessor entities and affiliates and certain other parties in
the Tampa, Florida Circuit Court, Wilson, et al, v. Mariner Post-Acute Network,
Inc., et al., case no. 98-03779, asserting seven claims for relief, including
breach of contract, breach of fiduciary duty, unjust enrichment, violation of
Florida Civil Remedies for Criminal Practices Act, violation of Florida
Racketeer and Corrupt Organization Act, false advertising and common-law
conspiracy arising out of quality of care issues at a health care facility
formerly operated by the Brian Center Health and Rehabilitation/Tampa, Inc. and
later by a subsidiary of LCA as a result of the Brian Center Corporation merger.
The Company removed this case to Federal Court on June 10, 1998 and the matter
is currently pending in the United States District Court for the Middle District
of Florida, Tampa division, case no. 98-1205-CIV-T23B.

     The plaintiffs filed a motion to remand on June 22, 1998 and the Company
filed a motion to dismiss on June 30, 1998. The Company is currently awaiting
the outcome of these motions. The Company continues to vigorously contest the
request for class certification as well as all alleged claims made by the
plaintiffs.

                                       19
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)
                                        
     On August 25, 1998, a complaint was filed by the United States against the
Company's GranCare and International X-Ray subsidiaries and certain other
parties under the Civil False Claims Act and in common law and equity. The
lawsuit, U.S. v. Sentry X-Ray, Ltd., et al., civil action no. 98-73722, was
filed in United States District Court for the Eastern District of Michigan.
Valley X-Ray operates a mobile X-Ray company in Michigan. A Company subsidiary,
International X-Ray, owns a minority partnership interest in defendant Valley X-
Ray. The case asserts five claims for relief, including two claims for violation
of the Civil False Claims Act, two alternative claims of common law fraud and
unjust enrichment, and one request for application of the Federal Debt
Collection Procedures Act. The two primary allegations of the complaint are:
that the X-Ray company received Medicare overpayments for transportation costs
in the amount of $657,767; and that the X-Ray company "upcoded" Medicare
claims for EKG services in the amount of $631,090. The United States has
requested treble damages as well as civil penalties of $5,000 to $10,000 for
each of the alleged 388 submitted Medicare claims. The total damages sought
varies from $5.3 to $7.2 million. The Company is vigorously contesting all
claims and filed two motions to dismiss on behalf of its subsidiaries on
November 23, 1998. The United States has agreed to the motion to dismiss
GranCare as a party.  The court recently heard the motion to dismiss the Civil
False Claims Act and other claims against International X-Ray.  The Company is
awaiting the court's decision.

     On September 18, 1998, the Company was served with an administrative
subpoena issued by the OIG. The subpoena was addressed to "Paragon Health
Network, Inc." The subpoena seeks, among other things, certain records of
twenty specified current or former LCA nursing facilities. The Company has been
advised that the investigation is civil in nature and focuses on nursing
facilities and nurse aide services. The government has not disclosed the origin
of this civil administrative investigation or its intended scope. The Company is
cooperating with the investigation and has retained experienced counsel to
assist in responding to the subpoena and to advise it with respect to this
investigation. This investigation is still in its preliminary stages; therefore,
the Company is unable to predict the outcome of this matter.

     On October 1, 1998, a class action complaint was asserted against certain
of the Company's predecessor entities and affiliates and certain other parties
in the Tampa, Florida, Circuit Court, Ayres, et al v. Donald C. Beaver, et al,
case no 98-7233. On April 16, 1999, this case was voluntarily dismissed without
prejudice.  The complaint asserted three claims for relief, including breach of
fiduciary duty against one group of defendants, breach of fiduciary duty against
another group of defendants, and civil conspiracy arising out of issues
involving facilities previously operated by the Brian Center Corporation or one
of its subsidiaries, and later by a subsidiary of LCA, as a result of the merger
with Brian Center Corporation.

     In October 1998, the Custodian of Records of Cambridge Bedford, Inc., also
known as Bedford Villa Nursing Center ("Bedford"), a wholly-owned subsidiary
of the Company, was served an administrative subpoena issued by the OIG.  The
Company has responded to the OIG's request, and has been informed that it is not
a subject or target of the investigation.  In November 1998, Bedford also
received a subpoena duces tecum from the DOJ, through the U.S. Attorney's Office
in Detroit, Michigan, requesting certain patient medical records as the result
of a criminal investigation of a named physician. The Company responded to the
DOJ's request, and has been informed that it is not a subject or target of the
investigation.  The Company does not anticipate any further activity with
respect to these two matters.

                                       20
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)

NOTE 12.  Subsequent Events

     The Balanced Budget Act enacted in August 1997 (the "Act") revised the
reimbursement methodology for therapy services under Medicare Part B.
Historically, Medicare Part B therapy services were reimbursed based on the cost
of the services provided, subject to prudent buyer and salary equivalency
restrictions.  In November 1998, certain fee screen schedules were published
setting forth the amounts that can be charged for specific therapy services.
Additionally, the Balanced Budget Act set forth maximum per beneficiary limits
of $1,500 per provider for physical therapy and speech pathology and $1,500 per
provider for occupational therapy.  Both the fee screens and per beneficiary
limits are effective for services rendered subsequent to December 31, 1998.  The
imposition of fee screens, together with the inclusion of ancillary services in
the Federal per diem, has had a material adverse effect on the Company's therapy
business resulting in the early-April decision by the Company to terminate its
contracts to provide therapy services to both unaffiliated third-parties and to
the Company's skilled nursing facilities as of May 31, 1999.  The termination of
the therapy contracts will result in a charge to income for severance and other
costs in the third fiscal quarter ending June 30, 1999.  The Company also plans
to evaluate the impact of closing the therapy business on the Company's recorded
goodwill in accordance with Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" during the third fiscal quarter ending June 30, 1999.

     On April 28, 1999 the Company announced that it had entered into definitive
agreements to sell the assets of it's outpatient rehabilitation clinics and
hospital rehabilitation management contract business, to HealthSouth Corporation
and National Rehab Partners, Inc., respectively.

     Subsequent to March 31, 1999, the Company communicated to its employees the
restructuring plan approved by its Board of Directors which focused on reducing
the overhead operating costs of the Company's nursing homes through staff
reductions and expense management and improving building operations. In
conjunction with the implementation of the restructuring plan, the Company
expects to record a restructuring charge during the third fiscal quarter ending
June 30, 1999.

     Subsequent to March 31, 1999, the Medicare fiscal intermediary for Mariner
Health notified Mariner Health that it intends to reopen certain 1995 and 1996
Medicare cost reports to incorporate adjustments that will reduce the allowable
cost of rehabilitation therapy services that were provided to the facilities by
Mariner Health's rehabilitation subsidiaries.  Approximately 15 of the 1995 cost
reports are to be reopened to incorporate prudent buyer adjustments for
occupational therapy and speech pathology.  Approximately 60 of the 1996 cost
reports are to be reopened to incorporate related party adjustments for all
rehabilitation services. Mariner Health believes that it has a strong position
with respect to both issues; however, the intermediary is moving forward with
the reopenings.

     Mariner Health has received revised notices of program reimbursement
("NPR's") for certain of the cost reports that will require Mariner Health to
repay approximately $1.3 million to the Medicare program.  The intermediary has
notified Mariner Health that it intends to issue revised NPR's on the remaining
1995 and 1996 cost reports by June 30, 1999.  Also at issue are approximately 60
cost reports for the 1997 fiscal year that are scheduled to be settled during
the fourth quarter and are expected to include related party adjustments.  Given
the magnitude of the adjustments that are included in the NPR's that have been
received, Mariner Health believes the total amount the intermediary intends to
recoup will be significant.

                                       21
<PAGE>
 
               MARINER POST-ACUTE NETWORK, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)

     Mariner Health has initiated discussions to reach an accommodation with the
intermediary and HCFA for an extended repayment period for the amounts that are
expected to be owing.  Mariner Health intends to vigorously contest the
intermediary's adjustments through the appeals process; however, the final
settlement of the appeals may not be achieved until after the expected
recoupments have been fully effected.  If an accommodation is not reached and
extended repayment terms are not achieved, the Company would be required to
repay a significant amount of cash to the Medicare program in a short period,
which would have a material adverse effect on Mariner Health and the Company.

                                       22
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS

Overview

     Effective July 31, 1998, the Company acquired Mariner Health Group, Inc.
("Mariner Health") in a stock for stock merger (the "Mariner Merger")
pursuant to which: (i) Mariner Health became a wholly-owned subsidiary of the
Company; and (ii) the Company changed its name to "Mariner Post-Acute Network,
Inc." The Mariner Merger was accounted for under the purchase method of
accounting and, accordingly, the results of Mariner Health's operations have
been included in the Company's consolidated financial statements since the date
of acquisition.

     Effective November 1, 1997 for accounting purposes, the Company completed
two merger transactions. First, pursuant to an agreement and plan of merger
among Apollo Management, L.P. ("Apollo Management," and together with certain
of its affiliates, "Apollo"), Apollo LCA Acquisition Corp. (a corporation
owned by certain Apollo affiliates and other investors, "Apollo Sub") and
Living Centers of America, Inc. ("LCA"), Apollo Sub was capitalized with $240
million in cash and was merged with and into LCA (the "Recapitalization
Merger"). In the Recapitalization Merger, LCA was the surviving corporation and
was renamed "Paragon Health Network, Inc." Second, pursuant to an agreement
and plan of merger among LCA, GranCare, Inc. ("GranCare"), Apollo Management
and LCA Acquisition Sub, Inc., a wholly-owned subsidiary of the Company ("LCA
Sub"), GranCare merged with LCA Sub with GranCare surviving as a wholly-owned
subsidiary of the Company (the "GranCare Merger," and collectively with the
Recapitalization Merger, the "Apollo/LCA/GranCare Mergers"). The GranCare
Merger was accounted for under the purchase method of accounting and,
accordingly, the results of GranCare's operations have been included in the
Company's consolidated financial statements since the date of acquisition,
which, for accounting purposes, is November 1, 1997.

     Unless otherwise indicated, the information herein does not give pro forma
effect to the Apollo/LCA/GranCare Mergers or the Mariner Merger as if they had
been completed as of the beginning of the period presented.


Results of Operations

     Revenues from nursing home operations accounted for $479.9 million and
$986.4 million of the Company's $614.7 million and $1,287.4 million total net
revenues for the three and six months ended March 31, 1999, respectively.
Nursing home revenues are derived from the provision of routine and ancillary
services and are a function of occupancy rates and payor mix in the Company's
long-term care facilities. Weighted average occupancy, as identified in the
following table, increased by 1.4% and 1.6% over the comparable three and six
month periods from 1998 to 1999.


<TABLE>
<CAPTION>
                                              Three Months Ended          Six Months Ended
                                                  March 31,                   March 31,
                                          --------------------------   -------------------------
                                              1999          1998          1999          1998
                                          ------------  ------------   -----------  ------------
                                       
<S>                                       <C>           <C>           <C>           <C>
Weighted average licensed bed count            48,206        37,526        48,198        34,987
Weighted average number of residents           40,916        31,343        41,150        29,323
Weighted average occupancy                       84.9%         83.5%         85.4%         83.8%
</TABLE>

                                       23
<PAGE>
 
     Payor mix is the source of payment for the services provided and consists
of private pay, Medicare and Medicaid. Private pay includes revenue from
individuals who pay directly for services without government assistance through
the Medicare and Medicaid programs, managed care companies, commercial insurers,
health maintenance organizations, Veteran's Administration contractual payments
and payments for services provided under contract management programs. Managed
care as a payor source to health care providers is expected to increase over the
next several years and the Company is increasing its managed care contracting
capabilities. However, revenue from managed care payors does not constitute a
significant portion of the Company's revenue at this time.

     Reimbursement rates from government sponsored programs, such as Medicare
and Medicaid, are strictly regulated and subject to funding appropriations from
federal and state governments. Changes in reimbursement rates, including the
implementation of the Prospective Payment System ("PPS") for the Medicare system
and fee screen schedules and therapy caps for Part B Medicare patients beginning
January 1, 1999, have adversely affected the Company resulting in significantly
lower revenues than the Company would have received under the old payment
methodology and the decision by the Company to terminate its contracts to
provide therapy services to unaffiliated third parties.  See "Liquidity and
Capital Resources." Revenues derived from the Company's pharmacy and therapy
groups are also influenced by payor mix. The table below presents the
approximate percentage of the Company's net patient revenues derived from the
various sources of payment for the periods indicated:

<TABLE>
<CAPTION>
                              Three Months Ended         Six Months Ended
                                   March 31,                 March 31,
                        --------------------------  ---------------------------
                            1999          1998          1999          1998
                        ------------  ------------  ------------  ------------
                     
<S>                     <C>           <C>           <C>           <C>
Private and other              32.7%         27.9%         32.5%         28.3%
Medicare                       24.1%         33.9%         25.8%         33.1%
Medicaid                       43.2%         38.2%         41.7%         38.6%
</TABLE>

     The combined mix of private/other and Medicare revenue was 56.8% and 58.3%,
respectively, for the three and six months ended March 31, 1999 as compared to
61.8% and 61.4%, respectively, for the three and six months ended March 31,
1998. The net revenues from the non-nursing home operations are primarily
reimbursed by facility providers which are considered private pay sources. The
impact of increased therapy revenue resulting from the Mariner Merger has
increased the percentage of private revenue for the Company, which is not
expected to continue once the Company exits the business of providing therapy
services to unaffiliated third parties. As of March 31, 1999, 293 nursing homes
had converted to PPS based Medicare payments.  As more of the Company's
facilities transitioned to PPS, Medicare rates declined which influenced the
comparison of revenue mix between the three and six month periods ended March
31, 1999 and 1998. See "Liquidity and Capital Resources."

     The administrative procedures associated with the Medicare cost
reimbursement program, with respect to facilities and periods not subject to
PPS, generally preclude final determination of amounts due the Company until
annual cost reports are audited or otherwise reviewed and settled with the
applicable administrative agencies. Certain Medicare fiscal intermediaries have
made audit adjustments to settle cost reports for some of the Company's
facilities that reduce the amount of reimbursement that was previously received
by the facilities. The Company believes that it has properly recorded revenue
under cost reimbursement programs based on the facts and current regulations. If
the Company was to receive adverse adjustments that it had not contemplated in
recording its revenue in the past, the differences could be significant to the
Company's results of operations in the period of final determination. Beginning
July 1, 1998, the Company's facilities began to be phased into the PPS System
under which nursing home providers are paid a fixed per diem rate for Medicare
patients based on their acuity level.  Under PPS, the Company is not required to
file cost reports and the audit and settlement process is eliminated. See
"Liquidity and Capital Resources."  Effective July 1, 1999, all of the
Company's skilled nursing facilities will be reimbursed under the PPS system.

                                       24
<PAGE>
 
     Various federal, state, and local regulations impose, depending on the
services provided, a variety of regulatory standards for the type, quality and
level of personnel required to provide care or services. These regulatory
requirements have an impact on staffing levels, as well as the mix of staff, and
therefore impact salaries, wages and employee benefits. The cost of ancillary
services, which includes pharmaceuticals and therapy, is also affected by the
level of service provided and patient acuity. General and administrative
expenses include the indirect administrative costs associated with operating the
Company and its lines of business. Insurance expense includes the costs of the
various insurance programs such as automobile, general and professional
liability and workers' compensation.


Seasonality

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


 Second Quarter of Fiscal 1999 Compared to Second Quarter of Fiscal 1998

     Net revenues comprising nursing home and non-nursing home operations
totaled $614.7 million for the three months ended March 31, 1999, an increase of
$127.5 million or 26.2%, as compared to the same period for fiscal 1998. Nursing
home operations contributed $113.6 million of the increase, which included
$123.1 million related to the acquisition of Mariner Health effective July 31,
1998.  Non-nursing home operations contributed $13.9 million of the increase,
consisting of an increase of $14.9 million for pharmacy services, an increase of
$14.0 million for therapy services, and a decrease of $15.0 million from home
health, hospital services and other. The increases in both pharmacy and therapy
services net revenues were primarily attributable to the Mariner Health
acquisition. The decrease in home health, hospital services, and other revenue
was the result of the Company's September 1998 divestiture of the majority of
its hospice entities. The Company is evaluating its options with respect to its
remaining hospice and home health agencies before September 30, 1999.

     Pre-tax indirect merger and other expenses totaled $5.1 million for the
three months ended March 31, 1999, all of which related to the Mariner Merger
and all of which were paid as of March 31, 1999. The Company anticipates
recording additional charges during fiscal year 1999 to close an existing shared
service center acquired in the Mariner Merger and continue the implementation of
its shared service centers and offices consolidation. In addition, the Company
expects to record a restructuring charge in its third fiscal quarter in
conjunction with a plan to reduce overhead operating costs of the Company's
nursing homes. The termination of contracts to provide therapy services to both
unaffiliated third parties and to the Company's skilled nursing facilities
effective May 31,1999 will also result in a charge to income for severance and
other costs in the third fiscal quarter.

                                       25
<PAGE>
 
     Costs and expenses excluding indirect merger and other expenses totaled
$641.4 million for the three months ended March 31, 1999, an increase of $190.5
million or 42.2% as compared to the same period for fiscal 1998. The increase
was primarily the result of costs for payroll and employee benefits which
increased by $106.9 million, while general and administrative expenses and
depreciation/amortization expense increased by $22.4 million and $14.6 million,
respectively. The increase in these cost categories was primarily attributable
to the acquisitions of Mariner Health and GranCare.

     The provision for bad debts increased by $37.4 million for the three months
ended March 31, 1999 as compared to the same period for fiscal 1998. The Company
continued to review the collectibility of its accounts receivable and recorded
an additional provision for bad debts of $29.6 million during the quarter ended
March 31, 1999 as a result of uncollectible accounts receivable in non-core
businesses, related principally to the Mariner Merger. The Company will continue
to review the collectability of its accounts receivable which may result in
increased provision for bad debts in the future.

     Interest expense totaled $49.3 million for the three months ended March 31,
1999, an increase of $18.9 million as compared to the same period for fiscal
1998.  The acquisition of Mariner Health contributed $15.1 million of the
increase, while the increased borrowings under the Company's revolver and term
loans and increased interest rates associated with the December Amendment
contributed to the remaining $3.8 million increase.


 Fiscal 1999 Year To Date Compared to Fiscal 1998 Year To Date

     Net revenues comprising nursing home and non-nursing home operations
totaled $1,287.4 million for the six months ended March 31, 1999, an increase of
$378.6 million or 41.7%, as compared to the same period for fiscal 1998. Nursing
home operations contributed $312.8 million of the increase, which included
$250.6 million related to the acquisition of Mariner Health effective July 31,
1998. Non-nursing home operations contributed $65.8 million of the increase,
consisting of an increase of $41.1 million for pharmacy services, an increase of
$49.3 million for therapy services, and a decrease of $24.6 million from home
health, hospital services and other. The increases in both pharmacy and therapy
services net revenues were primarily attributable to the Mariner Health
acquisition. The decrease in home health, hospital services, and other revenue
was the result of the Company's September 1998 divestiture of the majority of
its hospice entities. The Company is evaluating its options with respect to its
remaining hospice and home health agencies before September 30, 1999.

     Pre-tax indirect merger and other expenses totaled $7.1 million for the six
months ended March 31, 1999, all of which related to the Mariner Merger and all
of which were paid as of March 31, 1999. The Company anticipates recording
additional charges during fiscal year 1999 to close an existing shared service
center acquired in the Mariner Merger and continue the implementation of its
shared service centers and offices consolidation. In addition, the Company
expects to record a restructuring charge in its third fiscal quarter in
conjunction with a plan to reduce overhead operating costs of the Company's
nursing homes. The termination of contracts to provide therapy services to both
unaffiliated third parties and to the Company's skilled nursing facilities
effective May 31,1999 will also result in a charge to income for severance and
other costs in the third fiscal quarter.

                                       26
<PAGE>
 
     Costs and expenses excluding indirect merger and other expenses totaled
$1,305.7 million for the six months ended March 31, 1999, an increase of $460.3
million or 54.4% as compared to the same period for fiscal 1998. The increase
was primarily the result of costs for payroll and employee benefits which
increased by $241.3 million, while ancillary expenses, general and
administrative expenses and depreciation/amortization expenses increased by
$29.5 million, $51.9 million and $29.8 million, respectively. The increase in
all three of these cost categories was primarily attributable to the
acquisitions of Mariner Health and GranCare.

     The provision for bad debts increased by $65.2 million for the six months
ended March 31, 1999. The increase was the result of a $24.3 million bad debt
charge taken by the Company in the first fiscal quarter ended December 31, 1998
and a $29.6 million bad debt charge taken by the Company in the second fiscal
quarter ended March 31, 1999. The $24.3 million bad debt charge was recorded as
a result of management's review of Mariner Health's allowance for doubtful
accounts at December 31, 1998, and management's conclusion that an additional
charge of $24.3 million was necessary for Mariner Health as of December 31,
1998. The additional charge conformed to the Company's reserve policy. The
Company continued to review the collectibility of its accounts receivable other
than inpatient and recorded an additional provision for bad debts of $29.6
million during the quarter ended March 31, 1999 as a result of uncollectible
accounts receivable in non-core business, related principally to the Mariner
Merger. The Company will continue to review the collectibility of its accounts
receivable which may result in increased provision for bad debts in the future.

     Interest expense totaled $96.1 million for the six months ended March 31,
1999, an increase of $44.0 million as compared to the same period for fiscal
1998. The acquisition of Mariner Health contributed to $27.8 million of the
increase, while the  interest expense on the debt entered into on November 3,
1997 in conjunction with the Apollo/LCA/GranCare Merger and the increased
borrowings under the Company's revolver and term loans and increased interest
rates associated with the December Amendment contributed to the remaining $16.2
million increase.


The Year 2000 Issue

     In connection with the coming of the Year 2000, the Company is in the
process of evaluating and addressing issues that could arise in connection with
the potential inability of computer programs to recognize dates that follow
December 31, 1999 (the "Year 2000 Issue"). The Year 2000 Issue presents
potential problems not only for computer hardware and software but also for
devices that incorporate embedded chips, such as critical medical devices
utilized in the Company's facilities. Focus in early phases of the Company's
Year 2000 program was on its company-wide information systems and technology, in
recent months added attention has been placed on the inventory, assessment and
remediation of embedded chip issues in its facilities.

     To address issues inherent in operating disparate information systems
utilized by the Company's predecessor corporations, following the
Apollo/LCA/GranCare Mergers the Company decided to complete the installation of
a new client-server based financial and payroll/human resources software
package. The installation of the new system is in progress and the Company
anticipates that it will be fully operational on or about October 1, 1999. The
implementation of these systems was not in response to the Year 2000 Issue. The
Company expects that its business lines systems exposure to the Year 2000 Issue
will be substantially eliminated by approximately June 1999, at which time the
Company's non-Year 2000 compliant systems will have been upgraded or replaced.
The Company has received assurances from the providers of any new systems that
they are Year 2000 compliant.  The Company is also in the process of remediating
all local area networks ("LANs"), operating software and individual computers
and anticipates that the process will be substantially complete by September
1999.

     The Company has formed a committee with members from each of the Company's
business lines as well as representatives from the purchasing, legal,
accounting, payroll, and risk management areas of the Company (the "Year 2000
Committee"). This committee reports to the Company's senior management and is
responsible for identifying those business line specific Year 2000 Issues. The
Company has additionally established a corporate Year 2000 Office responsible
for project coordination.

                                       27
<PAGE>
 
     The Company has completed IT and embedded chip equipment inventory
processes and is currently completing Year 2000 research on the embedded chip
status of facility systems and medical devices. Although the Company is
conducting a facility by facility examination to determine which facilities and
systems are susceptible to the Year 2000 Issue, the Company does not believe
that there is significant risk in this area. Most of the Company's facilities
are older and thus do not have systems that are dependent on embedded chips. In
the newer facilities and those facilities where Year 2000 Issues are found to
exist, the Company plans on remediating any potential problems.  Embedded chip
research is expected to be completed by June 1999 and facility administrators
will be notified by the end of June 1999 of any Year 2000 issues with respect to
their facilities and equipment, providing up to six months for the completion of
any remediation and replacement.

     The Company has also contacted, and will continue to contact, its key
suppliers to gain assurance that they will be year 2000 compliant. This process
is ongoing, although most suppliers who have responded have indicated that they
expect to be Year 2000 compliant in a timely fashion. In addition, because the
Company maintains a broad base of vendors and suppliers, it does not believe
that it is at risk with respect to any individual vendor or supplier who may be
non-compliant.

     To date, the Company has expended $4.7 million to remedy problems
associated with the Year 2000 Issue and estimates that it will expend an
additional approximately $8.6 million in the future. This amount does not
include funds necessary to remedy Year 2000 Issues in the Company's facilities.
The Company believes that the costs associated therewith, together with the
costs of remedying issues with respect to embedded chips, will approximate $3.0
million.

     With respect to the Company's customers, the largest source of the
Company's revenues is the state and federal governments through the Medicaid and
Medicare programs, respectively. The Company is reimbursed under these programs
through fiscal intermediaries and state agencies. The Health Care Financing
Administration ("HCFA"), the government agency that administers the Medicare
program, had previously publicly stated that it will be Year 2000 compliant by
December 31, 1998 and had required all fiscal intermediaries to be Year 2000
compliant by the same date. HCFA has also stated that it expects state Medicaid
agencies to be Year 2000 compliant by March 31, 1999. While HCFA has made no
public announcement as to whether fiscal intermediaries and state Medicaid
agencies have met this schedule, recent reports by the General Accounting Office
report that the various states may currently be in compliance.  With respect to
itself, HCFA issued a Provider Correspondence Letter dated January 12, 1999,
available at HCFA's website (http://www.hcfa.gov/y2k/p1011299.htm). This letter
                             -------------------------------------             
states that HCFA's systems will function on January 1, 2000 and will be able to
process "acceptable" claims but did not indicate what would constitute an
"acceptable" claim. The failure by HCFA to issue appropriate standards in a
timely fashion could affect the ability of the Company to process claims in a
timely fashion which could have a material adverse effect on the Company.
Because the Company has no control over these entities, in the event the fiscal
intermediaries and the state and federal governments are not Year 2000
compliant, the timely receipt of the Company's receivables may be adversely
affected. A significant delay in the receipt of its receivables would have a
material adverse effect on the Company's financial condition and results of
operations.  The Company has sent letters to its fiscal intermediaries and state
agencies as to their readiness with respect to the Year 2000 Issue.  Responses
received to date have indicated that these organizations expect to be compliant
by September 1999 and that contingency plans are being developed to minimize any
disruption of payments to providers.

     The Company believes that the principal risk for the Company from the Year
2000 Issue is from the potential for delay in the receipt of payment from third-
party payors. The Company has minimal access to credit facilities and its
operating resources are limited to invested cash, liquidating working capital
and proceeds from asset sales not required to be applied to bank debt. With the
Company's current liquidity sources, a delay in receipt from third party payors
could have a material adverse effect on the Company's operations.

                                       28
<PAGE>
 
Liquidity and Capital Resources of the Company

     Cash and cash equivalents were $55.8 million at March 31, 1999.  Working
capital was $(928.1) million, a  decrease of $1,278.3 million during the six
months ended March 31, 1999, due to the current maturity of the a large portion
of the Company's debt (See Notes 2 and 7). Cash used in operations for the six
months ended March 31, 1999 was $33.5 million, which was net of approximately
$7.1 million in payments for indirect merger and other expenses.  Receivables
increased by $34.9 million due in part to payment remittance issues of the
federal government and its fiscal intermediaries. Other current assets decreased
by $25.9 million primarily as a result of income tax refunds the Company
received from federal and state taxing authorities. Accounts payable decreased
by $23.6 million, primarily as a result of timing differences on invoice payment
terms.

     Cash used in investing activities was $24.5 million in the six month period
ended March 31, 1999, as compared to $40.4 million for the same period in fiscal
1998.  Investing activities included the use of $35.1 million related to capital
expenditures. Capital expenditures are expected to be funded in the future by
cash from operations and proceeds from asset sales.

     Cash provided by financing activities was $110.5 million in the six month
period ended March 31, 1999, as compared to $102.3 million for the same period
in fiscal 1998.  Cash provided by financing activities included $125.6 million
in net draws under the Company's credit line of which approximately $41.7
million is invested cash at March 31, 1999, $8.4 million in principle repayments
on long-term debt, and $6.7 million in payments for financing fees associated
with certain amendments to the Company's long-term debt agreements.

     The Company receives payment for nursing facility services based on rates
set by individual state Medicaid programs.  Although payment cycles for these
programs vary, payments generally are made within 30 to 60 days after services
are provided.  The federal Medicare program, currently changing from a cost-
based reimbursement program to fixed per diem amount under PPS (See "Healthcare
Regulatory Matters"), with respect to those facilities still reimbursed on a
cost basis, pays interim rates based on estimated costs of services on a 30 to
45-day basis.  Final cost settlements, based on the difference between audited
costs and interim rates are paid following final cost report audits by Medicare
fiscal intermediaries.  Because of the cost report and audit process, final
settlement may not occur until up to 24 months or beyond after each facility's
Medicare year end.  With respect to those facilities currently operating under
PPS, the Company submits claims monthly and is reimbursed 14 days following the
receipt by the fiscal intermediary of claims for which no dispute is
outstanding, and there is no cost report and audit process.

     Receivables in respect of specialty medical services are generally received
on a delayed basis.  The Company is also moving to a single operating platform
for the inpatient group's accounts receivable.  At March 31, 1999, approximately
79% of the former GranCare facilities had been converted to the Company's field-
based accounts receivable system.  All former Mariner Health facilities will
remain on a Year 2000 compliant version of their existing accounts receivable
system.  The Company in reviewing the aging of the Mariner Health accounts
receivable and related allowance recorded a $24.3 million charge in the first
quarter of fiscal 1999 in order to conform the Mariner Health reserve
calculation to the calculation utilized by the Company. The Company continued to
review the collectability of its accounts receivable other than inpatient and
recorded an additional provision for bad debts of $29.6 million during the
quarter ended March 31, 1999, primarily as a result of uncollectable accounts
receivable acquired in the Mariner Merger. The Company will continue to review
the collectability of its accounts receivable which may result in increased
provision for bad debts in the future.

     In addition, the Company provides certain services between subsidiary
companies, some of which are charged at cost and others of which are charged at
market rates.  Subject to certain exceptions, Medicare's "related party rule"
generally requires that services between subsidiary companies or other entities
deemed to be related under the rule be charged at cost.  The Company believes
that the services that are charged at market rates qualify for an exception to
Medicare's related party rule. There can be no assurance, however, that HCFA
will accept the Company's position, and the Medicare reimbursement received for
such services may be subject to audit and recoupment.  Mariner Health recently
received certain notices of program reimbursement ("NPR's") with respect to
therapy services provided by Mariner Health's rehabilitation subsidiaries to
Mariner Health's skilled nursing 

                                       29
<PAGE>
 
facilities, and anticipates receiving additional NPR's in the future. (See 
"-Healthcare Regulatory Matters"). In the event HCFA does not agree with the
Company's position, this may result in a reduction in reimbursements in future
periods, and may have a material adverse effect on the Company's cash position,
business and results of operations.

     In addition to the related party recoupments and cost report settlements
discussed above, significant items that will affect the Company's liquidity in
the future include the ability of the Company to comply with financial covenants
under the Senior Credit Facility, Mariner Health Senior Credit Facility, and
Mariner Health Term Loan Facility, to refinance or extend the existing August
16, 1999 termination date of the Total Return Swap, to refinance the Mariner
Health Senior Credit Facility on or before January 3, 2000 and make interest
payments under the Notes and the Mariner Notes.  The failure by the Company to
meet these requirements, or refinance the indebtedness when it becomes due,
would have a material adverse affect on the Company.

     Senior Credit Facility.  In connection with the Recapitalization Merger,
the Company entered into the Senior Credit Facility, which originally consisted
of a $150.0 million revolving credit facility (the "Revolving Credit Facility"),
and three term loan credit facilities: a 6  1/2 year term loan facility in an
aggregate principal amount of $240.0 million (the "Tranche A Term Loan
Facility"), a 7 1/2 year term loan facility in an aggregate principal amount of
$250.0 million (the "Tranche B Term Loan Facility"), and an 8 1/2 year term loan
facility in an aggregate principal amount of $250.0 million (the "Tranche C Term
Loan Facility").  Loans made under the Tranche A Term Loan Facility ("Tranche A
Term Loans"), the Tranche B Term Loan Facility ("Tranche B Term Loans") and the
Tranche C Term Loan Facility ("Tranche C Term Loans") are collectively referred
to herein as "Term Loans."  Advances under the Revolving Credit Facility are
sometimes referred to as "Revolving Loans."  The proceeds from borrowings under
the Term Loans were used, along with the proceeds of the Notes (defined below)
offering, to fund a portion of the Recapitalization Merger, refinance a
significant portion of LCA's and GranCare's pre-merger indebtedness and to pay
costs and expenses associated with the Apollo/LCA/GranCare Mergers.

     In July 1998 the Revolving Credit Facility was increased to $175.0 million
and the Tranche A Term Loan Facility to $315.0 million in connection with the
Mariner Merger (of which $300.2 million remained outstanding at March 31, 1999).
The proceeds of the $75.0 million increase in the Tranche A Credit Facility and
of certain Revolving Credit Loans were used to pay various costs and expenses
incurred in connection with the Mariner Merger.  As of March 31, 1999, there was
$92.8 million borrowed under the Revolving Credit Facility and approximately
$6.1 million in letters of credit outstanding.

     The obligations of the Company under the Senior Credit Facility are
guaranteed by substantially all of the Company's subsidiaries other than Mariner
Health and its subsidiaries, and are secured by substantially all of the
otherwise unencumbered owned assets of the Company and such subsidiary.

     Principal amounts outstanding under the Revolving Credit Facility will be
due and payable in April 2005.  The Term Loans are amortized in quarterly
installments which increase over the term of those loans (see note 7 to the
consolidated financial statements).  Interest on outstanding borrowings under
the Senior Credit Facility accrue, at the option of the Company, at the
Alternate Base Rate (the "ABR") of The Chase Manhattan Bank ("Chase") or at a
reserve-adjusted Eurodollar Rate (the "Eurodollar Rate"), plus, in each case, an
Applicable Margin.  The term "Applicable Margin" means a percentage that will
vary in accordance with a pricing matrix based upon the respective term loan
tenor and the Company's leverage ratio (see note 7 to the consolidated financial
statements).

     The Senior Credit Facility is subject to prepayment, in whole or in part,
at the Company's option and in certain minimum increments from time to time, and
is also subject to mandatory prepayment from the net cash proceeds received from
certain transactions.  Those transactions include the sale or issuance of equity
by the Company, the incurrence of certain indebtedness by the Company, and the
sale of certain assets where the net cash proceeds are not reinvested in the
Company's business within 12 months (6 months in certain cases).  The Company
must also make annual prepayments to the extent of 75% of its excess cash flow
for each fiscal year (reduced to 50% of excess cash flow once the Company's
leverage ratio as of the last day of any fiscal year is less than or equal to
4.50 to 1.00).  Mandatory prepayments will be applied pro rata to the unmatured
installments of the Term Loans; provided, however, that holders of Tranche B
Term Loans or Tranche C Term Loans may refuse any such mandatory prepayment
otherwise allocable to them, in which case the amount so refused will be applied
as an 

                                       30
<PAGE>
 
additional prepayment of the Tranche A Term Loans. Amounts applied as
prepayments of the Revolving Credit Facility may be reborrowed; amounts prepaid
under the Term Loans may not be reborrowed.

     The covenants contained in the Senior Credit Facility, among other things,
require the Company to maintain certain financial ratios and restrict the
ability of the Company to dispose of assets, repay other indebtedness or amend
other debt instruments, pay dividends, make investments, and make acquisitions.
The Company received the consent of the requisite lenders under the Senior
Credit Facility to permit the Mariner Merger and certain covenants in the Senior
Credit Facility were modified to accommodate the Mariner Merger.  By amendment
effective December 22, 1998, certain of the Senior Credit Facility's financial
and operating covenants were amended to provide the Company with additional
flexibility, in return for which the Applicable Margins were increased (see Note
6 to the consolidated financial statements).

     In May 1999, the Senior Credit Facility was further amended in order to
waive non-compliance by the Company with certain financial covenants  as of
March 31, 1999 to increase loan pricing (see note 7 to the consolidated
financial statements) and, among other things, (i) to prohibit acquisitions,
(ii) to eliminate the Company's ability to defer mandatory prepayments with the
proceeds from asset sales and other transactions by reinvesting such proceeds in
other capital assets, and (iii) to restrict the Company's right to sell assets
without administrative agent or lender approval, incur capital expenditures
other than for maintenance and repair purposes, or make investments in Mariner
Health and the Mariner Health subsidiaries.

     The Company anticipates the need to seek additional waivers of financial
covenants following the quarter ended June 30, 1999, which the Company hopes
will be permanent in nature. Until the Company is in compliance with the
financial covenants under the Revolving Credit Facility, or the Senior Credit
Facility is amended to provide more permanent relief from the existing financial
covenants, the Company's ability to borrow funds under the Revolving Credit
Facility to finance its operations will be restricted. In addition, if the
Company is unable to refinance or obtain an amendment to the Senior Credit
Facility to provide more permanent relief from the existing financial covenants,
the lenders thereunder may exercise certain remedies including, without
limitation, accelerating the indebtedness thereunder and exercising their rights
with respect to the pledged collateral.

     Senior Subordinated Notes.  In connection with the Apollo/LCA/GranCare
Mergers, on November 4, 1997 the Company completed a private offering to
institutional investors of $275 million of its 9.5% Senior Subordinated Notes
due 2007 (the "Senior Subordinated Notes"), at a price of 99.5% of face value
and $294 million of its 10.5% Senior Subordinated Discount Notes due 2007, at a
price of 59.6% of face value (collectively, the "Notes").  Interest on the
Senior Subordinated Notes is payable semi-annually.  Interest on the Senior
Subordinated Discount Notes will accrete until November 1, 2002 at a rate of
10.57% per annum, compounded semi-annually, and will be cash pay at a rate of
10.5% per annum thereafter.  The Notes will mature on November 1, 2007.  The net
proceeds from this offering, along with proceeds from the Senior Credit
Facility, were used to fund a portion of the Recapitalization Merger, refinance
a significant portion of LCA's and GranCare's pre-merger indebtedness and to pay
costs and expenses associated with the Apollo/LCA/GranCare Mergers.  Pursuant to
the terms of the indenture with respect to the Notes, in March 1998, the Company
completed an exchange offer with respect to the Notes whereby Notes registered
under the Securities Act of 1933, as amended, were exchanged for unregistered
Notes.  The terms of the exchange Notes are identical to the original Notes.
Mariner Health and its subsidiaries are "restricted subsidiaries" under the
indenture pursuant to which the Notes were issued.  The Company recently made
its semi-annual interest payment under the Senior Subordinated Notes.  The
Company does not know if it will be able to, or if its senior lenders will
permit it to, make the next scheduled interest payment due in November 1999.

     Other Significant Indebtedness and Commitments. The Company, through
various of its GranCare subsidiaries, is a party to various agreements between
GranCare and Health and Retirement Properties Trust ("HRPT").

     HRPT is the lessor with respect to certain facilities leased by two
subsidiaries of GranCare (the "Tenant Entities").  In connection with obtaining
HRPT's consent to the Apollo/LCA/GranCare Mergers, GranCare and HRPT executed a
Restructure and Asset Exchange Agreement dated October 31, 1997 pursuant to
which HRPT and GranCare restructured their relationship (the "HRPT/GranCare
Restructuring").  As a part of the HRPT/GranCare 

                                       31
<PAGE>
 
Restructuring, HRPT consented to the consummation of the Apollo/LCA/GranCare
Mergers and the transactions related thereto, and HRPT received an unlimited
guaranty by the Company and all subsidiaries of the Company having an ownership
interest in Tenant Entities which guaranty is secured by a cash collateral
deposit of $15 million, the earned interest on which is retained by HRPT. The
performance by the Tenant Entities of their respective obligations to HRPT
continues to be secured by a pledge of one million shares of HRPT common stock
beneficially owned by GranCare and, as part of the HRPT/GranCare Restructuring,
GranCare agreed to waive the ability to request a release of such collateral
upon the attainment of certain financial conditions. Accordingly, the Company
does not have the ability to sell these shares to meet any capital requirements.
An uncured event of default under the Senior Credit Facility could result in
HRPT exercising its rights with respect to this collateral. In addition, an
uncured default under the Senior Credit Facility could result in the default and
acceleration of other obligations to which the Company and its subsidiaries are
party.

     In connection with the GranCare Merger, the Company became a party to an
agreement between GranCare and Omega Healthcare Investors, Inc. ("Omega").

     A wholly-owned subsidiary of the Company, Professional Health Care
Management, Inc. ("PHCMI"), is the borrower under a $58.8 million mortgage
note executed on August 14, 1992 (the "Omega Note") in favor of Omega, and
under the related Michigan loan agreement dated as of June 7, 1992 as amended
(the "Omega Loan Agreement"). All $58.8 million was outstanding as of March
31, 1999.

     The Omega Note bears interest at a rate which is adjusted annually based on
either (i) changes in the Consumer Price Index or (ii) a percentage of the
change in gross revenues of PHCMI and its subsidiaries from year to year,
divided by $58.8 million, whichever is higher, but in any event subject to a
maximum rate not to exceed 105% of the interest rate in effect for the Omega
Note for the prior calendar year.  The current interest rate is 15.5% per annum
which is paid monthly.  Additional interest accrues on the outstanding principal
of the Omega Note at the rate of 1% per annum and totaled $4.4 million at March
31, 1998   Such interest is compounded annually and is due and payable on a pro
rata basis at the time of each principal payment or prepayment.

     In addition to the interest on the Omega Note described in the preceding
paragraph, and as a condition to obtaining Omega's consent to a February 1997
transaction between Vitalink Pharmacy Services, Inc. and GranCare, PHCMI agreed
to pay additional interest to Omega in the amount of $20,500 per month, through
and including July 1, 2002.  If the principal balance of the Omega Note for any
reason becomes due and payable prior to that date, there will be added to the
indebtedness owed by PHCMI: (i) the sum of $1.0 million, plus (ii) interest
thereon at 11% per annum to the prepayment date; less (iii) the amount of such
additional interest paid to Omega prior to the prepayment date.

     Mariner Health Senior Credit Facility and Mariner Health Term Loan
Facility.  At the time of the Mariner Merger, Mariner Health was the borrower
under a $460.0 million revolving credit facility (the "Mariner Health Senior
Credit Facility"), by and among Mariner Health, the lenders signatory thereto
(the "Mariner Health Lenders"), and PNC Bank, National Association ("PNC Bank"),
as agent for the Mariner Health Lenders (the "Mariner Agent").  The Mariner
Health Senior Credit Facility expires on January 3, 2000. However, no assurance
can be given that financing will be available on terms that are acceptable to
the Company.

     Outstanding advances under the Mariner Health Senior Credit Facility bear
interest at interest rates based, at the borrower's option, either on PNC Bank's
prime rate or on a Eurodollar-based rate, in each case plus an applicable margin
which can fluctuate based on a pricing matrix related to Mariner Health's
maximum leverage ratio.  The Mariner Health Senior Credit Facility contains
covenants which, among other things, require Mariner Health and its subsidiaries
to maintain certain financial ratios and impose certain limitations or
prohibitions on Mariner Health with respect to the incurrence of indebtedness,
liens and capital leases; the payment of dividends on, and the redemption or
repurchase of, its capital stock; investments and acquisitions, including
acquisitions of new facilities; the merger or consolidation of Mariner Health
with any person or entity; and the disposition of any of Mariner Health's
properties or assets.

                                       32
<PAGE>
 
     Effective December 23, 1998, Mariner Health amended the Mariner Health
Senior Credit Facility (the "Mariner Health Senior Credit Facility Amendment")
(a) to reduce the amount of the revolving commitment from $460.0 million to
$250.0 million, (b) to provide additional financial covenant flexibility for
Mariner Health and its subsidiaries, (c) to modify certain of the financial and
operating covenants referred to in the immediately preceding paragraph, (d) to
increase the applicable interest rate margins (see footnote 7 to the financial
statements) and (e) to expand the amount and types of collateral pledged to
secure the Mariner Health Senior Credit Facility.

     Mariner Health's obligations under the Mariner Health Senior Credit
Facility are guaranteed by substantially all of its subsidiaries and are secured
by substantially all of the otherwise unencumbered assets of Mariner Health and
such subsidiary guarantors.

     Contemporaneously with the effectiveness of the Mariner Health Senior
Credit Facility Amendment, Mariner Health entered into a term loan agreement
dated as of December 23, 1998 (the "Mariner Health Term Loan Facility") with PNC
Bank, as administrative agent, First Union National Bank, as syndication agent,
and the financial institutions signatory thereto as lenders (the "Term
Lenders"), pursuant to which the Term Lenders made a $210.0 million senior
secured term loan to Mariner Health (the "Mariner Health Term Loan").  Proceeds
of the Mariner Term Loan were applied to reduce outstanding amounts under the
Mariner Health Senior Credit Facility in connection with the Mariner Health
Senior Credit Facility Amendment.  The interest rate pricing and covenants
contained in the Mariner Health Term Loan Agreement are substantially similar to
the corresponding provisions of the Mariner Health Senior Credit Facility, as
amended by the Mariner Health Senior Credit Facility Amendment.  The Mariner
Health Term Loan matures on January 3, 2000, is guaranteed by the same
subsidiary guarantors as the Mariner Health Senior Credit Facility, and is
cross-defaulted and cross-collateralized with the Mariner Health Senior Credit
Facility.  The Company plans to refinance the outstanding indebtedness under the
Mariner Health Senior Credit Facility prior to December 31, 1999.  However, no
assurance can be given that financing will be available.

     As of March 31, 1999, approximately $208.0 million of loans and $6.1
million of letters of credit were outstanding under the Mariner Health Senior
Credit Facility, and all $210.0 million of the Mariner Health Term Loan was
outstanding.

     Mariner Health and its subsidiaries are treated as unrestricted
subsidiaries under the Senior Credit Facility.  Unlike other subsidiaries of the
Company (the "Non-Mariner Subsidiaries"), Mariner Health and its subsidiaries
neither guarantee the Company's obligations under the Senior Credit Facility nor
pledge their assets to secure such obligations.  Correspondingly, the Company
and the Non-Mariner Subsidiaries do not guarantee or assume any obligations
under the Mariner Health Senior Credit Facility or the Mariner Health Term Loan
Facility.  Mariner Health and its subsidiaries are not subject to the covenants
contained in the Senior Credit Facility, and the covenants contained in the
Mariner Health Senior Credit Facility and the Mariner Health Term Loan Facility
are not binding on the Company and the Non-Mariner Subsidiaries.  Mariner Health
and the Mariner Health subsidiaries are obligated to continue to comply with the
covenants contained in the Mariner Health Senior Credit Facility and the Mariner
Health Term Loan Facility without taking into account the revenues, expenses,
net income, assets or liabilities of the Company and the Non-Mariner
Subsidiaries.  The converse is true with respect to the Company, which (together
with its Non-Mariner Subsidiaries) must continue to comply with the covenants
contained in its Senior Credit Facility without taking into account the
revenues, expenses, net income, assets or liabilities of Mariner Health and its
subsidiaries.

                                       33
<PAGE>
 
     Mariner Health was not in compliance with certain of the financial
covenants contained in the Mariner Health Senior Credit Facility and in the
Mariner Health Term Loan Facility as of March 31, 1999.  Although the Company is
actively engaged in discussions with the Mariner Agent, the Mariner Health
Lenders and the Term Lenders regarding a waiver of such noncompliance and
certain amendments to those credit facilities, and terms for a proposed waiver
and amendment have been circulated to the Mariner Lenders and the Term Lenders,
the requisite lender consents have not yet been received, nor can assurances be
given as to whether or when such approval will be received.  So long as Mariner
Health's noncompliance with the financial covenants remains unwaived, the
Mariner Lenders and the Term Lenders have the right to exercise remedies under
their loan documents.  In addition, the existence and continuation of such non-
compliance could afford certain other lenders or lessors of Mariner Health and
its subsidiaries the right to exercise remedies under their own loan or lease
documents.

     Mariner Health Senior Subordinated Notes.  Mariner Health is also the
issuer of $150.0 million of 9 1/2% Senior Subordinated Notes due 2006 (the
"Mariner Notes") which were issued pursuant to an indenture dated as of April 4,
1996 (the "Mariner Indenture") with Mariner Health as issuer and State Street
Bank and Trust Company as trustee (the "Mariner Trustee").  The Mariner Notes
are obligations solely of Mariner Health and are not guaranteed by the Company
or any of its subsidiaries. Mariner Health does not know if it will be able to, 
or if its senior lenders will permit it to, make the next scheduled interest 
payment due in October 1999.

     As a consequence of the Mariner Merger and the resulting change of control
at Mariner Health, the holders of the Mariner Notes had the right under the
Mariner Indenture to require that their Mariner Notes be purchased (the "Change
of Control Purchase") at a purchase price equal to 101% of the outstanding
principal amount of the Mariner Notes purchased.  Effective on September 11,
1998, Mariner and the Mariner Trustee entered into an amendment to the Mariner
Indenture which permitted Mariner to designate a third-party to purchase any
Mariner Notes tendered pursuant to the Change of Control Purchase.  Mariner
Health designated a financial institution as a third-party purchaser, and on
September 21, 1998 such financial institution acquired all $40,661,000 of the
Mariner Notes tendered in connection with the Change of Control Purchase (the
"Tendered Mariner Notes").  In agreeing to act as third-party purchaser, the
financial institution required the Company to enter into a total return swap
agreement (the "Total Return Swap"), with the financial institution as
counterparty.  See "Quantitative and Qualitative Disclosures about Market Risk."
The Tendered Mariner Notes remain outstanding and are owned and controlled by
such third-party purchaser.  The Company's obligations under the Total Return
Swap are guaranteed by Mariner Health and substantially all of the subsidiaries
of Mariner Health.  During the quarter ended December 31, 1998, an additional
$6.0 million of the Mariner Notes were acquired by such financial institution
and made a part of the Total Return Swap.

     The Total Return Swap Agreement expires on August 15, 1999, at which time
the Company will be required to purchase such notes, extend the Total Return
Swap Agreement, or cause such notes to be sold in the open market. Management is
unable to predict whether the Total Return Swap Agreement will be extended. If
the Mariner Notes are sold in the open market, the Company will be required to
reimburse the financial institution for the difference between the price at
which the Mariner Notes are sold and the price at which the Mariner Notes were
purchased (101%). At March 31, 1999, there was a $15 million letter of credit on
the Mariner Health Senior Credit Facility and $5 million in cash serving as
collateral against the $46.7 Total Return Swap Agreement. An uncured event of
default under the Mariner Health Senior Credit Facility could, in certain
circumstances, result in the early termination of the Total Return Swap
Agreement.
 
     Healthcare Regulatory Matters.   The Balanced Budget Act enacted in August
1997 (the "Balanced Budget Act"), contains numerous changes to the Medicare and
Medicaid programs with the intent of slowing the growth of payments under these
programs by $115.0 billion and $13.0 billion, respectively, through the year
ended 2002.  Approximately 50% of the savings were to be achieved through a
reduction in the growth of payments to providers and physicians.   These cuts
have had, and will continue to have, a material adverse effect on the Company.

     The Balanced Budget Act amended the Medicare program by revising the
payment system for skilled nursing services.  Historically, nursing homes were
reimbursed by the Medicare program based on the actual costs of services
provided.  However, the Balanced Budget Act required the establishment of a PPS
system for nursing homes for cost reporting periods beginning on or after July
1, 1998.  Under PPS, nursing homes receive a fixed per 

                                       34
<PAGE>
 
diem rate for each of their Medicare Part A patients which, during the first
three years, is based on a blend of facility specific rates and Federal acuity
adjusted rates. Thereafter, the per diem rates will be based solely on Federal
acuity adjusted rates. Subsumed in this per diem rate are ancillary services,
such as pharmacy and rehabilitation services, which historically have been
provided to many of the Company's nursing facilities by the Company's pharmacy
and therapy subsidiaries. The inclusion of ancillary services in the PPS per
diem has resulted in significantly lower margins in the Company's pharmacy and
therapy operations as a result of increased pricing competition and a change in
buying patterns by customers.

     On May 12, 1998, the Health Care Financing Administration released the
nursing home PPS rates for Part A Medicare Patients that are in effect from July
1, 1998 through September 30, 1999.  The Company's experience thus far under PPS
indicates that PPS has resulted in significantly lower overall reimbursement and
margins for the Company's skilled nursing facilities.  As of April 1, 1999,
substantially all of the Company's facilities transitioned to PPS.  This trend
is expected to continue as the Company's facilities move from a blended rate to
the Federal acuity adjusted rate.  The Company is preparing a detailed analysis
of the effect of this transition to full federal rates, however it is
anticipated that further significant reductions in same store Medicare revenue
will occur over the transition period.

     The Balanced Budget Act also repealed the Boren Amendment ("Boren"), which
had required state Medicaid programs to reimburse nursing facilities for the
costs that are incurred by efficiently and economically operated providers in
order to meet quality and safety standards.  Because of the repeal of Boren,
states now have considerable flexibility in establishing Medicaid payment rates.
In addition, Boren provided a dispute resolution mechanism whereby providers
could challenge Medicaid rates set by the various states, the repeal of which
will now make it more difficult to challenge these rates in the future.  While
the Company is not aware of any states that have adopted changes to their
Medicaid programs having an adverse effect on the Company following the repeal
of Boren, no assurances can be given that states will not adopt such changes in
the future.

     On January 30, 1998, the Health Care Financing Administration issued its
new salary equivalency guidelines which change Medicare reimbursement rates for
contracted therapy services.  Under salary equivalency, the Company is
reimbursed for contracted therapy services based on the time spent on the
premises by the contract therapist times a fixed rate, depending on the service
provided.  While the new rates for physical therapy represent an increase over
what the Company previously received for such services, the new rates for
occupational therapy and speech language pathology represent decreases from what
the Company previously received.  The salary equivalency guidelines will remain
in effect until the facility at which such services are provided, including the
Company's facilities and other facilities serviced by the Company's therapy
subsidiaries, start billing under PPS.  The Company believes that while salary
equivalency had a slight adverse effect on its therapy revenue, the Company does
not believe that salary equivalency has had a material adverse effect on the
Company's consolidated revenues.

     The Balanced Budget Act also revised the reimbursement methodology for
therapy services under Medicare Part B.  Historically, Medicare Part B therapy
services were reimbursed based on the cost of the services provided, subject to
prudent buyer and salary equivalency restrictions.  In November 1998, certain
fee screen schedules were published setting forth the amounts that can be
charged for specific therapy services.  Additionally, the Balanced Budget Act
set forth maximum per beneficiary limits of $1,500 per provider for physical
therapy and speech pathology and $1,500 per provider for occupational therapy.
Both the fee screens and per beneficiary limits are effective for services
rendered following December 31, 1998.  The imposition of fee screens, together
with the inclusion of ancillary services in the Federal per diem, has had a
material adverse effect on the Company's therapy business resulting in the
decision by the Company to terminate its contracts to provide therapy services
to unaffiliated third-parties as well as its own facilities.

     Certain Medicare fiscal intermediaries have made audit adjustments to
settle cost reports for some of the Company's facilities that reduce the amount
of reimbursement that was previously received by the facilities.  The Company is
appealing these adjustments, certain of which are significant.  Certain of these
are based on the fiscal intermediaries' denials of the exception to the related
organizations principle with regard to services and supplies 

                                       35
<PAGE>
 
furnished by the Company's pharmacy and rehabilitation divisions to its nursing
facilities, and reductions to costs claimed for therapy services for alleged
failures to comply with prudent buyer requirements.

     The prudent buyer principle states, in part, "the prudent and cost-
conscious buyer not only refuses to pay more than the going price for an item or
service, he also seeks to economize by minimizing cost." Some of the fiscal
intermediaries have alleged that the Company was not prudent in its purchasing
of occupational therapy and speech pathology services prior to HCFA's
establishing salary equivalency guidelines for these services effective in April
1998.  Adjustments have been made in settling cost reports that reduced the cost
from the amounts that were paid to contract therapy providers to the amount that
the intermediary calculated would have been paid if the facility had employed
therapists to provide services.  Appeals were filed with the Provider
Reimbursement Review Board ("PRRB") and resulted in a favorable outcome.
However, on review the Social Security Administrator reversed the PRRB and
allowed the intermediary's adjustments.  The Company believes that it has
substantial arguments to support its position that the contested costs are
allowable and the issue is being pursued through the appropriate legal
processes.  There can be no assurance that the Company will prevail or that it
will not be required to expend significant amounts to complete the appeal
process.  In addition contracts for therapy services generally provide for the
therapy provider to indemnify the nursing facility in the event of denials or
cost report disallowances.  There can be no assurance that the therapy providers
will not contest the indemnity provisions of the contracts or that they will be
able to fund the indemnity provisions.

     The related organization principle states, in part, "a provider's allowable
cost for services, facilities, and supplies furnished by a party related to the
provider are the costs the related party incurred in furnishing the items in
question." The regulations provide for an exception to the related organization
principle if certain requirements are met and the Company believes that it meets
these requirements with respect to its pharmacy and rehabilitation companies.
Some fiscal intermediaries have denied the request for exception and have made
adjustments to reduce the allowable cost that is included in nursing facility
cost reports to the cost of the related organization.  The Company has requested
PRRB appeals for these adjustments, but the appeals have not yet been heard.

     The Medicare fiscal intermediary for the Mariner Health facilities has
notified Mariner Health that it intends to reopen certain 1995 and 1996 Medicare
cost reports to incorporate adjustments that will reduce the allowable cost of
rehabilitation therapy services that were provided to the facilities by Mariner
Health's rehabilitation subsidiaries.  Approximately 15 of the 1995 cost reports
are to be reopened to incorporate prudent buyer adjustments for occupational
therapy and speech pathology.  Approximately 60 of the 1996 cost reports are to
be reopened to incorporate related party adjustments for all rehabilitation
services. Mariner Health believes that it has a strong position with respect to
both issues; however, the intermediary is moving forward with the reopenings.

     Mariner Health has received revised notices of program reimbursement
("NPR's") for certain of the cost reports that will require Mariner Health to
repay approximately $1.3 million to the Medicare program.  The intermediary has
notified Mariner Health that it intends to issue revised NPR's on the remaining
1995 and 1996 cost reports by June 30, 1999.  Also at issue are approximately 60
cost reports for the 1997 fiscal year that are scheduled to be settled during
the fourth quarter and are expected to include related party adjustments.  Given
the magnitude of the adjustments that are included in the NPR's that have been
received, Mariner Health believes the total amount the intermediary intends to
recoup will be significant.

     Mariner Health has initiated discussions to reach an accommodation with the
intermediary and HCFA for an extended repayment period for the amounts that are
expected to be owing.  Mariner Health intends to vigorously contest the
intermediary's adjustments through the appeals process; however, the final
settlement of the appeals may not be achieved until after the expected
recoupments have been fully affected.  If an accommodation is not reached and
extended repayment terms are not achieved, Mariner Health would be required to
repay a significant amount of cash to the Medicare program in a short period,
which would have a material adverse effect on Mariner Health and the Company.

     Other Factors Affecting Liquidity and Capital Resources. In addition to
principal and interest payments on its long-term indebtedness, the Company has
significant rent obligations relating to its leased facilities.  The 

                                       36
<PAGE>
 
Company's estimated principal payments, cash interest payments, and rent
obligations for fiscal year 1999 are approximately $299.0 Million.

     The Company's operations require capital expenditures for renovations of
existing facilities in order to continue to meet regulatory requirements, to
upgrade facilities for the treatment of subacute patients and to accommodate the
addition of specialty medical services, and to improve the physical appearance
of its facilities for marketing purposes. In addition, there are capital
expenditures required for completion of certain existing facility expansions and
new construction projects in process as well as supporting non-nursing home
operations and Year 2000 compliance. The Company estimates that total capital
expenditures for the year ending September 30, 1999 will be approximately $79.3
million, however stricter spending guidelines have been implemented which may
reduce this estimate.  Through March 31, 1999 approximately $35.1 million has
been spent in capital expenditures.


     In addition to the Senior Credit Facility, the Company has a lease
arrangement providing for up to $100.0 million to be used as a funding mechanism
for future skilled nursing facility construction, lease conversions, and other
facility acquisitions (the "Synthetic Lease").  This leasing program allows the
Company to complete these projects without committing significant financing
resources.  The lease is an unconditional "triple net" lease for a period of
seven years with the annual lease obligation a function of the amount spent by
the lessor to acquire or construct the project, a variable interest rate, and
commitment and other fees.  The Company guarantees a minimum of approximately
83% of the residual value of the leased property and also has an option to
purchase the properties at any time prior to the maturity date at a price
sufficient to pay the entire amount financed, accrued interest, and certain
expenses.  At March 31, 1999, approximately $51.6 million of this leasing
arrangement was utilized.  The leasing program is accounted for as an operating
lease.  The Synthetic Lease was amended on December 23, 1998 to mirror certain
changes made to the Senior Credit Facility and subsequently amended effective
March 31, 1999 to reduce the commitment to $80 million, which will allow the
Company to complete those facilities currently under construction but will not
allow the Company to initiate any new projects.

     Mariner Health was not in compliance with certain of the financial
covenants contained in the Mariner Health Senior Credit Facility and in the
Mariner Term Loan Agreement as of March 31, 1999.  Although the Company is
actively engaged in discussions with the Mariner Agent, the Mariner Lenders and
the Term Lenders regarding a waiver of such noncompliance and certain amendments
to those credit facilities, and a proposed waiver and amendment have been
circulated to the Mariner Lenders and the Term Lenders, the requisite lender
consents have not yet been received, nor can assurances be given as to whether
or when such approval will be received.  So long as Mariner Health's
noncompliance with the financial covenants remains unwaived, the Mariner Lenders
and the Term Lenders have the right to exercise remedies under their loan
documents.  In addition, the existence and continuation of such non-compliance
could afford certain other lenders or lessors of Mariner Health and its
subsidiaries the right to exercise remedies under their own loan or lease
documents.

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

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

     The Mariner Health Senior Credit Facility generally prohibits Mariner
Health from paying dividends or making distributions to the Company, except as
follows: (a) Mariner Health can make a one-time dividend (which 

                                       37
<PAGE>
 
has not yet been utilized) to the Company in an amount not to exceed Mariner
Health's consolidated net income for the most recent 12 fiscal months subject to
the absence of any default under the Mariner Health Senior Credit Facility or
the Mariner Health Term Loan Facility, and subject further to demonstrating pro
forma compliance with certain financial covenants; and (b) Mariner Health may
reimburse the Company for ordinary course of business expenses paid by the
Company on behalf of Mariner Health or its subsidiaries. By amendments effective
as of January 19, 1999, the Mariner Health Senior Credit Facility and the
Mariner Health Term Loan Facility were each amended to allow Mariner Health also
to make a dividend or distribution of up to $25.0 million to the Company to
enable the Company to purchase Mariner Notes pursuant to the Total Return Swap
or to otherwise satisfy the Company's obligations under the Total Return Swap,
subject to the absence of any default under the Mariner Health Senior Credit
Facility or the Mariner Health Term Loan Facility, and subject further to
demonstrating pro forma compliance with certain financial covenants thereunder.
In the judgment of the Company's senior management, these restrictions have not
had a material effect on the ability of the Company to meet its obligations.
However, in light of the existing, unwaived noncompliance by Mariner Health with
certain financial covenant defaults as of March 31, 1999, and the terms of the
proposed waiver and amendment being considered by the Mariner Lenders and the
Term Lenders (which would eliminate all of the foregoing dividend capability
other than reimbursement for ordinary course of business expenses), the Company
cannot give any assurances regarding the possible effect of such restrictions on
the ability of the Company to fulfill its obligations under the Total Return
Swap, which is currently scheduled to terminate on August 16, 1999.


     The Company believes that the cash flow generated from its operations, the
Company's cash and cash equivalents, should be sufficient to fund its working
capital needs, anticipated capital expenditures and other operating expenses in
the immediate future.  The Company is unable to predict at this time if it will
have sufficient cash to fund its debt service requirements or its debt, if such
amounts are accelerated, in the future.  The ability of the Company to fund such
requirements will depend, among other things, on future economic conditions and
on financial, business and other factors, many of which are beyond the Company's
control, including the ability of the Company to consummate certain planned
divestitures and benefit from the resulting reduction in leverage and increase
in liquidity. As of May 14, 1999 the Company had $28.0 million in cash and $1.1
million available under the Revolving Credit Facility to fund its working
capital needs. Mariner Health had $22.0 million in cash available to fund its
working capital needs. Approximately $7.5 million may be available under the
Mariner Health Senior Credit Facility in the future if the Company is successful
in obtaining a waiver of Mariner Health's covenant violations. In order to
improve its cash position and leveraged capital structure, the Company is
evaluating alternatives with respect to certain of its facilities and product
groups, which the Company believes will result in the divestiture of certain
assets during fiscal 1999.  The Company recently announced the execution of
definitive agreements with respect to the Company's rehabilitation clinics and
hospital rehabilitation contract businesses.  Management believes that these
transactions will close during the quarter ended June 30, 1999.  The proceeds
from any divestiture generally would be used to pay down the Company's
indebtedness and fund working capital requirements.

     The Mariner Indenture contains a restriction which, with the exception of
certain indebtedness that is expressly excluded from the incurrence test
described in this paragraph ("Permitted Mariner Health Debt"), only permits
Mariner Health and its subsidiaries to incur indebtedness if, after giving pro
forma effect to such incurrence, Mariner Health's consolidated coverage ratio
would equal or exceed 2.25 to 1.00 for the most recently completed four fiscal
quarter period.  This test is not a financial condition which Mariner Health is
required to maintain under the terms of the Mariner Indenture but rather is a
condition to incurring additional debt.  Mariner Health's consolidated coverage
ratio for the four fiscal quarters ended December 31, 1998 was less than 2.25 to
1.00.  Accordingly, until its consolidated coverage ratio for the four trailing
fiscal quarters once again equals or exceeds 2.25 to 1.00, Mariner Health and
its subsidiaries will not be permitted under the Mariner Health Indenture to
incur indebtedness other than Permitted Mariner Health Debt.  Since indebtedness
now or hereafter incurred under the Mariner Health Senior Credit Facility
constitutes Mariner Health Permitted Debt, Mariner Health can continue to obtain
advances thereunder (subject to the other funding conditions contained therein);
consequently, the inability of Mariner Health and its subsidiaries to incur debt
other than Mariner Health Permitted Debt is not, in and of itself, expected to
have a material adverse affect on the liquidity of Mariner Health and its
subsidiaries. However, no assurances can be given in this regard to the extent
that Mariner Health's noncompliance with the March 31, 1999 

                                       38
<PAGE>
 
financial covenants continues unwaived, rendering Mariner Health unable, on a
continuing basis, to access its remaining availability under the Mariner Health
Senior Credit Facility.

     In addition, so long as Mariner Health's consolidated coverage ratio for
the trailing four-quarter period is less than 2.25 to 1.00, Mariner Health will
not be allowed to make dividends or distributions to the Company, except for
certain restricted payments expressly permitted under the Mariner indenture.  As
a result thereof, all or a portion of the net income (loss) of Mariner Health
and its subsidiaries may have to be excluded from the Company's consolidated net
income for purposes of determining compliance with the consolidated coverage
incurrence test contained in the indenture pursuant to which the Notes were
issued (the "Company Indenture").  As of March 31, 1999, the Company's
consolidated coverage ratio did not meet the 1.75 to 1.00 incurrence test.
Because the incurrence of certain indebtedness is not subject to such incurrence
test, any resulting restriction against the incurrence of additional debt is not
expected to have a material adverse impact on the abiltiy of the Company to
conduct its business and to fulfill its projected liquidity needs.

     Impact of Inflation.  The health care industry is labor intensive.  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 adversely impact the Company.   In certain of
the markets where the Company operates there is a labor shortage that could have
an adverse effect upon the Company's ability to attract or retain sufficient
numbers of skilled and unskilled personnel at reasonable wages.  Accordingly,
rising wage rates could have an adverse effect on the Company in certain of its
markets.


Cautionary Statements

     Information provided herein by the Company contains, and from time to time
the Company may disseminate materials and make statements which may contain
"forward-looking" information, as that term is defined by the Private
Securities Litigation Reform Act of 1995 (the "Act"). In particular, the
information contained in "Management's Discussion and Analysis of Financial
Position and Results of Operations--Liquidity and Capital Resources" contains
information concerning the ability of the Company to service its debt
obligations and other financial commitments as they come due; and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Year
2000" contains information concerning management's belief regarding the
Company's and third parties' readiness to face the Year 2000 issue. The
aforementioned forward looking statements, as well as other forward looking
statements made herein, are qualified in their entirety by these cautionary
statements, which are being made pursuant to the provisions of the Act and with
the intention of obtaining the benefits of the "safe harbor" provisions of the
Act.

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


   (i)   There can be no assurance that the Company's creditors will not
         accelerate the indebtedness owing by the Company due to the financial
         covenant defaults by the Company that have occurred and are anticipated
         to occur in the future.

   (ii)  The Company's available cash may not be sufficient to fund the
         Company's working capital needs for an extended period of time.

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

                                       39
<PAGE>
 
  (iv)  The Company derives substantial portions of its revenues from third-
        party payors, including government reimbursement programs such as
        Medicare and Medicaid, and some portions of its revenues from
        nongovernmental sources, such as commercial insurance companies, health
        maintenance organizations and other charge-based contracted payment
        sources. Both government and non government payors have undertaken cost-
        containment measures designed to limit payments to healthcare providers.
        There can be no assurance that payments under governmental and
        nongovernmental payor programs will be sufficient to cover the costs
        allocable to patients eligible for reimbursement, especially with the
        implementation of PPS and fee screens with respect to therapy services.
        The Company cannot predict whether or what proposals or cost-containment
        measures will be adopted in the future or, if adopted and implemented,
        what effect, if any, such proposals might have on the operations of the
        Company.

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

  (vi)  There can be no assurance that the Company will be able to divest
        certain of its operations in order to fund working capital requirements
        and repay its long term debt.

  (vii) With respect to the year 2000 disclosure contained in Management's
        Discussion and Analysis of Financial Position and Results of Operations-
        Year 2000, management is unable to predict the extent to which its 
        third-party payors will be affected by the Year 2000 Issue or the extent
        to which it will be able to remedy issues associated with embedded chips
        in critical medical devices located in the Company's facilities, which
        may malfunction as a result of the Year 2000 Issue.

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

                                       40
<PAGE>
 
Item 3.  Quantitative and Qualitative Disclosure About Market Risk

     The Company periodically enters into interest rate swap agreements (the
"Swap Agreements") to manage its interest rate risk. The Swap Agreements
effectively convert a portion of the Company's floating interest rate debt to
fixed interest rate debt. Notional amounts of interest rate agreements are used
to measure interest to be paid or received relating to such agreements and do
not represent an amount of exposure to credit loss. As of March 31, 1999 the
Company had Swap Agreements in effect totaling $60.0 million notional amount of
which $40.0 million will mature in July 2005 and $20.0 million will mature in
November 2005. Under the Swap Agreements, the Company pays interest at an
average fixed rate of 6.79% and receives interest at a rate of three-month
LIBOR. At March 31, 1999, the fair market value of the Swap Agreements would
represent a loss of approximately $3 million for the Company. Additionally, in
September 1998 the Company entered into a total return swap agreement relating
to approximately $40.7 million face amount of Mariner Notes (the "Total Return
Swap Agreement"). The Total Return Swap Agreement provides for the Company to
receive 9.5% interest on approximately $40.7 million of Mariner Notes and to pay
interest at one-month LIBOR plus 2.25%. Upon expiration of the Total Return
Swap, if not extended, the Company has the right, but not the obligation, to
purchase the Mariner Notes. If the Company chooses not to purchase the Mariner
Notes, it is responsible for any decrease in the market value and receives the
benefit of any increase in market value realized by the third party purchasee.
At March 31, 1999, the fair market value of the Total Return Swap Agreement
would represent a loss to the Company of approximately $25 million. Although the
market value of the Mariner Notes has not been directly related to interest rate
movements in recent months, to the extent interest rate movements impact the
market value of the Mariner Notes, fluctuations in the market value of the
Mariner Notes affect the Company's obligation at expiration of the Total Return
Swap Agreement.

                                       41
<PAGE>
 
PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings

     As is typical in the healthcare industry, the Company is and will be
subject to claims that its services have resulted in resident injury or other
adverse effects, the risks of which will be greater for higher acuity residents
receiving services from the Company than for other long-term care residents. The
Company is, from time to time, subject to such negligence claims and other
litigation. In addition, resident, visitor and employee injuries will also
subject the Company to the risk of litigation. The Company has experienced an
increasing trend in the past year in the number and severity of litigation
claims asserted against the Company. Management believes that this trend is
endemic to the long-term care industry and is a result of several large
judgments against long-term care providers, in the last year resulting in an
increased awareness by plaintiff's lawyers of potentially large recoveries. The
Company also believes that there has been, and will continue to be, an increase
in governmental investigations of long-term care providers, particularly in the
area of false claims, as well as an increase in enforcement actions resulting
from the investigations. While the Company believes that it provides quality
care to the patients in its facilities and materially complies with all
applicable regulatory requirements, an adverse determination in a legal
proceeding or governmental investigation, whether currently asserted or arising
in the future, could have a material adverse effect on the Company.

     From time to time, the Company and its subsidiaries have been parties to
various legal proceedings in the ordinary course of their respective businesses.
In the opinion of management, except as described below, there have been no
material developments in the litigation matters set forth in the Company's
Annual Report on Form 10-K for the year ended September 30, 1998 and, except as
described therein and herein, there are currently no proceedings which,
individually or in the aggregate, if determined adversely to the Company and
after taking into account the insurance coverage maintained by the Company,
would have a material adverse effect on the Company's financial position or
results of operations.

     The Company received a letter dated September 5, 1997 from an Assistant
United States Attorney ("AUSA") in the United States Attorney's Office for the
Eastern District of Texas (Beaumont) advising that the office was involved in an
investigation of allegations that services provided at some of the Company's
facilities may violate the Civil False Claims Act. The AUSA informed the Company
that the investigation was the result of a qui tam complaint filed under seal
against the Company. The Company has recently been advised that the goverment
has declined to intervene in this matter. The Company will vigorously contest
the alleged claims if the complaint is pursued by the private plaintiffs.

     In 1997, the Department of Justice ("DOJ") advised the Company that the
United States had declined to intervene in a qui tam complaint filed against The
Brian Center Corporation ("BCC") and one of its subsidiaries, Med-Therapy
Rehabilitation Services, Inc. ("Med-Therapy") in the federal district court
for the Western District of North Carolina. This matter has been preliminarily
settled, and the parties anticipate executing a settlement agreement in the near
future.

     On October 1, 1998, a class action complaint was asserted against certain
of the Company's predecessor entities and affiliates and certain other parties
in the Tampa, Florida, Circuit Court, Ayres, et al v. Donald C. Beaver, et al,
case no 98-7233. On April 16, 1999, this case was voluntarily dismissed without
prejudice.  The complaint asserted three claims for relief, including breach of
fiduciary duty against one group of defendants, breach of fiduciary duty against
another group of defendants, and civil conspiracy arising out of issues
involving facilities previously operated by the Brian Center Corporation or one
of its subsidiaries, and later by a subsidiary of LCA, as a result of the merger
with Brian Center Corporation.

                                       42
<PAGE>
 
     In October 1998, the Custodian of Records of Cambridge Bedford, Inc., also
known as Bedford Villa Nursing Center ("Bedford"), a wholly-owned subsidiary
of the Company, was served an administrative subpoena issued by the OIG.  The
Company has responded to the OIG's request, and has been informed that it is not
a subject or target of the investigation.  In November 1998, Bedford also
received a subpoena duces tecum from the DOJ, through the U.S. Attorney's Office
in Detroit, Michigan, requesting certain patient medical records as the result
of a criminal investigation of a named physician. The Company responded to the
DOJ's request, and has been informed that it is not a subject or target of the
investigation.  The Company does not anticipate any further activity with
respect to these two matters.


Item 2.    Changes in Securities and Use of Proceeds

            As part of their compensation package, the Company's outside
          directors receive $25,000 in annual compensation, one-half of which is
          paid in shares of the Company's common stock.  In addition, non-
          employee director committee chairmen receive an additional $5,000
          annually in Company common stock.  The number of shares of stock
          granted is determined by dividing the cash amount by the closing price
          of the Company's common stock on the date of the annual meeting.
          Accordingly, on February 19, 1998, the Company made the following
          grants of unregistered common stock to its non-employee directors:
<TABLE>
<CAPTION>
 
                                                     Shares
                                                     Granted
                                                     -------
<S>                                                  <C>
 
            Laurence M. Berg                           3,846
            Gene E. Burleson (committee chairman)      5,385
            Peter P. Copses (committee chairman)       5,385
            Jay M. Gellert                             3,846
            Joel S. Kanter                             3,846
            Samuel B. Kellett                          3,846
            John H. Kissick                            3,846
            William G. Petty, Jr.                      3,846
            Robert L. Rosen (committee chairman)       5,385
</TABLE>

Item 3.     Defaults Upon Certain Securities

            None

                                       43
<PAGE>
 
Item 4.   Submission of Matters to a Vote of Security Holders

            The annual meeting of stockholders of the Company was held on
          February 18, 1999 in Atlanta, Georgia.  At that time the following
          directors were elected (the votes cast for and withheld for each
          director are summarized below):

<TABLE>
<CAPTION>
                                   Votes                        Votes
                                    For                        Withheld
                                   -----                       --------
<S>                               <C>                          <C>
                                 
Laurence M. Berg                 66,703,122                       678,371
Gene E. Burleson                 66,702,530                       678,963
Peter P. Copses                  66,703,196                       678,297
Jay M. Gellert                   66,703,108                       678,385
Joel S. Kanter                   66,702,629                       678,864
Samuel B. Kellett                66,550,845                       830,648
John H. Kissick                  66,703,533                       677,960
William G. Petty, Jr.            66,702,702                       678,791
Keith B. Pitts                   66,701,528                       679,965
Robert L. Rosen                  66,703,310                       678,183
Arthur W. Stratton               60,906,510                     6,474,982
</TABLE>


Item 5.   Other Information

            On May 3, 1999, the Company received a letter from the New York
          Stock Exchange, Inc. (the "NYSE") notifying the Company that it was
          not in compliance with certain of the NYSE's continued listing
          requirements and alerting the Company that delisting proceedings will
          be imposed unless the Company submits a plan setting forth how the
          Company will bring itself into compliance.  The Company responded to
          the NYSE's letter and plans to submit such a plan to the NYSE in the
          near future.  If the NYSE does not approve the Company's plan, then
          the NYSE may commence delisting proceedings immediately.  However,
          management believes that delisting is unlikely at this time.

                                       44
<PAGE>
 
Item 6.   Exhibits and Reports on Form 8-K

     (a)  Exhibits
 
          10.1      Third Amendment to Credit Agreement dated as of May 11,
                    1999, by and among the Company, The Chase Manhattan Bank, as
                    Administrative Agent, and the lenders signatory thereto,
                    amending the Senior Credit Facility.
 
          10.2      Third Amendment to Guarantee dated as of May 11, 1999, by
                    and among the Company, its subsidiaries signatory thereto,
                    and The Chase Manhattan Bank, as Administrative Agent,
                    amending the Amended and Restated Guarantee dated as of
                    November 4, 1997.
                    
          10.3      Third Amendment to Participation Agreement dated as of May
                    11, 1999, by and among Living Centers Holding Company, FBTC
                    Leasing Corp., The Chase Manhattan Bank, as Agent, and The
                    Fuji Bank, Limited (Houston Agency), amending the Amended
                    and Restated Participation Agreement dated as of November 4,
                    1997.

          10.4      Amendment No. 19 to Revolving Credit Facility Credit
                    Agreement, dated as of January 19, 1999, by and among
                    Mariner Health, PNC Bank, as Administrative Agent, First
                    Union National Bank, as Syndication Agent, and the financial
                    institutions referred to therein, to which is attached as an
                    exhibit an amended and restated $250,000,000 Revolving
                    Credit Facility Credit Agreement, by and among Mariner
                    Health, PNC Bank, as Administrative Agent, First Union
                    National Bank, as Syndication Agent, and the financial
                    institutions referred to therein, as "Banks".

          10.5      Amendment No. 1 to Term Loan Facility Credit Agreement,
                    dated as of January 19, 1999, by and among Mariner Health,
                    PNC Bank, as Administrative Agent, First Union National
                    Bank, as Syndication Agent, and the financial institutions
                    referred to therein, to which is attached as an exhibit an
                    amended and restated $210,000,000 Term Loan Facility Credit
                    Agreement, by and among Mariner Health, PNC Bank, as
                    Administrative Agent, First Union National Bank, as
                    Syndication Agent, and the financial institutions referred
                    to therein, as "Banks".

          27        Financial Data Schedule

     (b)     Reports on Form 8-K

             None

                                       45
<PAGE>
 
                                   SIGNATURES

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

                             MARINER POST-ACUTE NETWORK, INC.
                             (Registrant)


                            By:  /s/   George D. Morgan
                                 --------------------------------------------- 
                                 George D. Morgan
                                 Executive Vice President and Chief Financial
                                 Officer


                            By:  /s/   Ronald W. Fleming
                                 ------------------------ 
                                 Ronald W. Fleming
                                 Vice President, Controller and Chief
                                 Accounting Officer


Date: May 17, 1999

                                       46